Here is article that I have written -the answer is it depends -but here are some factors to look at
“If I fill a short form CRA gets a chunk of money, if I fill out a long form the accountant keeps the money- but when I incorporate –all the professionals dig into my pocket book because I created a new taxpayer-a corporate entity”
This topic should be addressed by 4 professionals, a lawyer and an insurance agent to cover legal liability issues, a mortgage broker/banker to address the difficulties in obtaining commercial financing and an accountant to deal with taxation issues. When I am discussing items that should be discussed with the 3 other professionals, the lawyer, the banker and the insurance agent, I am referring to my personal experience and clients experiences –not as a professional. These pointers will help you have a decent dialogue with the other professionals so that you can make a decision for yourself.
Firstly, from a tax perspective it is important to understand the difference between active and passive income. Passive income is income earned from investments such as rental income, interest and dividend income. Active income is income from businesses that are active such as a retail store, restaurants, professional practices, developers and rental income in a corporation that has more than 5 full time employees under one corporation. The first $400,000 from these business which are Canadian Controlled Private Corporations(CCPC) are taxed at the low rate of corporate tax for the income that you leave in the corporation–around 18% depending on your province. Income from passive sources are taxed at the highest rate –around 46% depending upon your province.
As a result of this, if you are purchasing rental properties it is not advisable to incorporate. If you are a builder, land developer or a flipper, then you should consider incorporating. If you are buying multi-family buildings in Alberta –the banks will make you incorporate.
t-size:12pt;line-height:100%">My banker tells me - anytime I borrow funds in a corporation, they ask for personal guarantees – which mean the banks can come after me personally for the loan. This document is so iron tight, that even if I want to file bankruptcy, the bankers have to approve it. They will only do it if it benefits them. From a banker`s perspective, why would they risk loaning me the money if I do not have faith in my project?
Secondly, there are only a few lenders who like to work with a corporation. So you will limit the number of bankers that will deal with you. Their costs are also higher when you are dealing with commercial loans.
When I talk to my insurance agent, he tells me most of the lawsuits are frivolous and small. Buy the best liability insurance you can get of at least a million. Top this one with an umbrella policy between 5-10 Million. They have full time lawyers whose jobs are to try and get out of paying a claim. When a claim comes in, inform them immediately and they will deal with person suing you –as this person will most likely hire a lawyer on a retainer. The insurance company may try to get out of paying a claim and take the position that it is not covered in the policy-if this happens hire your own lawyer who specializes in suing insurance companies. You would like the insurance company to hire a lawyer to defend you from the lawsuit.
A lawyer will tell you-the frivolous lawsuits will stop at the door of the corporation –unless they go after you personally as a director being negligent. The difficulty with lawsuits is they take time and money. If the other party has hired a lawyer on a retainer, you have to pay your own lawyer at an hourly rate. As a result, the person with the deepest pockets can keep it going and the one without money has to settle. Who do you think will get the best deal? If such an event takes place, you would loose the equity in that property if your insurance company does not cover it.
The main disadvantage to incorporating for single family homes is the cost and complexity of maintaining and creating a corporation will be higher. Your accounting fees are higher as you will be required to keep a double entry bookkeeping system to create accurate financial statements, corporate tax returns take longer to prepare, working paper files have to be more detailed. Your insurance costs will be higher as you will be required to buy a commercial policy. Your banking costs will go up as commercial bank account fees will be higher, interest rates will be higher and the closing documentation will be higher.
There are other issues such as dealing with Capital Gains. If you own a property on your own, you sell the property and claim it as a Capital Gain, you report only half your income. If CRA disallows the capital gain – your only discussion point who is correct. You will pay interest if CRA wins. On the other hand, you own a property in a Corporation, you claim a capital gain, you are required to file a document that allows you to pay a Capital Dividend. If CRA challenges your claim for a capital gain because they think you are a flipper and they win – now you have a problem. You will have deemed to have paid a capital dividend when one did not exist hence you end up paying penalties. This is a complex issue –hence if you do not understand it –just shake your head at the complexities of a corporation.
Similar rules exist for any income you earn in a corporation. The Corporation earning rental income is taxed at the highest rate. If your Corporation has taxable income, you will be required to pay dividends to claim back Refundable Divided Tax Credit on Hand (RDTOH). Now you have to file your T5’s prior to February 28 of the following year. All these forms take time to prepare and are complex. You end up paying for them.
So at this point you can see the complexity of having a Corporation. Which one will be easier to maintain? Which one will cost you more?
