Banka: Determine the right timing to follow the incorporation path
Incorporation can offer a number of advantages for a business.
There are some tax savings due to the fact that the corporation is taxed as a separate entity and also due to tax planning.
Tax planning is the structuring of allowable deductions so that the corporation can take advantage of the small business deduction and also to provide the lowest tax payable overall between corporate and personal taxes for an owner/manager.
To qualify for the small business deduction you need to be a Canadian Controlled private corporation, which means that you must generate income from active business in Canada, and if you are associated with other corporations, they must not have already claimed the deduction.
Personal service businesses where your main customer is one company and your services could be considered that of an employee will not qualify for the small business deduction, neither will investment companies.
Other than tax savings, there are other advantages such as the possibility for more capital investment by investors.
People may be more likely to invest in an incorporated company without becoming liable for the debts of the company.
A company has limited liability when the shareholders are only liable up to the amount of their investment in the company, unless of course they have signed personal guarantees as officers of the company which is required by most banks.
Directors of the company are liable for any debts to government agencies.
Is there a ‘magic’ income number of when you should incorporate?
If your proprietorship’s taxable income is above the lowest personal tax bracket and you expect that your business will continue to grow or at least stay at the same level, then I think incorporation requires some serious consideration.
So if you have decided to incorporate, what would be the best time?
You can incorporate at any time of the year. You have up to 52 weeks in your first year of operation to ‘pick a year end date.’
Your first fiscal period can be less than a full year.
You should not pick a year end date without some consultation with an accountant.
Here is why.
If you were to pick a Jan. 31, 2012, year end date, your corporate income tax T2 return would not need to be filed for three months after your incorporation date which would be April 30, 2012, if you had taxable income.
That would coincide with the personal tax season when accountants are the busiest.
If you did not have any taxable income you could put off filing for six months which would be July 31, 2012.
You also don’t want to be putting your year end documentation together for the accountant when it is the busiest time of the year for you but you do want to make sure that you have the cash flow when it comes time to pay your corporate taxes.
Now, if you wanted to reduce the corporate taxes payable at your year end by paying the shareholder a bonus, you could deduct that bonus in your current year end, but it would not need to be paid until 180 days after your year end.
So for a Jan. 31, 2012, year end, the bonus would need to be paid by July 30, 2012, and the payroll taxes on that bonus would need to be paid by Aug. 15, 2012.
All these dates fall in the same calendar period, so you would feel the effect of that bonus on your 2012 T4 that you would file April 30, 2013.
So keeping in mind that payroll follows a calendar year and corporations have the option of following a fiscal year, let’s look at what would happen if we picked a July 31, 2012, year-end.
If you have taxable income, your return would not need to be filed until Oct. 31, 2012, and if you don’t have any taxable income, Jan. 31 2013.
If you were to pay a bonus to the shareholder, it would not be due to be payable until 180 days after the year-end, so that would make it Jan. 27, 2013, of the following year with payroll taxes on that bonus being due on Feb. 15, 2013.
That means that you, as the shareholder, would not be T4’d for that bonus until 2013 (T4s due out Feb. 28, 2014).
And your personal taxes are due to be filed April 30, 2014, so you have effectively deferred that tax on that bonus.
The year-end dates that take advantage of the ability to defer taxes on bonuses are July, August, September, October and November.