The Top 8 Advantages of Incorporation
Incorporation is probably the most popular form of business entity. Why? Because of the long list of advantages it offers to help businesses cover their legal bases, cut their taxes and build wealth.
Let’s delve into these benefits in more depth so you can determine which of them is important for your business.
1. Business Longevity
When you incorporate your business, you create a distinct legal entity separate from yourself. This is not the case with any other legal form of business. In a sole proprietorship for example, if you die, so does your business.
As a separate legal entity, a corporation is granted the possibility of longevity. You can put a succession plan in place and pass the company to your heirs in the future, or sell it altogether. This means the company you create can live on beyond you, lasting for decades, centuries or even more.
Think of some of the world’s most successful company. Every single one was a separate legal entity from its founder so it could growth beyond his or her lifetime.
2. Limited Liability
Since you create a separate legal entity from yourself when you incorporate your business, you benefit from what is called limited liability. What this means is that as a director or shareholder of the corporation, in most circumstances you cannot be held personally responsible for the corporation’s debts or obligations. If the corporation is sued or goes bankrupt, the business’s assets will be at stake, but not your personal assets such as savings, a home or vehicle. You might lose your investment in the corporation, but you won’t be responsible for any other amounts the corporation owes.
Remember, however, that limited liability does not mean unlimited liability, as there are certain situations when directors of a corporation can be held liable. For more information of the benefits and limitations of limited liability, see our article, Limited Liability Demystified: The Benefits and Limitations of Incorporation.
3. Lower Tax Rate
When you earn profit through a non-incorporated business such as a sole proprietorship, you’re taxed at the full rate. Incorporation, however, offers you the benefit of paying a lower tax rate on the income generated in the year. This is one reason why incorporation can be a pivotal aspect of a profit strategy.
Note that this lower tax rate is for active business income, but does not apply to passive income such as rental and capital gains.
4. Tax Deferral
As the owner of a non-incorporated sole proprietorship, you are taxed each year on the profits you earn. When you incorporate, however, you are only taxed on the earning you take out of the company in the form of salaries or dividends. What this means is that you could go years without removing money from the corporation and you won’t pay taxes – you’ll only pay taxes when you decide to take that money out of the bank.
This is known as tax deferral, by which you delay the paying of taxes to some future date. While the net taxes paid may end up being the same, there may be opportunities to benefit from a reduced tax rate in the future.
5. Offset Losses
No matter what legal form of business you choose, you won’t be taxed of the business incurs losses. However, each legal form of business deals with losses differently. In a non-incorporated sole proprietorship, losses incurred in the start up phase can be applied against income from employment, for example, but you can’t carry over losses from year to year.
In a corporation you can. If you incurred losses at the beginning, these losses can be stockpiled, so to speak, and applied against future income.
6. Payout Options
Incorporating offers you additional financial options not available to other forms of business entities. When you incorporate, you can choose how you’d like to remunerate shareholders and directors, either with a salary or through dividends which can result in significant tax advantages.
If you hire family members, the corporation can deduct their salaries as an expense. You can also make family members or associates shareholders and pay them – as well as yourself – through dividends, which are taxed at a reduced rate. Both of these options can help the corporation save money on taxes.
To determine the best payout options for your corporation, speak to an accountant or fiscalist.
7. Securing Funding
If you’re looking for funding, incorporation is usually a prerequisite. Lenders and investors want to know you’ve ensured your corporation longevity and basic protection through limited liability.
Of course, you’ll still have to pitch your business model, provide financials and perhaps even collateral, but incorporation will give you a much needed head start.
8. Tax Exemptions When Selling
Planning to sell your business? Make sure it’s incorporated as you can benefit from attractive tax exemptions on your capital gains.
At current, selling your shares in a Canadian-controlled private corporation that uses at least 90 percent of its assets to do business in Canada makes you eligible to claim a one-time personal capital-gains tax exemption of $800,000.
The above advantages make incorporation one of the most popular legal forms of business. If you’re wondering if incorporation is right for you, checkout our our article, Should You Incorporate? 5 Questions to Help You Decide.
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