Entrepreneurship & Small Business

When does it make sense to incorporate?

  • Last Updated:
  • Feb 28th, 2018 2:09 am
[OP]
Deal Addict
Feb 16, 2018
1292 posts
1296 upvotes

When does it make sense to incorporate?

I have run a small seasonal business for the past 4 years, it operates 7 months of the year. I am a sole proprietor. Why and at what point does it make sense to incorporate?

If it matters, I don't make a ton of money, about 55k per year on sales of 150k and there is zero concern of assets being seized or being responsible for debts

Thanks
14 replies
Deal Fanatic
Jul 4, 2004
6315 posts
2421 upvotes
Ottawa
I suspect it would probably make sense to incorporate but you should talk to an accountant.

Do you have any other income during the year (e.g. do you work elsewhere during those 5 months). Do you have a spouse that could technically get paid by the business? Do you need all the profits from business or could you afford to leave them in the corporation? Do you expect business / revenue to grow?

If you answered yes to any of these, I think a corporation would likely be beneficial. Having said that, the government is proposing changes to small business taxation which could impact that (which I really haven't followed).
Deal Addict
Feb 5, 2009
2808 posts
935 upvotes
Newmarket
In very simplistic way it makes sense to incorporate if you keep the profits in the corporation.
In your case if you incorporate but withdraw 55K for personal purposes via wages or dividends, there will be very little to no benefit, however if you keep the 55K in the corporation you will only pay 15% income tax as oppose to your personal rate, if you draw in the future when your personal income is lower you will benefit.

There are number of other aspects when considering incorporating, but in most cases the above is the main factor.
Deal Addict
Feb 25, 2007
1323 posts
786 upvotes
Ottawa
I agree with Homerhomer and would slightly broaden it.
If you (if necessary) put in money into the business (investments, fixed expenses), make money through the business, and spend profits on your personal needs all within the same calendar year, there tends to be little benefit to incorporation. If you need to - or can - play with the timing, or if multiple people are involved in the business, that's when it usually becomes worthwhile.
Deal Expert
User avatar
Aug 2, 2010
15193 posts
4943 upvotes
Here 'n There
HghSsociety wrote: I have run a small seasonal business for the past 4 years, it operates 7 months of the year. I am a sole proprietor. Why and at what point does it make sense to incorporate?

If it matters, I don't make a ton of money, about 55k per year on sales of 150k and there is zero concern of assets being seized or being responsible for debts

Thanks
Makes zero sense for you given no concern regarding assets being seized and you don't make much money either and no doubt want to use the money not keep it in a corporation for a decade or more to invest (which gives you a marginally better return at that minimum time frame than investing it outside the corporation if you have a positive return).

Don't waste money on an accountant like someone else advised. The cost of being incorporated each year if you have to use professionals to do your return, financial statements, minute book etc is going to far outweigh any benefit if you could even split the income with a spouse/family member (who would then have to have a lower marginal tax rate than you).
Deal Addict
Feb 25, 2007
1323 posts
786 upvotes
Ottawa
I generally agree with eonibm. Would just ask: how variable/volatile are your earnings? And other income (not sure what you do the other months...) you and anyone you could income split with.
It makes "zero sense" if you personally withdraw and spend all your $55k or whatever every year to live on anyway. It starts making sense if you wish you could only move "income smooth" over time or income split with others to a significant sense.
Newbie
Jan 6, 2018
31 posts
5 upvotes
I disagree with what many said here. Incorporation has other benefits other than just tax. You get a substantial liability protection with a corporation, and no matter what others say, that in itself might be worth incorporating.
As a one-man corporation, someone may still sue you as a director, but they still have to pierce the corporate vial, which is difficult unless you do something significantly or grossly negligent.

On top of that, a corporation forces you to keep your personal and business records separate. You should do that regardless, but with a corporation, it is mandatory. Yes, you may need to pay an accountant for it, but it still may be worth it. Some people give out silly thresholds like "don't incorporate until you make 120k" but I disagree with that too. It really depends on the unique situation of your business and what you want to do with it.

One example: I know a person who got sued for a copyright infringement mistake on a brochure. Without going into the details, the plaintiff tried to go after the director's personal assets, but failed. Only the corporation's assets were at risk-even though it was a one man corporation. Now, in this case, the corporation settled. Now this cost money, for the cooperation and the director himself but at least the director's personal life earnings were not at risk.


