Here is some basic information to help you reduce your personal liability (and maybe your tax bill too!) by incorporating your business.
Why do people incorporate their businesses?
The main reasons are: reducing personal liability as a sole proprietor, reducing personal income tax, and being able to have investors. There may be other reasons as well, such as insurance and estate planning.
Do I HAVE to incorporate my business?
No. It is not a requirement. Many small businesses incorporate right away, while others carry on as a sole proprietor or in partnership without ever incorporating. It depends on the business owner and her objectives.
What does incorporating mean?
When you incorporate a business, you create a new legal entity: the corporation. The corporation bears liability for the actions of the business, not you. This means you no longer have unlimited personal liability.
The corporation files its own taxes and can hire you as an employee. You can earn money from the corporation as an employee, or by dividends or both.
Incorporating makes it possible to offer shares to investors or bring in a “partner” as a co-shareholder.
The money left in the corporation would be taxed at the corporate tax rate. The money you earn from the corporation would be taxed at your personal income tax rate.
You incorporate by filing certain documents with your provincial or territorial government including Articles of Incorporation (Ontario) and paying filing fees. You must do taxes each year and keep your annual corporate records up to date. CLICK TO SEE BLOG 1.
When you incorporate, at least one director must be appointed. Directors have a fiduciary duty to the corporation to do what is in the best interests of the corporation and not what is in the best interests of shareholders. Directors who fail in their fiduciary duty can be liable under the law (eg. Ontario Business Corporations Act). Some corporate statutes require resident Canadians to be the majority of directors.
Should I incorporate my business?
As noted above, you do not have to incorporate. However, businesspeople often ask themselves these questions when deciding:
- Do I want to eliminate the risk of having unlimited personal liability?
- Do I plan to grow and get investors?
- Will it help or hurt my personal income tax situation?
- Do I (possibly) want to share management?
It’s an individual choice and should be made with legal and accounting advice.
Example 1:
You start hand-making furniture and gain a following on Instagram. Your business grows fast. Your biggest sale is for 100 dining chairs to a new restaurant, and its worth $50, 000 in revenue to you.
Within 6 months, the restaurant successfully sues you for $60, 000. The reason? The chairs keep breaking with the restaurant’s customers crashing to the floor. The restaurant lost a lot of business as a result. They sued you for the original $50, 000 plus $10, 000 for lost business.
If you incorporated, the corporation would be on the hook for the $60, 000, if it had $60, 000 (or was insured for this type of risk). If the corporation only had $40, 000 in assets, then the restaurant would only be able to get $40, 000.
You would NOT have to take the additional $20, 000 out of your personal assets (unless you had given personal guarantees).
What are the alternatives to incorporating? Sole proprietorships and general partnerships.
- Sole proprietorship
- As soon as you start a business (unless you incorporate it), you are a sole proprietor.
- You do not have to take any steps to be a sole proprietor, it happens automatically; other than a simple filing with the local government if you carry on business in a name other than your own.
- There is no difference between you and your business in terms of liability or income taxes.
- You have unlimited personal liability.
- Income from the business would be added to your personal income taxes.
- Losses from the business could be deducted from your personal income taxes.
Example 2:
Going back to our furniture business, as the sole proprietor you would be on the hook for $60, 000 personally. Meaning that if you did not have the money to pay the $60, 000, you might have to take the money out of your house or from other personal assets.
- Partnership
- Partners are two (or more) people (or businesses) who carry on business together for the purpose of a profit (even if the business is never profitable).
- You do not need to register your partnership, its automatic (and also like the sole proprietorships, if your partnership involves a business name you would need to file it). It is basically as if you and your partner are both sole proprietors.
- Each member of a partnership has unlimited personal liability, and either partner is liable for 100%.
- Each member of a partnership has a fiduciary duty to do what is best for the partnership, and not for themselves.
- There are different types of partnership: general partnerships & limited partnerships. This blog relates to general partnerships.
Example 3:
If your sister had partnered with you 50/50 in the furniture business, you would both be responsible for the $60, 000 on a joint and several basis, meaning the restaurant could come after you or your sister for the whole $60, 000. The restaurant could choose to pursue your sister for all of it. Or you.
What if I am a professional (doctor, lawyer, accountant, etc)?
- Many professionals are not allowed to incorporate unless they use a professional corporation. Check with your governing body.
- If you prefer the partnership route, you can enter a general partnership or, in some provinces, a limited liability partnership.
- In both cases, the professional still faces unlimited personal liability for professional negligence claims.
How do I know which option is best for me?
Here is a lawyer answer for you: It depends! There is no one-size-fits-all answer.
It depends on what is best for you and your business, at that time.
Ensure that you speak to both an accountant as well as a lawyer, so that you understand the different ways this decision to incorporate (or not) may affect you, your business and your family.
Amee Sandhu has been a business lawyer in Ontario for 20 years. She created Lex Integra Professional Corporation in 2019 and focuses exclusively on business law and corporate ethics.
In her current practice Amee advises clients on commercial, corporate, integrity, anti-corruption, ethics and compliance, and supply chain risks.
Lex Integra:
Understand your risks. Perform with Integrity.
The purpose and contents of this blog is to provide information only, and it does not constitute legal advice. Reading this blog does not create a solicitor-client relationship between the reader and Amee Sandhu or Lex Integra. It is recommended to engage (hire) a lawyer if you require or are interested in legal advice.
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