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Incorporation: now, later or never?

If you’re like most unincorporated small farming businesses, you’re likely contemplating these thorny questions: Should I incorporate? If so, when’s the best time? If not, why not?

The simple answer is: Incorporation is always good because it delivers terrific tax benefits while creditor-proofing my personal finances. But, like all simple answers, this one is much too simplistic. Whether or not to incorporate raises a number of issues, including the length of time you’ve been in business, your personal cash flow needs and the personal and corporate tax rates in your province. Here is a closer look at how these issues might affect your decision.

Cash flow and you
If you need all of the profits from your farming business to support your personal cash flow needs, incorporation may not be for you. The cost of setting up and maintaining the corporation could outweigh the tax benefits. But when your financial position allows you to retain some of your business profits inside the company, incorporation could deliver significant tax savings. The money retained in the company can be used to grow the operations or invest in other
non-related investments.

Taxing questions and answers
When it comes to taxes, incorporation can be tricky. If you’re in the initial stages, it’s usually advisable not to incorporate because losses incurred by an incorporated business can’t flow through to shareholders. You’re better off being able to use those losses personally against other income. Once your business becomes profitable, incorporation can provide tax advantages.

If your business earns active business income (income earned as a direct result of the farming operation as opposed to passive income earned, for example, by holding other investments through the corporation), you may gain an immediate tax break (in some provinces) and the opportunity to defer part of your tax payment.

A Canadian controlled private corporation’s active business income is taxed at a relatively low combined federal/provincial rate of 12 to 19 per cent, depending on the province in which you’re doing business. In most provinces, the lower rate is applied federally on the first $500,000 of active business income, with the exception of Manitoba and Nova Scotia, where the lower rate may be applied on the first $400,000. Even though shareholders must pay a second level of tax once the after tax income is paid out as dividends, this second level of tax is applied only when the dividends are paid.

So you can control when you pay these taxes by choosing to declare dividends in years when your personal taxable income is lower.

Incorporation also allows you to take advantage of income splitting to reduce taxes. If your spouse or adult children are shareholders in your corporation, any dividends they receive will usually be taxed in their hands. Your corporation can also employ your family members as long as their remuneration is reasonable for the work performed. You can defer certain expenses as well, such as employee bonuses. In order to be deductible in the year by the
corporation, it must actually be paid to you no later than six months after the end of the year.

Creditor-proofing personal assets
Incorporation can limit your liability because corporate assets and personal assets are kept separate and corporate creditors can only go after assets owned by the corporation. But incorporation may not protect you from all creditors: banks and other corporate suppliers often require small business owners to personally guarantee any liabilities and directors of a corporation may be liable for many types of unpaid debts.

Estate planning
The life of an unincorporated business usually ends with the life of its proprietor. But a corporation can continue to exist indefinitely, which is why corporations are often used for estate planning purposes. It is important to take steps so that after your death the business remains profitable with sound management provided by family members or others.

If after assessing the pros and cons, you’re leaning toward incorporation, you still have a few important decisions to make:

• Who will be the shareholders? You may choose to make family members shareholders for income splitting purposes, but the ability to issue shares to family members is limited in certain corporate structures.

• Who will be on the board of directors? Directors have exposure to many different types of liabilities, so becoming a director is not a decision to be taken lightly.

• Who should be the officers? These are the people entitled to sign documents on behalf of the corporation. They must be chosen with care and with an eye to the future direction of your business.

This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Paul Vaillancourt is solely responsible for its content. For more information on this topic or any other financial matter, please contact an Investors Group Consultant.

September 25, 2013  By Paul R. Vaillancourt CFP CLU CHS and CPCA


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