Entrepreneurship & Small Business

Incorporation or not? (single person)

  • Last Updated:
  • Jun 6th, 2011 11:55 am
Tags:
None
Deal Addict
May 7, 2006
2373 posts
149 upvotes
Toronto

Incorporation or not? (single person)

My buddy is a single guy with no family. He earns six figures. He was wondering if he should incorporate?

Seeing I have no knowledge of this issue really, I was wondering if anyone would be able to share their knowledge.

Can he do tax savings and shelter the money from tax into investments? I'm not sure if he will benefit from incorporation since he won't be able to share the money with spouses or kids since he has no family.

Thanks
6 replies
Member
Aug 1, 2008
284 posts
50 upvotes
Toronto
aokec wrote: Can he do tax savings and shelter the money from tax into investments? I'm not sure if he will benefit from incorporation since he won't be able to share the money with spouses or kids since he has no family.
The key advantages of incorporation are to:
1) Shield your personal assets from some types of business liability;
2) Have the ability to split income with adult family members via dividends;
3) Appear "more professional" with a Inc. or Ltd.; and
4) Keep some profits within the corporation for future business-related investments (e.g. launch a new product, buy another company, buy a franchise, etc.). If the cash stays in the corporation, he'll be able to keep about $0.83 on each dollar (~17% corporate tax for small businesses in Ontario), instead of taking a 40% personal tax hit on the sole proprietorship income, and then turning around a few years later and re-investing the remaining $0.60 on the dollar back into the business.

If he is going to continue to draw the same salary out of the corporation that he currently gets as a sole proprietorship -- and his clients don't mind that he is unincorporated -- I don't see any real advantages to incorporation (aside from #1). Assuming he doesn't get sued, the real benefits of incorporation are in #2 and #4.

He'll lose most of the tax advantages of the small business if he uses it to hold investments that are unrelated to his day-to-day business, or real estate; so #4 only "shields tax" if whatever he invests in eventually becomes a part of his working business (i.e. he can't just stick the business savings in stocks and bonds forever and expect to keep paying the lower small business tax rate).
Banned
Jul 23, 2010
204 posts
2 upvotes
If he's trying to maximize his earning he definitely should.
Newbie
May 24, 2011
92 posts
13 upvotes
Islington wrote: He'll lose most of the tax advantages of the small business if he uses it to hold investments that are unrelated to his day-to-day business, or real estate; so #4 only "shields tax" if whatever he invests in eventually becomes a part of his working business (i.e. he can't just stick the business savings in stocks and bonds forever and expect to keep paying the lower small business tax rate).

This is true, investment income is taxed at a very high rate when held in a corporation. However, the excess tax is tracked in what's called the Retained Dividend Tax On Hand (RDTOH) account. All this excess tax will be recovered when a dividend is paid from the corporation to the shareholder. The dividend has to be at least 3x the size of the RDTOH account in order to get it all back.
Deal Addict
May 7, 2006
2373 posts
149 upvotes
Toronto
So if I incorporate and say put the money earned (eg. I don't need the money now) into mutual funds, it doesn't work exactly like an RRSP, does it? Cuz it's not really related to the business.

Thanks
Islington wrote: The key advantages of incorporation are to:
1) Shield your personal assets from some types of business liability;
2) Have the ability to split income with adult family members via dividends;
3) Appear "more professional" with a Inc. or Ltd.; and
4) Keep some profits within the corporation for future business-related investments (e.g. launch a new product, buy another company, buy a franchise, etc.). If the cash stays in the corporation, he'll be able to keep about $0.83 on each dollar (~17% corporate tax for small businesses in Ontario), instead of taking a 40% personal tax hit on the sole proprietorship income, and then turning around a few years later and re-investing the remaining $0.60 on the dollar back into the business.

If he is going to continue to draw the same salary out of the corporation that he currently gets as a sole proprietorship -- and his clients don't mind that he is unincorporated -- I don't see any real advantages to incorporation (aside from #1). Assuming he doesn't get sued, the real benefits of incorporation are in #2 and #4.

He'll lose most of the tax advantages of the small business if he uses it to hold investments that are unrelated to his day-to-day business, or real estate; so #4 only "shields tax" if whatever he invests in eventually becomes a part of his working business (i.e. he can't just stick the business savings in stocks and bonds forever and expect to keep paying the lower small business tax rate).

Top