It’s time to talk about the scintillating details of business and the risqué question of whether to be incorporated or unincorporated. Not scintillating or risqué? We were trying to trick you into thinking so. But while there are more exciting issues to occupy a few minutes of your time, this is an incredibly important one for entrepreneurs. The structure of your business will determine issues as diverse as liability, and even ownership. What are the pros and cons for each structure?
Both incorporated and unincorporated businesses are the same in one aspect: there is little to no difference in the types of expenses and deductions that are allowed. Essentially, both structures play by the same set of expense and deduction rules. What is different then?
Incorporation is the process of operating your business within a corporation. It is its own legal entity, and shares must be issued. A separate bank account is required, as is the maintenance of official corporate records. The benefits:
- Incorporation allows for multiple shareholders and different classes of shares.
- One may defer personal income taxes on income not withdrawn from the corporation.
- Owners can be paid by salary or dividends. They only pay personal taxes when the funds are withdrawn from the corporation.
- Limited liability. This is probably the most important benefit for owners. Rather than having the liability lie at the feet of the owner as in a sole proprietorship, your liability is limited to the amount that you have invested in the company. Your personal assets cannot be seized unless you have issued a personal guarantee.
- It may be easier to raise funds because you can sell shares to other investors.
- An owner of an incorporated business may be able to sell shares and be eligible for a capital gains exemption if the corporation meets specified criteria.
- It is more expensive to maintain (annual legal and accounting fees, for example).
- In some cases, credit proofing and structuring your businesses might make it incredibly complex.
- You have to conform to regulations, such as keeping accurate accounting records, shareholder minutes.
This, of course, is when you choose to retain sole proprietorship and not create a corporation. It has the clear benefit of being much less complex than incorporation, but is it the best move for your business? Its benefits:
- Your business can still be a partnership which involves multiple people.
- It is less expensive to maintain.
- You simply report revenue and expenses on your personal tax returns (which may or may not be a benefit).
- You have unlimited liability. It is not spread out over investors as it is in a corporation.
- Business income is taxed in the year it is earned, and no deferrals are available.
- Corporations can pick when their tax year ends; you are restricted to a tax year end of December 31st, tax due date of April 30th, and a file date of June 15th.
Your decision to incorporate or not is based on your business’s needs, as well as your individual situation.
Consultation with a chartered accountant and lawyer can point you in the right direction.
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