Should you incorporate your small business?
Your side hustle is taking off and now you’re wondering, is it time? Should I incorporate?
And like most other tax related decisions, our answer is, it depends!
Generally speaking, if your unincorporated small business is earning more net cash than you need to meet your personal spending needs, it could be beneficial to incorporate.
An incorporated business pays tax on active business income at a rate of approximately 11% in Alberta currently. When the shareholder takes money out of the corporation (i.e. dividend or salary), there will be personal tax on those withdrawals. The more cash you take out of the corporation, the more personal tax there will be.
If you don’t need all of the funds that you earn in the corporation, leaving them there (and investing them within the corporation rather than a personal account like a TFSA) can provide a deferral of your personal tax payable. These funds can then be drawn out of the corporation in retirement which will allow for smoothing of income levels for the business owner (and if you are over 65, can allow for income splitting under the TOSI rules).
There are other factors that should be considered when choosing to incorporate, including access to the Lifetime Capital Gains Exemption, limitation of liability, the ability to use business losses and the ongoing costs of corporate filings. Which is why we still say, it depends.
I want to incorporate, now what?
In order to incorporate, a business owner can either create a corporation from an Alberta Registry office or retain the services of a qualified legal professional, depending on their needs and complexity.
Once the corporation is established. VR can assist with the registration of the new corporation for GST, payroll and any other setup with the CRA that is necessary.
Now that the corporation exists and has a federal business number, the next step is to set up a separate corporate bank account and corporate credit card. Your accountants love you when business expenses are not being mixed with personal items!
As soon as everything is set up you can now start to run your business through the corporation! Invoices should be issued to customers in the corporate name, and deposits and payments should come out of the corporate bank rather than personal accounts. We would highly recommend using accounting software like QuickBooks Online (we have some handy tricks here) or a spreadsheet to track your business activities as you go. Trust us on this one.
Once the first year-end has passed, VR will assist with preparing and filing the corporate tax return. The tax payable is generally due three months after your fiscal year-end.
At the year-end, VR will also discuss your personal tax planning and compensation. If dividends or a bonus are declared they will be reported on the personal tax return in the calendar year after your fiscal year-end.
For example, if your December 31, 2021 corporate year-end results in a dividend of $10,000 being declared to the shareholders, then a T5 slip will need to be filed by February 28, 2022 to report the income to the shareholders. This slip would be included on the shareholders’ 2021 personal tax return due on April 30, 2022.
And that is the process after incorporating! It is a big change from running an unincorporated business, but don’t worry, because VR will be here to help you every step of the way!