From Proprietorship to Corporation - When is the Best Time to Incorporate?

The  dog days of summer are a great time for the Tax Specialist to review 2014 returns for Proprietors and Partnerships to determine whether it is time for some of these taxpayers to consider incorporating their business and removing their business from their personal tax return. But when is the best time to incorporate?

The answer to this question varies depending on the needs of the financial needs of the individual taxpayer, the vision for their business and their ability to take their business to its next level of growth; however, a few basic questions will help determine if you should be approaching your client with the suggestion, from a tax savings point of view:

1. Is the taxpayer currently paying a higher effective income tax rate than the corporate tax rate for the province of residence?

The current federal tax rate for a Canadian Controlled Private Corporation is 11% on the first $500,000 of net income. Provincially, rates vary by province from a low of 0% in Manitoba to 4.5% in Ontario and PEI. To put this in perspective, a net corporate income of ~$34,000 in Ontario attracts about a 15.5% effective tax rate. If this corporate tax rate is lower than the proprietor’s personal income tax rate, it may be time to look at incorporating.

2. Is the taxpayer earning more money in the proprietorship than is required to meet their personal and household needs?

A corporation’s lower income tax rate is only effective if the earned income remains within the corporation. If the proprietorship is earning $100K and the taxpayer needs $100K, it is unlikely that a corporation is beneficial for tax purposes.

3. Is there a liability or asset protection benefit to incorporation?

Even if there is no tax benefit to incorporating, there may be a benefit from a liability or asset protection viewpoint. A corporation is a separate legal entity; therefore, the individual cannot be held personally liable for debts incurred within the corporation. This protection can go a long way to protecting family wealth in the event of a business mishap.

4. Is there currently income-splitting potential within the proprietorship?

In most cases the answer to this is no. However, within a corporate structure different classes of shares can be issued, opening up various dividend options. This will then allow income sprinkling among family members to take full advantage of individual graduated rates, exemptions and deductions.

5. Is your client financially disciplined enough to manage a fiscal year-end?

One of the underlying advantages to operating through a corporate structure is the ability to establish a non-calendar fiscal year. This opens up income deferral options, allowing the taxpayer to retain more wealth longer by utilizing ITA S. 78(4).

Example – S. 78(4)

• Acme Corporation has a fiscal year-end of July 30th and elects to declare a bonus payable of $30,000. The bonus is expensed on the corporate tax return as of July 30, 2015.

• The bonus is then paid to the individual on January 3rd, 2016 – within the 179 day requirement of S. 78(4).

• The bonus is reported on the T4 slip for 2016 and reported on the personal tax return filed April 30, 2017, resulting in a 21-month deferral of personal income taxes.

The move from proprietorship to corporation may hold many benefits for the individual taxpayer and at the same time opens up many tax planning and wealth retention opportunities for the individual and their Tax Specialist to explore as the business continues to grow.