If you are serious with running a business and want to grow it or if you have liability concerns(ie a repair man, IT, or have landed property), I would seriously consider incorporate it...even if you withdraw all your company's earnings as wages each year.
Last edited by ontbusiness2018 on Feb 22nd, 2018 3:02 pm, edited 1 time in total.
[OP]
Deal Addict
Feb 16, 2018
1292 posts
1296 upvotes
in regards to the questions asked:

I don't work the other months of the year.
I don't need the money, I am married and we can live comfortably without it, my wife works
in regards to other income I have rental properties that generate a positive cash flow of about $3500/month
I quit a highly lucrative career that I hated, in order to spend more time with family for less $$
Newbie
Jan 6, 2018
31 posts
5 upvotes
Are you able to share the line of business?

From a pure tax perspective, you may not get significant savings. But like I said in my previous post, the kind of business you run should determine if you should incorporate. Not just the gross income your business makes.

B/C as a SP, you are in theory placing your entire personal assets at risk for your business.
Member
May 28, 2012
436 posts
383 upvotes
ONT
We were in a similar position. We also bought a seasonal business (we called it semi-retirement) with the intention of holding long term (about 15 years) then fully retiring.
We incorporated for reasons previously mentioned but also for not having to pay capital gains when we did eventually sell the company. Our Accountant made 2 spreadsheets, one with what we would end up with by selling the assets and the other by selling the company.
There was a substantial difference in less taxes due by selling the company, this also meant we could have a lower asking price which would appeal to potential purchasers.
In addition there was no Land Transfer Tax due by selling the company.
The only “negative” for the purchaser was that IF we had monies owed (taxes, loans, insurance claims) these would carry over to the purchaser. At our lawyer’s suggestion we overcame this by having a $30K holdback for 2 years.
Deal Expert
User avatar
Aug 2, 2010
15193 posts
4943 upvotes
Here 'n There
mrct1944 wrote: We were in a similar position. We also bought a seasonal business (we called it semi-retirement) with the intention of holding long term (about 15 years) then fully retiring.
We incorporated for reasons previously mentioned but also for not having to pay capital gains when we did eventually sell the company. Our Accountant made 2 spreadsheets, one with what we would end up with by selling the assets and the other by selling the company.
There was a substantial difference in less taxes due by selling the company, this also meant we could have a lower asking price which would appeal to potential purchasers.
In addition there was no Land Transfer Tax due by selling the company.
The only “negative” for the purchaser was that IF we had monies owed (taxes, loans, insurance claims) these would carry over to the purchaser. At our lawyer’s suggestion we overcame this by having a $30K holdback for 2 years.
Let's see. OP has seasonal business and is the only employee. Let's say $500 to incorporate and ongoing costs of $2,500/yr for financial statements & income tax return (if he doesn't do it himself), business bank account, and other filing charges etc. That's $40,000 over 15 years and more if that money is invested.

$2,500 invested at 7% (easily obtained using a broad market equity index fund over that time period) grows to $62,822 and the initial $500 initial paid for incorporation invested similarly grows to $1,380 for a total of $64,202. The capital gain on that is $64,202 - ($500 + 15 *$2,500) = $26,202 for a taxable capital gain of 1/2 x 26,202 = $13,101. Let's assume a marginal tax rate of 40% so the net would be $64,202 - 0.4 * $13,101 = $58,961. So, one would have to sell the business for at least ($58,961/0.4)/.5=$294,808 for it to be worth it to incorporate for the sold purpose of saving tax because you have to recoup what the expenditures due to incorporation would have grown to after tax. That is also excluding what I find a bit of administrative hassle by being incorporated. It also does not even take into account that accounting and filing fees rise over time, but I digress.

Reconciliation of Net to Owner if sold for $294,808 under either scenario:

Scenario A - Sell sole proprietorship in 15 years - $294,808 capital gain = $147,404 taxable capital gain @ 40% tax = $58,961 tax. Net = $294,808-$58,961 = $235,847

Scenario B - Incorporate and sell in 15 years - $294,808 sale price (no taxes) - $58,961 future value of expenditures due to incorporation if they had been invested, after tax = $235,847

FYI, the price could lower under both scenarios (but the same) if the annual cost of being incorporated turn out to be lower (because of DIY elements). Only if the sale price is higher than the above amount does it make sense to incorporate as any additional sale value is untaxed (as long as it does not exceed the small business sale capital gains exemption). If you can get it as low as $1,500 all in for annual filing costs, financial statements and tax return the break even is $144K.

So, if the sole proprietor with a seasonal business like the OP or you is even lucky enough to sell for that amount, whether incorporated or not, all you do is break even. You would have to sell it for much more for it to be worth it to incorporate. I would venture to say that a seasonal business run by a sole proprietor would likely be one without much infrastructure or assets and therefore the value might just be in some assets such as equipment and a customer list. Also, I have found that with one man operations the value usually goes out the door when that one man leaves.

