Sooner or later, almost every freelancer and small business owner hears the same advice: “You should incorporate.” Sometimes it’s right. Often, especially in the early years, it isn’t. Incorporating changes how you’re taxed, how you pay yourself and how much paperwork you handle, so it’s worth understanding what you’d actually gain before you sign anything.
Sole proprietorship: simple by default
If you’ve started working for yourself and haven’t set anything up, you’re already a sole proprietor. You and your business are the same person in the eyes of the law and CRA.
- Your business income goes on your personal tax return.
- You pay income tax at your personal rates, plus both halves of CPP, which we explained in CPP and self-employment.
- Paperwork is light: no separate company tax return, and no separate legal entity to maintain.
- The trade-off is that the business’s debts are your debts.
For most people starting out, this is the right place to be. It’s cheap, flexible and easy to change later.
Incorporation: a separate business
When you incorporate, you create a corporation that’s legally separate from you. It earns the income, pays its own tax and files its own return every year.
The main attraction is the tax rate. A Canadian-controlled private corporation pays a much lower rate on the first $500,000 of active business income each year. Federally that rate is 9%, and once the provincial rate is added, it ranges from about 9% to just over 12% depending on where you live. You can see each province’s rate on CRA’s page of corporation tax rates.
The catch: you still pay tax when you take money out
That low corporate rate only applies to money that stays in the corporation. When you pay yourself, through a salary or dividends, that money is taxed again on your personal return. The system is designed so that, overall, you end up paying roughly the same tax either way.
So the real benefit of incorporating is deferral. If your business earns more than you need to live on, the extra can stay in the corporation, taxed at the lower rate, until you need it, perhaps in a slower year or later in life.
If you need every dollar your business earns to pay your bills, there’s very little to defer, and the extra costs may outweigh the benefit.
What incorporating costs
- Setting up: a few hundred dollars in government fees, more if you use a lawyer.
- A corporate tax return every year: most incorporated businesses pay an accountant to prepare it, which costs noticeably more than a personal return.
- Separate everything: a business bank account, its own records, and keeping your personal and company money strictly apart.
- Paying yourself properly: a salary means running payroll and paying CPP; dividends avoid CPP but don’t build your CPP pension or RRSP room. Your accountant can help you find the right mix.
What about protecting your personal assets?
Limited liability is real, but it’s often overstated for small businesses. Banks and landlords usually ask owners to personally guarantee loans and leases, and you can still be personally responsible for your own professional mistakes. Good insurance often protects you more than incorporation does.
So when does it make sense?
A common rule of thumb is to look seriously at incorporating once your business is steadily earning more than you need to live on, and you expect that to continue. Other good reasons include taking on staff, signing large contracts, or clients who prefer working with a corporation.
If you do incorporate, remember that the corporation is a new, separate business. It gets its own business number, it needs its own GST/HST registration, and from the date it starts operating, your invoices should go out in the corporation’s legal name.
This is general information, not tax or legal advice. An accountant who knows your numbers can tell you whether, and when, incorporating is right for you.
How Ledger helps
Whether you’re a sole proprietor or a corporation, Ledger works the same way. Your business name, logo and GST/HST number appear on every invoice, and if you incorporate, you simply update your details so new invoices go out under the new name, while your earlier invoices stay exactly as they were sent. Ledger’s revenue and margin figures also give you and your accountant a clear view of your profit when it’s time to make the call. See how Ledger works.