Should you incorporate?

You started out helping friends redecorate their houses for fun. Turns out, you are really good at it. Soon people start telling you “you should charge for this!” and suddenly your hobby has become a hustle. A few years later and you have quit your day job and turned your hobby into a bona fide business.

Now you’re earning great money and enjoying serious success.

Is it time to incorporate?

There is no hard and fast rule that applies across the board, but one good indicator is: when your income is consistently higher than what you need to live on.

How do you know what you need to live on?

For many people, earning more also means spending more. Without a comprehensive financial plan, it can be difficult to know what you actually need to live on comfortably. But being aware of this number means you can be strategic about when you incorporate so you end up with more money in your pocket (and less in the government’s!)

For example, if you know you need $50,000 annually to live on but you are earning $100,000 annually – it might be time to sit down with your tax accountant and inquire about incorporating!

What benefits are there to incorporating?

1. Pay less income tax

It’s no secret that corporate taxes are low. Incorporating allows you to take advantage of this low tax rate while the funds remain in your corporation.

If you earn $100,000 as a sole proprietor, you are paying personal income tax rates on every penny now. That means you would pay about $23,000 in taxes and you’re sitting at about a 43% marginal tax rate.

If your corporation earns $100,000 and you pay yourself a $50,000 salary (because you determined that’s all you need), you would only be paying between about $7,600 in personal taxes + $6,100 in corporate taxes = $13,700.  That is a tax deferral of $9,300!  You can invest those funds in the corporation without taking them out as well, which allows you to grow your corporation as an asset without paying those high personal income taxes first.

All that tax savings could help you reach your financial goals a lot sooner.

2. Decide how you want to pay yourself

When you incorporate, you can pay yourself through a salary, dividends, or a combination of both.

When you pay yourself a salary:

-          You generate 18% of your salary in RSP contribution room. If your retirement plan includes a focus on RRSPs, this might be the best option for you. Contributing to your RRSPs are a great way to grow wealth because they give you an immediate refund of your tax bracket (ex: 30% return on a $50,000 income) that you can then use to invest further or put towards your other goals.

-          You are required to pay into the Canada Pension Plan (CPP) – both as the “employer” (the corporation) and the “employee” (you as the salaried individual). Since CPP benefits are determined based on how much and for how long you contributed, this option allows you to collect more CPP in retirement.

-          You will receive personal income. This may help you to qualify for a loan, as most lenders prefer to see consistent and predictable income.

When you pay yourself in dividends:

-          You are taxed at a lower rate than if you withdrew salary because the corporation already paid some tax previously.

-          You are not required to pay into CPP. This frees up about 10% of your income (ex: approx. $4,600 on a $50,000 income) that you can put towards building your own pension and retirement planning.

-          You can declare income any time. This offers flexibility and the ability to be strategic about your tax situation.

You may choose to pay yourself with a combination of salary and dividends. Working with a financial advisor and a tax accountant will help you determine the ideal ratio for your unique situation.

3. More purchasing power

As the corporation builds up assets, it can make purchases as its own entity. For example: a building.

If you were to purchase the building as a sole proprietor, you would be purchasing the building with 43% taxed income. If your corporation is the purchaser, it makes the purchase with 12.2% taxed income.  You do need to take into consideration that any income from renters will be taxed at about 50% versus what your personal rate would be, and the higher costs of annual corporate tax filings.

Essentially, incorporating can give you a lot more bang for your buck.

4. Creditor protection

As a sole proprietor there is no financial or legal separation between you and your business. Effectively, you are your business. If someone were to sue your business, that means they are really suing you as an individual. They could go after your house, your car, your assets.

Once you incorporate, in most cases your liability is limited to what you invested in the company. For those in industries where the risk of legal liability is high (construction, for example), incorporating even before you can take advantage of the tax benefits makes sense from a legal perspective.

Knowing the right time to incorporate can mean keeping more money in your pocket. But simply incorporating won’t mean you will suddenly be flush with cash. You need a solid financial plan to be sure you are maximizing all those benefits to fund your future.

Book a call to discuss what options you have as a self-employed individual to maximize your income.