Understanding the Benefits of Incorporating Your Small Business in British Columbia
DISCLAIMER
This information is intended for business owners in Canada and serves as general guidance only. Always consult with a qualified advisor before making any legal decision.
In this article we’ll cover the following topics:
Why incorporate? The advantage of limited liability
The tax advantage of being incorporated
Maximizing lifetime capital gains exemption
Increased flexibility with incorporation
Sole proprietorship vs incorporation: A comparative overview
Are you considering a transition from a sole proprietorship to a corporation? If you are running a small business in British Columbia (BC), understanding the benefits of incorporating your venture is an essential step in your entrepreneurial journey.
Incorporation can offer several benefits, including limited liability, favourable tax conditions, lifetime capital gains exemption, and operational flexibility.
In this comprehensive guide, we will dive into these benefits, unpack what it means to be "incorporated," and draw comparisons between a sole proprietorship vs incorporation using real-life examples.
Why Incorporate: The Advantage of Limited Liability
One of the most significant advantages of incorporation is limited liability. As a sole proprietor, you and your business are one entity. This means all the business risks, including debts, grievances, or legal disputes, directly affect you personally. Incorporation, on the other hand, creates a distinct legal entity that assumes these risks.
If you choose to incorporate in BC or, more broadly, incorporate in Canada, you're essentially creating a separate' person.' This 'person' is your company, which enters into contracts and relationships on behalf of the business, providing a protective shield between you, the owner, and potential business pitfalls and thus embracing the liability shield!
To illustrate this, consider the hypothetical example of John, who runs a small home renovation business as a sole proprietor. One day, an unfortunate accident on the job leads to a costly lawsuit. As a sole proprietor, John's personal assets, including his home and personal savings, are at risk. If John had chosen to incorporate his business, only the assets owned by the corporation would have been at risk. This stark contrast exemplifies the significant protection incorporation offers.
The Tax Advantage of Being Incorporated
Taxes are another major factor when comparing incorporating a business in BC with operating as a sole proprietor.
The combined federal and provincial tax rate in BC can range from 20% to 50% for a sole proprietor. This income is attributed to you personally, taxed at your highest marginal rate.
However, if you decide to incorporate, your business will be charged at a substantially reduced rate. As of 2020, the combined federal-provincial corporate tax rate is 11%. This tax advantage is more beneficial as your earnings increase, and you can keep more money within the company, creating significant savings over time.
Take the example of Sarah, a successful freelance graphic designer. As her business grows, so does her income, pushing her into a higher tax bracket. By incorporating her business, Sarah can take advantage of the lower corporate tax rate, resulting in considerable annual tax savings.
Maximizing Lifetime Capital Gains Exemption
A lifetime capital gains exemption is a noteworthy advantage if you plan to sell your business in the future. This exemption allows every Canadian to sell shares in a company tax-free up to a certain limit.
For instance, let's say your business is worth $100,000 now, and it's worth a million dollars in ten years. If you sell it as a sole proprietor, you will be paying capital gains on that entire increase. However, if your business is incorporated, you will only pay capital gains tax (at a rate 50% lower than your marginal tax rate) on the initial $100,000. Moreover, each shareholder can take advantage of this exemption, increasing potential tax savings.
Increased Flexibility with Incorporation
The last advantage we will discuss is the flexibility that incorporation provides. Compared to a sole proprietorship, an incorporated entity is more attractive to investors, easier to sell, and offers more options for business structuring. For instance, you can issue shares, bring in new partners, or offer stock options to employees.
Sole Proprietorship vs Incorporation: A Comparative Overview
Sole proprietorships are simple to set up and offer direct control to the owner. However, the benefits of incorporation, such as limited liability, lower tax rates, capital gains exemptions, and greater business flexibility, often outweigh the simplicity a sole proprietorship offers.
Incorporating a business in BC, or Canada as a whole, can unlock potential for growth and development that would otherwise be difficult to achieve. Understanding how to incorporate in BC and what "incorporated" means in the context of business operations are critical steps toward making the best decisions for your business's future.
Overall
Navigating the world of incorporation can be complex but also rewarding. Always remember that seeking professional advice is invaluable during this transition. As legal experts and BC corporate lawyers, we at Parr Business Law will identify your unique situation and plan the best course of action. Get in touch today for tailored advice!
