Setting up a professional corporation can be easy and financially beneficial, but before you decide to incorporate, it helps to consider the pros and cons and make sure that your profession allows it.
There are many advantages to being incorporated which I will list below but it may not be needed just yet unless there is a potential liability. For many self-employed individuals, there is rarely a need to be incorporated unless they make an income greater than what is needed to live. For most very successful self-employed, it is not a matter of if they should be incorporated, it is a matter of when they should do it. Here are the details.
There are two main reasons to incorporate:
1.Liability potential: Can you be held legally responsible for the work you do? Could you be sued and potentially lose a significant part of your personal assets? If the answer is yes, you need to incorporate now to protect these assets regardless of the tax situation. This just makes sense.
2.Tax saving: The rule of thumb regarding the tax aspect of incorporation is that you need to keep in the corporation about $50k. The resulting tax saved by keeping that $50k in the corporation will offset the annual costs of accounting and bookkeeping. In other words, if you need all of the money you make to pay bills and pay for your lifestyle and nothing gets saved in the corporation, there is no tax advantage to incorporating. If you only need to draw a portion of the self-employment income and at least $50k can stay within the corporation, the personal and corporate combined tax owing will be less. Please remember that you would also be able to direct funds from the corporation to your RRSP tax-free effectively transferring money from the corporation to you personally without immediate tax. Therefore, the $50k is after the RRSP contribution. If you do make enough to draw the salary you need, maximize your RRSP and still have $50k left in the corporation, you should incorporate. The funds left in the corporation not required in the short-term can be invested for retirement as well.
If you are just starting out, I would wait at least a year before incorporating unless there is a large liability potential. You will know by then whether you like being self-employed and how much money you will be making. Incorporating will cost you anywhere from $2500 to $5000. This is a one-time up-front cost. The accounting fees are generally about $2500 to $3000 per year.
Here are more details on how a professional corporation can help with your tax planning.
1. Tax deferral on corporately retained earnings:
·As long as the money earned by shareholder in his corporation, stays in the business, personal tax won’t be due on the amount until it’s paid out to shareholders (you, your kids or spouse). Your money doesn’t need to be paid out; it can stay in the business for years.
·It’s best to leave at least $50,000 a year in the business to justify the cost of incorporating.
2. Income splitting:
·Some professions allow family members to hold non-voting shares. In these cases a spouse or child (over 18) who is not active in the business can share a part of the professional corporation’s after-tax income by receiving dividends on shares they own directly or indirectly.
·If your children are 18 or older and earning income that puts them in a low tax bracket, the family will pay less tax overall than if the professional personally earns all the income.
·Accumulation of equity: With more after-tax income inside the business, you can accrue assets faster than if you used your money on personal expenses.
·Dividend-sprinkling shares: This is a cost effective alternative to trusts involves issuing various classes of common shares to each family member, permitting the corporation to pay dividends on one class of shares to the exclusion of others. Paying family members dividends instead of a salary should be considered in some cases because salaries paid are subject to reasonableness tests. Dividend payments are not subject to the same test.
3. Tax savings with cheaper non-deductibility
·Consider having the corporation incur non-deductible expenses such as life insurance premiums. Since a professional corporation pays tax at a lower rate than an unincorporated professional, the cost of non-deductibility is less.
The benefits of incorporating don’t end there. Setting up a professional corporation can help professionals in their retirement years as well.
Dividends after retirement
·It’s not imperative that a person closes their professional corporation when they retire; funds can be left in the professional corporation to grow. The company can retain the earnings and pay them out as dividends.
Individual pension plans (IPP)
·An incorporated professional can have a pension plan established by the corporation for their benefit. Contributions are made to this plan instead of an RRSP.
·In some provinces, creating a corporation can significantly reduce probate taxes at death, using a secondary will to address the transfer of shares after death.
While there are some great benefits to incorporating, there are a few drawbacks as well.
·Start-up and annual costs are high
·A lawyer is needed to set up a professional corporation. In some situations this can cost upwards of $3,500.
·The cost of moving existing assets into a corporation can run between $5,000 and $7,500.
·Additional tax returns are needed
·Your client will be required to fill out a T2 for corporate returns. They’ll also need to file an annual corporate financial statement, which can cost $1,500 – $3500.
Please contact us to further discuss your situation. You can reach us at 604-878-0702 for Anthony, Odette or Terry.
Please note remember that we are not accountants. This is only a very general summary of the advantages and disadvantages of incorporating. It is provided in a financial planning perspective. Only a qualified accountant can give you professional advice.