January/February 2004: by Jim Nellis

Less tax, more flexibility - incorporating your business is win-win

If you like paying less tax - and who doesn't - then incorporate your business. It is fast, easy, and relatively inexpensive. It can apply to anyone who runs their own business, from driving your own rig, to running a convenience store, to offering professional services like a doctor or lawyer.

Incorporating your business is probably the single-most effective wealth management decision available to a small business owner or professional. That's because incorporation lets you defer a substantial portion of your income tax and charge expenses more efficiently against your income. It also provides some capital gains benefits as well as broader liability protection.

When you incorporate your business, all of your billings are paid to your corporation. You then earn a dividend or draw a salary for your living expenses. The tax benefit is that the small business income tax, at 19 per cent in Saskatchewan, is far less than the tax rate on personal income - up to 44 per cent - so any money left in your corporation is taxed at a much lower rate than if you earned the money personally. Of course when you withdraw this income you will pay personal income tax on it, just like an RRSP, but holding the funds in your corporation lets you push these payments into the future.

The small business rate applies to the first $250,000 of your annual business income (for fiscal year end 2004), or a potential tax deferral of $62,500 every year (the difference between the marginal personal income tax rate of 44 per cent and the small business rate of 19 per cent). To receive this full benefit, you would have to keep the full $250,000 in your business and draw a salary on top of this.

When you make a withdrawal you can save even more taxes by splitting the income with family members. You can do this by paying a spouse or adult child a fair wage. Or, because in most small businesses family members or a family trust can own shares, you can pay out profits as dividends. This is a very effective way of splitting income with your spouse or grown-up children, especially if they are in a low tax bracket.

For example, if you wanted a family income of $100,000, you could pay this out as two incomes of $50,000, saving thousands of dollars in income tax over a single income.

There are pros and cons with each structure. It is difficult to split income with an underage child because of ''attribution'' rules that return the tax burden to the trust or corporation. The rules for capital gains are different for family trusts than for individuals. Some professions limit family ownership of professional practices. On the plus side, you may be able to set up profit sharing or a personalized pension plan within the corporation.

Another benefit of incorporation is that you need less income (because you're paying less tax) to pay for nondeductible expenses, like meals and entertainment. For example, to pay $1,000 in club dues, you need a personal income of about $1,800 (at the 44 per cent marginal tax rate), but you only need a business income of $1,235 (at the small business rate of 19 per cent). The difference - $565 - is money in your pocket, however you need to be careful that the expense is not considered a taxable benefit.

A third benefit of incorporation is that when selling your business you may be able to shelter up to $500,000 of capital gains from the sale. Because of technicalities, you should review this policy with your financial planner or accountant before assuming to make sure you qualify for the exemption.

Finally, running a corporation offers more liability protection to you as a shareholder than if you were running a sole proprietorship. If you are a professional, you are still personally liable for the delivery of professional services, but you may be protected against creditors like landlords or suppliers.

Of course there are costs to incorporation, including legal and accounting fees. And the more complex your business structure, the greater the difficulties due to business disruption, problems with creditors, marital break-down or winding up a partnership.

Ideally your ownership structure should be integrated with your investments and wealth management strategy. At Assante we work in partnership with your accountant and lawyer to help you develop a holistic strategy that combines your wealth management goals, business needs, estate plan and retirement intentions... and pay less tax.

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About the author
Jim Nellis, B.Comm, is a Financial Planning Advisor with Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 306-665-3377, or click to email Jim Nellis.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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