Business Incorporation? - FAQ

FAQ: How do I decide if I should incorporate my business?

First of all there are three types of business structures - sole proprietorship, partnership and corporation. In my view most entrepreneurs should steer clear of a partnership - just too many pitfalls, relative to any perceived benefits.

Therefore the choice is really between a sole proprietorship and forming a corporation. If it is just you in the business you have the choice; if there are others, then the only real choice is a corporation.

So, let's look at some reasons for you to be a sole proprietor.

To begin with, a sole proprietorship is more easily formed (basically register a name and obtain any licenses required); the financial records are simpler (but still lots of records to keep); the income taxes are simpler to file (but still complicated and convoluted for sure); and if you have a loss from the business you can likely claim it on your personal income tax return (if you have taxable income of course).

I bet that last sentence got your attention.

But hold it a minute. Don't get the idea that you are going to turn your interest in tennis into a sole proprietorship so you can claim your losses against your personal taxes - it doesn't work that way.

There is something called the REOP (Reasonable Expectation of Profit) that will likely prevent this, but this is a topic for another blog.

OK, back to your question. How do you decide?

In my opinion, in most situations, incorporating is the overall better alternative. The corporate tax rate on the "active business income" of a small business is lower than personal taxes; you have more flexibility on how to pay yourself (wages or dividends for example) and there are more tax advantages with a corporation (the lifetime capital gains deduction and certain investment tax credits, for a start).

Since a corporation is a separate legal entity, any business related lawsuits (by creditors or others) would be against the corporation, not you personally - at least in theory. In practice, there are exceptions and often creditors will require your personal guarantees on loans. Still, incorporation can provide some protection to you.

So, am I suggesting that you should incorporate?

Well, it depends. There are other considerations.

If the investment in your business is relatively small and you do not want to spend any more money than absolutely necessary, you likely should operate as a sole proprietor, at least until you get a sense of how successful your venture might be. If need be, you can always incorporate later.

However, if you have just quit your job and invested most of your savings in your new business, then incorporation may be in order, especially if you think you may need additional venture capital to grow your business.

The fact is, incorporating is often a personal decision. Certainly size matters and larger companies are just about always incorporated.

However, when I started Peters & Associates Ltd. (PAL) some 17 years ago I chose to incorporate right at the start: I liked the idea that PAL was a separate legal entity from myself; I thought "Ltd." was kinda cool; I knew that I was in this for the long term; and I also knew that I did not need to hire a lawyer to fill out the paperwork to incorporate.

For me it just seemed right. It still seems right.

But enough about me ... what about you?

If you are still not sure, a sole proprietorship is likely the right decision for you, at least in the early stage. As I said, you can always incorporate later on. Don't worry; most of the benefits of incorporation won't be lost just because your business started out as a sole proprietorship.

My next blog will consider the question "I would like to apply for the New Brunswick Small Business Investor Tax Credit Program, but it looks complicated.  Is it really worth the effort?"  Stay tuned!