Advantages and Disadvantages of Incorporation
To incorporate or not to incorporate, that is the question. This is one of the most important and most frequently asked questions when starting a new business. Each small business must weight the advantages and disadvantages of incorporation to determine which course is best for your company. There is no one best answer. Here are just a few of the considerations.
Advantages of Incorporation
Separation of ownership
A corporation is a separate entity for legal and tax purposes. Once a company becomes incorporated, the owner’s legal liability, including personal assets, is limited. Should the business fail the personal assets are insulated from creditors of the business.
Tax savings and tax deferral
Because small business corporations are subject to lower income tax rates on income up to a certain threshold ($500,000 at the time of writing) than individuals are, there is immediate tax savings. There is also an opportunity to defer tax if income can be retained by the corporation rather than distributing income out in the form of dividends or salary.
There are many tax opportunities such as income splitting with other members of the business owner’s family that are available to the incorporated business, as well as determination of an appropriate salary/dividend mix. There are also special tax incentives such as access to the capital gains exemption on the sale of a qualified small business corporation.
Access to financing
In general terms, an incorporated business can be a stronger vehicle to obtain debt financing through the corporate entity, or by way of attracting equity investors.
Disadvantages of Incorporation
Higher start-up expenses
The process of incorporation requires completing and filing formal incorporation documents. Corporate tax returns must also be filed every year and depending on the jurisdiction of incorporation, there may be other yearly filing requirements. In addition, most jurisdictions will require that you keep accurate and updated records on director’s meetings, corporate decisions and financial records – this can be both time consuming and costly.
Unless you are lucky, most businesses incur losses in their first few years. If you incorporate these losses cannot be used other personal income you may have. Rather, they will be carried forward for a period of time (up to 20 years at the time of writing) to be used to offset future corporate income earned.
You may have personal assets within the corporation or inadvertently use corporate assets for personal purposes, with some unintended tax consequences. Removal of assets or money from the corporation can trigger severe personal tax consequences if not monitored and remedied in a timely manner.
Corporate income is taxed within the corporation and money flowed out in the form of dividends is taxed again at the personal level. While there is some measure of integration in the tax legislation to reduce double taxation, some double taxation still remains.