So, purely on a "I wanna save tax' basis the break-even sale price is quite high to make incorporation worthwhile, hold back issues aside and likely higher legal costs that selling a sole proprietorship, but what I want to know is what seasonal business run by a sole proprietor sells for $236K+! That is because it is only after that selling price threshold is reached that it is worth being incorporated.

mrct944's accountant appears to have erred in not considering the invested value after tax of the extra costs of incorporation annually. That is because the advice was that the company could be sold for less because of the lack of tax if incorporated (due to the lifetime capital gains exemption on small businesses). It would actually have to be the same or more that the threshold amount I calculated above.
Member
May 28, 2012
436 posts
383 upvotes
ONT
My financial knowledge is insufficient to argue with the above, suffice it to say that buying the business for $400K and selling for $800K incurred substantial capital gains.

I felt that having an Accountant “do the books” every year made it easier to prove to potential purchasers that the gross figures were accurate, rather than showing figures on the back of an envelope. Also, wouldn’t the CRA be more likely to trust an Accountant’s submission rather than the owners, especially in a business that has a large cash component?

I need to correct eonibm’s comment “ mrct944's accountant appears to have erred in not considering the invested value after tax of the extra costs of incorporation annually”. We incorporated when we purchased the business and only asked for the assets/business comparison years later when we were selling.
Deal Expert
User avatar
Aug 2, 2010
15193 posts
4943 upvotes
Here 'n There
mrct1944 wrote: My financial knowledge is insufficient to argue with the above, suffice it to say that buying the business for $400K and selling for $800K incurred substantial capital gains.

I felt that having an Accountant “do the books” every year made it easier to prove to potential purchasers that the gross figures were accurate, rather than showing figures on the back of an envelope. Also, wouldn’t the CRA be more likely to trust an Accountant’s submission rather than the owners, especially in a business that has a large cash component?

I need to correct eonibm’s comment “ mrct944's accountant appears to have erred in not considering the invested value after tax of the extra costs of incorporation annually”. We incorporated when we purchased the business and only asked for the assets/business comparison years later when we were selling.
You are not really correcting me. Buying for $400K and selling for $800K that is 20-20 hindsight. What if you had not sold it for that but a lot less? Did the accountant inform you of what the threshold was? ie You better sell it for $400K + $X dollars in 15 years, or $400 +$Y dollars in 10 years, etc. , as per the analysis I did, or it's simply not worth it to incorporate from a financial point of view? What were the thresholds if he gave you based on your $400K purchase price? Given the accountant cannot predict the future in terms of when you are going to sell he should have provided that information so I am wondering what the amounts were.
Last edited by eonibm on Feb 24th, 2018 12:27 pm, edited 1 time in total.
Deal Addict
Feb 25, 2007
1323 posts
786 upvotes
Ottawa
HghSsociety wrote: in regards to the questions asked:

I don't work the other months of the year.
I don't need the money, I am married and we can live comfortably without it, my wife works
in regards to other income I have rental properties that generate a positive cash flow of about $3500/month
I quit a highly lucrative career that I hated, in order to spend more time with family for less $$
I did something partially similar: quitting a high paying job and going independent with my own incorporated consulting business. It's not seasonal like yours, but like you we don't (currently) need the money. We live on my wife's income, and my business earnings -- which have interestingly grown to be in the same ballpark as my employment income used to be -- will improve our lifestyle later.

It's for those reasons that I incorporated. I can income smooth between good years and not so good years, and "income split with my future self".

What's different in my situation is that I have no other personal income (no rental properties) but also the business income is higher than yours. It means I pay ~15% corporate income tax on my earnings immediately, but can then dribble them out at minimal additional personal tax, as opposed to having to pay top marginal personal income tax rates on it during a busy year. This more than compensates - for me - for the expenses in running the corporation (actually 2, an opco and a holdco), and for the fact that passive income is treated worse in a corporation (and likely will be treated worse still) than personal investment income.

Since your business income is less, and your other personal income is more, this effect will be moderated but still there. Without running the #s, my gut feel is that your situation will be about borderline worth it from this point of view. Therefore the liability features, and the possible benefits on sale of your business, may be enough to push you over the edge to doing it.

(Am not engaging on the subthread of quantifying the benefits in the event of sale of the business, since that's an area I have not looked into. My company will have zero sale value when I decide to close it.)
Deal Addict
User avatar
Aug 15, 2015
1568 posts
199 upvotes
Markham, ON
It might make sense to incorporate and slowly transition stuff in your name into the corporation name. It might make it easier to sell them down the road. Since you quit your lucrative job, you might actually have more time at home to make sense of your documents and organize it in a manner that make sense to you and your family.

If you ever approach "professionals" make sure you don't give them originals immediately. Some "professionals" think they are smarter than they are and you might end up losing your documents which may have originally been prestige.

Top