Choosing whether or not to incorporate your company is an important decision that can have far-reaching consequences for you and your business. There are a number of benefits to incorporation and ultimately, once a company has reached a certain stage of its lifecycle, it does makes sense to incorporate. However, if you rush into incorporation too early, you might forego many important benefits that you won’t be able to take advantage of after the fact.
There are two key factors that inform whether and when a company should incorporate. These are legal liability and tax.
In terms of legal liability, it is clear that a corporation is preferable to any of the simpler legal structures like a partnership or sole proprietorship. A corporation is a separate legal entity, it has perpetual existence and, other than in exceptional circumstances, the owners of the corporation (the shareholders) cannot be held liable for the debts and other liabilities (including lawsuits) of the corporation. This is contrasted with sole proprietorships and partnerships, which are not separate legal entities, and are more like extensions of their owners. For example, in a sole proprietorship, the single owner receives all of the company’s profits, but is personally responsible for all its debts and liabilities. A general partnership operates in the same way, except the profits and liabilities are split among the partners. Therefore, as far as legal liability goes, the corporate structure is clearly preferable, which is why companies in high-risk industries, such as food processing or medical sciences, tend to incorporate early on, to limit their risk at the outset. However, in lower risk industries, the added expense of incorporating and managing a corporation are not justifiable early on, particularly if the company is not yet selling its products in the marketplace.
On the tax side, there are many potential benefits that a corporate structure can provide. These include the lower corporate tax rate, availability of the capital gains exemption, and others. However, these benefits must be balanced against the benefits available to sole proprietorships and partnerships. The key benefit in these structures is that the owners (the sole proprietor or partners) are able to offset any losses sustained by the business against income from other sources in their personal income tax. As a result, many businesses find it advantageous to remain in a simpler business structure until the business has reached a certain threshold of profitability.
The benefits of incorporation must also always be weighed against the greater start-up and maintenance costs and added governing formalities and administrative requirements involved in a corporation.
There is no single formula that will tell each business owner whether and when it makes sense to incorporate as it depends on each business’ specific circumstances. One common strategy that business owners employ is to wait until the company earns enough money for them to comfortably live on before incorporating. After that point, it is thought that the business owner could be missing out on many opportunities to make their finances more efficient through tax planning. However, this must be considered in the context of the industry in which the business operates, its long-term objectives and other factors.
Regardless of the business, if you are considering incorporating your business, it is always advisable to consult with a lawyer and an accountant before doing so. If you have any questions about whether or not it makes sense for you to incorporate, contact HazloLaw today.
This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact Hugues today. 613-747-2459 ext.304, [email protected]