If you are a Sole Proprietor Should you Incorporate?

Posted by on Sep 28, 2011 in QuickBooks Tips | 3 comments

Although this is a QuickBooks site and having been in the accounting profession since 1988, I also consult with a number of clients that are still in the starting stages of their Canadian company. With most clients of this type, they have set up their business structure as a Proprietorship, which is okay, depending on the type of industry they are in and the amount of before tax net income they are generating.

So at what stage will it be advantageous for them to incorporate? Will it be the first year, second, or never? Will it be net income before tax of $20,000 to $40,000, $40,000 to $80,000 or $80,000 plus?

There are a few guidelines that will be presented in this article that one should be cognizant of, but once again if your are uncertain, then contact your professional resources.

First of all, one needs to understand the taxation of a proprietor, which except for the CRA allowable deductions (expenses), can be the same as an individual working as an employee. Meaning, if you have net income of $50,000 – $75,000 after expenses but before tax, then you might be faced with the below Federal and Provincial tax rates as a proprietor (individual).

These figures will depend on the province that you live in and of course your allowable exemptions and deductions.

Federal tax rates for 2011 are:

  • 15% on the first $41,544 of taxable income, +
  • 22% on the next $41,544 of taxable income (on the portion of taxable income between $41,544 and $83,088), +
  • 26% on the next $45,712 of taxable income (on the portion of taxable income between $83,088 and $128,800), +
  • 29% of taxable income over $128,800

PROVINCIAL TAX RATES

 

 

I will not go into the more intricate parts of a T2 Corporate return, or what is displayed on the left, but instead let you contact your tax accountant to further elaborate. What will be apparent is, that the corporate tax rates should be lower than the Proprietorship (individual) ones.

Another item to contemplate with the Proprietor vs. Incorporation, is that you can not pay yourself a Dividend as a Proprietor, while you can as a corporation.

Once again this can be beneficial in regards to how a Dividend is taxed, in comparison to you as a shareholder would be, if you paid yourself a salary or fee (individual income).

The next item I will deal with has to do with liability as a Proprietor vs. a Corporation. Since I do not profess to be a lawyer, I will let you contact one to explain to you the differences.

The last item has to do with incorporation when you are already three quarters through your fiscal year. You have to remember that your incorporated company starts upon the date that the corporation document is verified and stamped.  You can not back-date the Proprietorship’s calendar year earnings with the new corporation’s fiscal year.

What you may be able to do, is to purchase a shell company from a lawyer, that was incorporated around the same time as your Proprietorship started. Then, there may be a possibility of rolling the Proprietorship’s assets (equity) into the corporation. Once again your would have to contact a lawyer to verify all this.

If nothing else, if you are a Proprietor that has a company that is generating income, and is faced with a substantial amount of net income before tax, which is a good problem to have, I hope this generates some thought where you will seek out some professional guidance.  A word of warning – do not procrastinate!

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3 Responses to “If you are a Sole Proprietor Should you Incorporate?”

  1. I’m impressed, I must say. Really rarely do I encounter a blog that’s both educative and entertaining, and let me tell you, you have hit the nail on the head. Your idea is outstanding; the issue is something that not enough people are speaking intelligently about. I am very happy that I stumbled across this in my search for something relating to this.

    • Larry Johnson says:

      Thanks Bonnie, I have added your link to my site in case vistors my be in need of your services.

      • Larry,

        First and foremost, love the article!

        I wanted to point out to you that ‘Bonnie Mercurio’ is a fake name, and their post is spam. It’s a cookie cutter post that I’ve seen 1000s of times already.

        Just thought I’d let you know.

        Jon

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