To incorporate or not to incorporate

If you’re currently carrying on a business as a sole proprietor or in an unincorporated partnership, consider whether you should transfer your business to a corporation. It depends on your circumstances and the amount of income you earn. As a first step, you should talk it over with your tax adviser, who can “crunch the numbers” and examine the advantages and disadvantages of being incorporated.

Business income earned as a sole proprietor or partner is subject to income tax at your personal marginal rates. However, if you operate your business in a corporation, income that qualifies for the small business deduction (see topic 24) is taxed at a relatively low rate.

If you incorporate your business and can retain earnings in the corporation for growth, you’ll be able to defer tax to the extent the earnings are not distributed to you as a salary or dividend (see topic 28).

As an added benefit, with appropriate planning, shares of a small business corporation may be able to qualify for the enhanced capital gains deduction on their disposition (see topic 136). However, if you incorporate your business, you have to be careful that your business is not a “personal services business.” The problems with operating as a personal services business are discussed more fully in topic 24.

Transferring your business assets to the corporation on a tax-deferred basis

Most business assets can be transferred to a corporation without incurring immediate income taxes on the transfer. But there are some rules that apply, which means you must follow definite procedures and meet specific criteria. Your tax adviser can advise you on the merits of incorporation and how it might be accomplished on a tax-deferred basis. Provincial transfer taxes, such as property transfer tax and retail sales tax, also have to be addressed. In some cases, these taxes are unavoidable. There may also be GST/HST considerations on the transfer, as well as other non-tax issues.