Incorporating your small business certainly has its tax advantages, but there are also a few financial housekeeping items you’ll need to put in order when you decide to make that leap. Here are some important implications you should be aware of.
1. Income Tax Savings
Small Business Deduction If your business is a Canadian Controlled Private Corporation (CCPC), you can benefit from the small business deduction and pay lower income tax on the first $500,000 of active business income in the corporation. From 2016 to 2019, the small business tax rate will be reduced from 11% to 9%. To qualify for the deduction, a business must be a private corporation that is controlled by Canadian residents. Active business income does not include investment income, income from a specified investment business or income from a personal services business. Lifetime Capital Gains Exemption Another big tax savings that may be available to you as the shareholder of a CCPC is the Lifetime Capital Gains Exemption. When the time comes to sell your shares, the first $800,000 of taxable capital gains will be exempt from income tax.
2. Risk Management
Shareholder agreement If there are multiple owners with an equity position, you should draw up a shareholders’ agreement. This document will dictate how the activities of your corporation will be managed. It will address such issues as changes of ownership and what will happen in the event that a partner becomes disabled, retires or dies. It will also make it easier for a shareholder to buy out a partner, or their estate, if these situations arise. Insurance It’s important to make sure your company can continue to operate in the event of the disability or death of a key employee, such as the president. This requires you to purchase key person disability and life insurance. Disability insurance will make it possible to replace the disabled individual without paying an extra salary to their replacement. The life insurance death benefit will make it possible for the remaining shareholders to buy out the estate of the deceased individual. You should also purchase business overhead expense insurance as this policy will continue to pay for your fixed expenses when the company’s income is reduced as a result of disability or death.
3. Estate Planning
Estate Freeze If part of your business plan includes leaving your company to your children, you may want to consider doing an estate freeze now. An estate freeze is done by exchanging your common shares for preferred shares, and issuing new common shares to your children or a trust. This will lock in your future taxable capital gain now, and transfer the future growth of your company to your children. Dual Wills If you’d like to save on Estate Administration fees, consider drafting multiple Wills for your estate. The executor of an estate seeking probate is not obligated to probate all of the Wills. The executor has the option to probate whichever of the Wills of the deceased, and probate taxes would only apply on the assets that were part of the probated Will. Your primary Will would cover all of your assets, except for the shares of your corporation. The secondary Will would cover the shares of your corporation. With an Estate Administration fee of 1.5% on assets over $50,000 in Ontario, there can be significant savings. Incorporating your business can result in a lot of tax savings. But make sure that you take the risks into account as well. Not sure if incorporating your business is in your company’s best interest? I can help.
Marcy Ages is a passionate, detail-driven provider of financial planning services, including investment management and tax preparation. As founder of The Care Network, Marcy also works with other service professionals to support high-net-worth individuals with their estate planning and assisted living issues.
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