If you have been operating your business as a partnership or as a sole proprietorship, you might be thinking about incorporation. Can you change from one structure to another?
This was a question posed by a reader to Canadian Tax Resource. The reader has previously operated a business with others in the form of a partnership. The business has since grown and the partnership structure no longer seems to make sense.
Before making the decision to change the ownership structure, you should take the opportunity to review your situation and make sure it make sense. There are many advantages and disadvantages of incorporation, but here are a few general considerations.
Is Your Business Profitable?
If your business is not turning a profit, then from a taxation point of view, incorporation may not make sense.
When you a re self-employed or operate as a partnership, any losses your business generates can be personally deducted from your other personal income. A corporation is a separate taxpayer and it cannot transfer its losses to another taxpayer. Therefore, any losses generated by the corporation are trapped in the corporation until it turns a profit.
Are There Liability Concerns?
Are you concerned that your business may get sued? If you operate as a sole proprietorship or partnership, your personal assets may be at risk of seizure. A corporation is a separate legal entity and may be used to insulate yourself from liability.
Be sure to discuss this with your legal counsel because there may be some limitations.
Tax Advantages of Incorporation
If you have an active business, the Income Tax Act will provide a preferred flat rate of income tax on your first $500,000 of business income. This can be a tremendous advantage to the owner/shareholder who can pay themselves or their family members dividends. Making family members shareholders can be an excellent income splitting opportunity.
If you have no other sources of income other than dividends from your corporation, you may be able to earn as much as $40,000 per year at the corporate tax rate which currently is averaging 15% on the first $500,000 of business income, depending on your province of residence.
Tax Deferred Rollover
If you decide that incorporation is right for you have the opportunity to transfer assets to the corporation on a tax-deferred basis.
Normally when you transfer ownership of property, you will be deemed to have disposed of that property at its fair market value. Any accrued capital gains would become taxable. However, there is a section in the Income Tax Act that allows you to transfer ownership of your assets to your business in exchange for shares of the corporation at the original cost of the asset.
Known as a section 85 rollover, these rules can be complicated if the transfer is not structured right, you should speak with your accountant to make sure it’s done right.