Having passed the personal tax deadline of April 30 (moved to May 5 this year), many of us now face the deadline for the filing of the sole proprietorship (small business) returns.
Any balance owing on a small business return would have needed to been paid by April 30 (again, May 5 this year).
I usually get asked the same questions each year surrounding the incorporation of a small business.
Many people that have proprietorships ask how they can reduce their tax bill. One way is to incorporate.
There are many tax advantages to incorporation.
An incorporated company is considered to be a distinct legal entity. A small incorporated business is taxed at an average tax rate of 25 per cent (federal and provincial combined).
If your company is eligible for the small business deduction, the combined rate drops to 13.5 per cent for 2014.
Compare that with the lowest combined personal tax rate for 2014 of 20.06 per cent (up to a combined federal and provincial taxable income of $37,568, ignoring personal tax credits), it certainly does make sense to incorporate for tax savings alone.
However, if you will be drawing out all of the income out of the company, it would not be a good idea to incorporate because you may be exposing yourself to double taxation.
To qualify for the small business deduction, you need to be a Canadian controlled private corporation, the company must generate income from active business in Canada.
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 specified investment companies.
Depending on how your share structure is set up and the limitations stated in your Articles of Incorporation, you may be able to split income with your family by issuing dividends to them out of the corporation.
Dividends are grossed up and then the dividend tax credit is deducted, resulting in zero personal tax effect if your income remains in the lower tax bracket.
If you decide that you would like to earn a salary from your business, you can determine the amount of salary that you would wish to earn to keep your personal income in a certain tax bracket and enjoy some tax savings.
You can also declare and pay yourself a bonus that doesn’t need to be paid until six months after the fiscal year end of the company, to defer the tax on that bonus until the following year depending on when you set your fiscal year end date.
There are also ways of estate and family planning using a company whereby you can “crystallize” the value of your company for future generations, or set up a family trust to provide for your family in the future.
The company has a perpetual existence and does not expire when the shareholders die.
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 in that the shareholders are only liable up to the amount of their investment in the company, unless 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.
An incorporated company is usually taken more seriously in the eyes of banks, creditors and customers.
It is believed that if you have gone through the trouble and expense of incorporating you must have long range plans for your business.
The disadvantages to incorporation are the increase in paperwork.
You need to file incorporation documents, notices, minutes and annual reports.
You will need to file a corporate tax return in addition to your personal tax return.
The BC Company’s Act indicates that each company requires an audit unless waived at an annual meeting by the board of directors and this needs to be documented in your minute book.
This Act also requires that you maintain proper accounting records. The financial statements and the fair representation of the numbers represented in the financial statements are the responsibility of management so for your own protection, it would be a good idea to understand what is in your financial statement.
Your accountant can explain all the different aspects of your financial statement to you and although not usually made obvious, you are approving the financial statements produced by your accountant, so if you are uncomfortable with any of the numbers, it is up to you to speak up and ask questions.