Liliane Fortier, Les Affaires 15-09-2012

In deciding whether it’s better to operate your firm as a sole proprietorship, a partnership, or a corporation, you should know that these options have different legal and fiscal implications.

1.  Sole Proprietorship

The profits or losses of a sole proprietorship are included on the owner’s income tax return.  This means the tax rate will be graduated, and could be as high as 48%.  If, in the first few years, it appears the enterprise will be making a loss, that loss will reduce the owner’s taxable income, thereby reducing the amount payable.

2.   Corporation

If the profits generated by the enterprise are higher than the income required by the owner’s lifestyle, incorporation might be a better choice.  The marginal tax rate for someone earning more than $100,000 a year is at least 45%, and could reach 48%.  The rate for a corporation, however, is 19% on the first $500,000 of taxable income, provided that corporation is an active business.  Profits remaining in the corporation are taxed at a lower rate.

Control Over Income

As cash inflows can fluctuate from month to month, managing a personal budget may be problematic. With a corporation, shareholders can choose to be paid by either salary or dividend.  Furthermore, remuneration can be paid in a flat amount with a period determined by the shareholder (weekly, every two weeks, etc).

Income Splitting

Being able to split income with family members is likely one of the biggest tax advantages.  With a corporation, a spouse and children can receive dividend income, for which the highest marginal tax rate is approximately 36%.  In paying a dividend to one’s spouse or adult child, therefore, the tax rate on the dividend is reduced if that person’s income is low.

Estate and Tax Planning

Operating a corporation also facilitates estate planning and limits tax liability at death by freezing assets in favour of the family.

A corporation can also elect when to end its financial year, making it possible to defer payment of taxes due the first year.

Lastly, it is possible to incorporate a sole proprietorship tax-free.  So why not take advantage of the sole proprietorship at the outset, and of the corporation thereafter?

Liliane Fortier, CPA, CA, LL.M. Fisc. Partner – Taxation Services – Demers Beaulne – 514 878-0258 – lfortier@demersbeaulne.com