Accountants: When is the right time for your sole proprietor or partnership clients to incorporate?

WHAT do you do when your clients ask if it’s time for them to incorporate their business? How do you determine whether or not it’s the right time? Ownr breaks down what you should consider to help your client make the right decision. 

As a Canadian accountant, you know that incorporation is the process of creating a separate legal entity distinct from the owner. This new entity can then enter into contracts, borrow money, and own assets in its own name. If you have clients that are running their businesses as either sole proprietorships or partnerships, and you’re wondering if it’s time to have the ‘incorporation’ chat, this article is for you. 

We break down two main factors to look at with your client to help navigate through their business’s next stage.

Want to learn more about Ownr? Read: How entrepreneurship tools are strengthening the relationship between business owners and their accountants on Canadian Accountant. (Shutterstock)

Increased Liability Risk

The first factor to assess is your client’s liability risk. Look at their business and determine if it involves a significant amount of risk or potential for legal or financial liability. This assessment often comes down to reviewing three pillars: the nature and industry of their business, whether or not they have employees, and the number of sales originating from the United States.

With respect to the first (nature and industry), health care, professional services, moving services, technology and software services, landscape and construction services are all industries that come with increased liability risk. Businesses that handle large amounts of personal identifiable information (PII) are also inherently riskier. Ultimately, it’s best practice to encourage your client to seek legal advice if they are unsure of where they sit on the “risk continuum” before they make any big decisions.

The second pillar to consider for risk is whether the business has any employees, as the simple fact of having an employee will increase the risk profile of the business. The last pillar to consider is whether the business has sales originating from the United States. These final two categories are easier to identify and as both can indicate a higher-risk profile, they are more likely to lead your client to incorporating. 

Taxes: Advantages and Benefits as a Corporation

The second major factor to review before incorporating a business is potential tax benefits. We’re all aware that with significant business income, comes great tax advantages through incorporation. Incorporating can also provide flexibility with how your client is paid by choosing either employment income or dividends.

There’s no magic number for when a client should incorporate. Rather, it comes down to their lifestyle — do they need a $80,000 salary or a $150,000 salary? With the higher salary, it will take more revenue to justify incorporating from a pure tax perspective. Whereas with a lower salary, your client can realize substantial tax savings and keep the extra money in the business as a corporation.

Let’s use an example:

A client of yours based in Ontario currently operates a business selling vintage photography prints and earns $150,000 per year in profit — but she only needs $80,000 to support her lifestyle.

• If she is a sole proprietorship, she would pay approximately $50,000 in personal income taxes.
• If her business operates as a corporation and she takes an $80,000 salary, she would owe about $30,500 ($20,000 personal + $8,500 corporate) in taxes. This leaves her about $20,000, which can be reinvested in an income-producing asset for the business (like a new printing press) or put into a public investment vehicle and deferred to be paid out at a later date.

Ask your client to consider their lifestyle’s needs before incorporation. As we laid out above, they have the potential to save significant taxes while improving their business.

Another potential tax benefit is the ability to take advantage of a lifetime capital gains exemption. This may be applicable if your client ends up selling their business. As long as they satisfy the conditions outlined here, their capital gains (up to a certain amount) could be exempt from being taxed.

When the time comes to sell the business, your client should get specific advice on how to structure the transaction to maintain their eligibility. But remember, their exemption isn’t possible unless the business is incorporated.  

Other Benefits to Consider

Other incorporation benefits include name reservation (different from name protection), increasing credibility or professionalism,  and optionality around estate-planning. While your clients are unlikely to incorporate for these reasons alone, they can certainly help tip the scales.

As partners, Canadian accountants can help support small business clients with digital tools like Ownr that automate incorporation and legal work for entrepreneurs in Canada. Learn more here or email professionals@ownr.co to find out more about Ownr’s Professional Partner Program. (Shutterstock)

Does your accounting firm have clients that are in a position where incorporation makes sense for liability and/or tax reasons? Then Ownr’s professional partner program can help. Ownr’s professional partner program provides a quick, affordable, and reliable method for your clients to incorporate, while also creating a new revenue stream for your accounting practice. 

Over 50 accounting firms in Canada currently leverage Ownr’s professional partnership program. If you’re interested in learning more click here or email professionals@ownr.co. We’d be happy to see if it’s a good fit for your firm.

Maggie Chuang is senior marketing specialist at Ownr. Advertising feature produced by Ownr. Images: Shutterstock. Author photo courtesy: Ownr.