Pros & Cons of Incorporating
As more companies require their independent tech contractors and consultants to operate as corporations, knowing the pros and cons of incorporating can help you better plan your career as an IT consultant.
What is Incorporation?
In Canada, there are four types of business structures for companies: sole proprietorship, partnership, corporation and co-operative. Companies select the most appropriate structure depending on their needs, and each structure requires distinct legal, accounting, governance, and administrative obligations.
Individual IT and tech consultants typically take one of two roads, either sole proprietorship or incorporation. For consultants entering a contract or making the commitment to full-time contracting work, incorporation elevates your career…at a cost.
While your quality of work will be the same whether as a sole proprietor or a corporation, incorporated consultants frequently are viewed more positively by prospective clients and industry partners.
Investing the time, energy and money into incorporation signifies that a consultant is serious about and committed to their career.
Tech consultants and independent contractors face the threat of a lawsuit if a client is not satisfied with a project or the consultant does not fulfill their obligations.
In that situation, a consultant operating as a sole proprietor is personally liable for any claims. Homes, cars and other personally-owned assets and financials accounts would be subject to creditor action. (Some clients will require the sole proprietor to have insurance coverage for errors and omission, product liability, intellectual property rights infringement, and more, costing up to $1200 for a $1 million coverage.)
Under incorporation, the company and its assets – not the consultant or their assets – would be responsible for any damages.
A sole proprietor pays personal income taxes at the same level that a traditional employee pays.
Once incorporated, however, the consultant pays a corporate tax on the company’s income, called active business income (ABI). The corporate tax rate of 15.5% (up to $500,000) is lower than the personal income taxes. In turn, the consultant will pay personal taxes on their salary withdrawn from the corporation’s funds.
Incorporating offers a consultant more options for how to structure key business activities. For instance, some incorporated consultants may opt to take dividends, not salary, from the company for tax advantages.
Also, corporations can select their financial year-end at any point during the calendar year, giving the consultant flexibility to choose a date that makes the most financial sense.
Though the professionalism associated with incorporation can be a benefit, running a formal company will cost time and money.
Running a corporation, regardless of its size, involves paperwork: accounting, corporate bylaws, register of directors, etc. If you incorporate, build in time to manage the required administration.
Unlike a sole proprietorship, setting up a corporation will cost approximately $1,000, and the cost for the legal and accounting services to administer the company can easily cost $1,900 annually. Note: Those costs are less expensive than the personal income taxes paid by a sole proprietor.
Depending where the consultant does business, they will need to choose either provincial or federal incorporation. If the company operates exclusively in the home province, then provincial incorporation is required, while federal incorporation is necessary for any business outside of a home province. There are different costs for the various provincial and federal incorporation too.
If you are ready to progress from sole proprietor to an incorporating your business, resources are available online to get you started including Sole proprietorship, partnership, corporation or co-operative, from the Canada Business Network.
What are your thoughts on the pros & cons of incorporating?