Legalese: September 2012

Personal protection is great, but it is not free.

There are generally three different ways your business can be formed. It can be a sole proprietorship (you personally), a partnership (you personally, along with others), or through a corporation. In this month’s article we will examine some of the pros and cons of operating your business as a corporation.

Being the owner of a business can expose you to personal liability in some cases. For instance, if you run a construction company and a project is deficient, you could possibly face a major lawsuit. You would be personally responsible to your client, and your personal assets would be at stake.

When a company is incorporated the company gains its own identity. It is considered to be a separate person under the law (with some important exceptions). Generally speaking, if the company is sued, it is only the company’s assets that are exposed to liability, not your own. This is a great way to protect your house, your bank accounts, vehicles and other personal assets.

This is useful not only in the event of a lawsuit, but also for creditor protection in the event of a bankruptcy. It will be the company that goes bankrupt, not you personally, and all outstanding creditors will be left to fight over the remaining company assets while your personal assets remain out of reach.

Setting up a corporation can result in tax benefits for the owners. You can pay yourself a salary while keeping some of the company’s earnings held within the company. This can help to keep you out of the upper tax bracket and delay giving you your money until later years when you may not be earning as much income.

Tax benefits can also be found if your family members are involved in the business. Shareholders can receive dividends, and these can be awarded in a variety of ways to different classes of shareholders. This is just another way to avoid earning money in high-income years and to release money during low-income years.

Obviously, tax planning is complex and will vary significantly from person to person. You should consult your own tax lawyer or accountant in order to obtain specific advice for your individual situation.

There are regulatory requirements for all registered corporations under provincial and federal law. This means preparing annual filings, which should be done by an attorney or an accountant. Although this will mean an annual cost that you would not otherwise have as a sole proprietor, it can be compared to paying insurance premiums. You pay annually to keep the corporation alive and your personal assets are protected.

If you are a sole proprietor contracting out your services in Canada, whoever hires you must withhold some of your payment to go to CPP and EI. This is not the case with corporations. If your company is incorporated there is no withholding payment and you will receive the full amount for the services you charge.

It might seem silly to some but there is a common perception that businesses with Ltd. or Inc. after their name are more professional and more reputable than simply “Jim’s Construction Company.” This improved perception could lead to bigger and better projects for your business.

If your operation grows large enough you may want to bring on investors to expand your business. This is much easier to do with a corporation than a sole proprietorship or a partnership. Issuing new shares can be a simple procedure and a great way to bring cash in to the company coffers.

Disputes can arise over whether or not contractors for a company are employees or independent contractors which can affect payment, employment benefits and taxes. This problem is much less likely to occur if a corporation is involved instead of a sole proprietor.

If you are running a small business which is growing, incorporating may be the next logical step for you to help your business expand and to protect your personal assets.