I love small businesses. Every owner has a story to tell of dreams, struggles, growing pains and successes. I can relate because I too am a small business owner.
Small businesses (less than 500 employees) comprise over 98% of ALL businesses in Canada, employing over 10 million people. Amazingly, 73.9% of these have less than 10 employees. These are the companies that I love – hands on ownership, niche markets, and an integral part of their local communities.
Many of my business clients struggle with knowing if or when to incorporate. Taking the leap from sole proprietor to incorporation has advantages and disadvantages. I’ve taken the leap from sole proprietor to incorporated business for some specific reasons that may apply to you too. Here are some things to consider:
- Do you always eat what you kill?
If you spend everything you make and want every dollar of income for yourself, incorporation may not make sense. If you rent space for your business (or operate from a home office), pay all your bills, and take an income with no money left over, there’s no need to incorporate. I have both doctor clients and carpenters that operate this way.The corporate tax rate is 15% in Canada (2023 tax year), but this only applies to monies left inside a corporation (ie. net profit/retained earnings). If you have a corporation and spend all the income, there’s nothing left to tax at that favorable rate anyways. I went through this early on in my financial services practice. I made money each month and with that I paid rent, professional fees, took an income, and had a computer/phone etc. that were business expenses. This business model works as a sole proprietorship, but once you grow to the point that you don’t need all your revenue for income/expenses you may want to incorporate.
- Do you need to borrow money to grow?
Many businesses choose to grow by buying assets like an office building or equipment. The arms-length protection of borrowing through your corporation combined with the small business tax rate is a huge advantage. Consider paying off your house with personal after-tax dollars, at your top marginal tax rate versus paying off a building or equipment at a 15% corporate tax rate. If your income is more than $103K you pay 41% tax on every dollar you make. If incorporated, you’d save 26% on every dollar that stays in the corporation. That’s a real game changer. Having assets in the company name also protects you from lawsuits and bankruptcy, assuming there are no personal guarantees attached to your loans. This protects your family’s financial well-being.
- “Build it to sell it”
Annual corporate financial statements showing a track record of growth and profitability is the standard for anyone buying your business. Banks typically want three years of financial statements to finance the purchase/sale of a small business. Sole proprietors rarely have these ‘business items’ separated from their own income. It’s tough to see where the sole proprietor ends and the ‘business’ begins. Although it’s an added cost, having properly prepared financial statements by a professional accountant is critical in tracking the health of your business. The other huge advantage of being incorporated when you sell is being able to avail of the Lifetime Capital Gains Exemption (LCGE) for small business corporation shares, farm property and fishing property. The LCGE applies to all shareholders of the small business. So having a spouse as a shareholder effectively DOUBLES this exemption. For 2023 the exemption is $971,190 for small businesses and $1,000,000 for farm or fishing property. So, if you sold a business for $2.5M and you and your spouse were the only shareholders, you’d only pay tax on $557,620. The remaining $1,942,380 (2 x $971,190) would be Tax Free. A sole proprietor would pay tax on all this money and may be forced to spread the taxable gain out over multiple tax years and/or pay tremendous amounts of tax upon the sale.
In my 18-year career, I’ve made the transition from sole proprietor to incorporation. Eventually I formed another corporation (a Holding Company) to buy a building for my growing practice. I’ve hired employees, created a brand, borrowed money from the banks, and created annual budgets and cash flow targets to move forward. I love it.
If you’re a small business owner, I’d really like to help. I have the experience and knowledge to help you navigate these waters. A strong local business community benefits everyone. “A rising tide lifts all boats.”