Canada: Every Strong Business Starts With A Strong Transition

For anyone making the transition to self-employment, deciding whether to incorporate is a major decision. From a tax perspective, you should generally start thinking about incorporating when you have substantial funds that will be reinvested in the business annually and not need to be drawn out for personal use. A corporation enjoys lower tax rates for funds left inside the corporation. While some try to determine what level of income justifies incorporation, viable cases can be made for and against, whether your net income is $75,000 or $200,000. Sometimes people think there's a magic number, but there really isn't. This is a personal decision that has a unique impact on every business.  

Those deciding to incorporate should also consider the benefits of limited liability. When a business is incorporated, it is separate and distinct from the owner. This reduces the risk of personal loss if there are claims against the corporation. You should also consider incorporating when the benefits of limited liability and a lower corporate tax rate outweigh the cost of incorporating and maintaining the corporation.

When you start your business, you need to decide whether you will operate as a sole proprietorship, partnership or corporation. Choosing to operate as a sole proprietor or a partnership means that your business income will be reported on your personal income tax return. A corporation is a separate legal entity and prepares a separate tax return for the corporation.

Once you have decided on how your business will be structured, you may feel like the hard work is over, but it doesn't stop there. If you want to turn your plan into a prosperous business, you need to work your way through all the steps to make a successful transition.

1. Organize your records

When you start working toward incorporation, it's wise to get serious about organizing your records. Some businesses choose to use low-tech methods (gathering papers in shoe boxes, envelopes, spreadsheets, etc.), but that doesn't let you see how your business is doing throughout the year. It's better to have some sort of computerized accounting records, so you can run an income statement at any time. Convinced of their accounting ignorance, some people resist these kinds of modern solutions, but accounting software like QuickBooks is relatively simple and not that different from the familiar process of paying bills and receiving payments on paper.

2. Automate bookkeeping

Automated accounting also allows you to automate your bookkeeping, so you can get to the point where you simply take a picture of a receipt and upload it to your accounting software, which recognizes the receipt and records the numbers in the correct accounts. This allows you to find documents and information that might be difficult to quickly produce in a traditional paper system. Rather than labour over manually reconciling your bank transactions for the month, you can simply download a list from your accounting software. Your only real responsibility is ensuring the software has allocated receipts and numbers accurately. Your bookkeeping is in the cloud, so you can access your records from your phone or tablet from anywhere. This system also allows better collaboration with your accountant because you can both access your accounting records at the same time.

3. Don't overlook deductions

In determining which business expenses are deductible, people sometimes overlook the business use of their home or automobile expenses. All expenses incurred to conduct your business and earn income can be deducted as long as they are reasonable and not specifically limited or prohibited by CRA. In some cases, small businesses have hobbies that they have turned into their business. Before they were incorporated, the costs related to this hobby weren't deductible, but now that they are contributing to a business, these costs may be deductible. However, even deductible expenses are subject to restrictions. For that reason, it's important you carefully record relevant expenses and clearly differentiate between business and personal use.

4. Get registered

When setting up a business, it is often necessary to register for several new accounts, including an HST account. The only real challenge this adds to the business is additional paperwork. Fortunately, an accounting program can make this additional reporting much easier.

Newly incorporated people are often overwhelmed by the knowledge that they also need to be registered for payroll. As soon as you start paying someone else or yourself, you are required to pay source deductions for those employees. You also have new obligations regarding T4s and worker's compensation. However, this is another area where accounting software is extremely helpful. As long as you've collected the appropriate information, you can often print out filings and T4s directly from your accounting software.

5. Deal with your personal return

People with employers are used to having little control over what's on their personal tax return – they get a T4 and that's it – but when you're self-employed, you have a little more control. If you are self-employed, you must put your business income and expenses on your personal tax return, but if you're incorporated, you can pay yourself a salary or dividend out of the corporation. This gives you the ability to leave money in a corporation, rather than pull it out personally. As such, your personal income could be lower than when you were an employee. This could place you in a lower personal tax bracket, allowing you to claim deductions you could not claim in the past.

6. Talk to an expert

The key thing to remember when incorporating your business is the importance of talking to an expert. Sometimes people go into business without first talking to their accountant, which could prevent them from learning ways to structure the business. You may want to consider splitting income with a spouse or even a child, as that can make it more advantageous. In any case, it will always be easier if you take these steps right from the outset.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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