While there are several advantages to incorporating a small business, there are also disadvantages that need to be considered. The main disadvantages of incorporation, I think, are the increases in paperwork and cost, which can be substantial compared to a sole proprietorship or partnership.
1. Another Tax Return
When you incorporate your small business, you'll have to file two tax returns each year, one for your personal income, and one for the corporation. This, of course, will mean increased accounting fees. Unlike a sole proprietorship or partnership, corporate losses can't be deducted from the personal income of the owner.
2. Increased Paperwork
There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. Corporations, for example, must maintain a minute book, containing the corporate bylaws and minutes from corporate meetings. Other corporate documents, that must be kept up to date at all times, include the register of directors, the share register, and the transfer register. (See Getting Your New Corporation Up and Running for more information on the corporate minute book and other documents necessary for corporations.)
3. No Personal Tax Credits
Another disadvantage of incorporating is that being incorporated may actually be a tax disadvantage for your business. Corporations are not eligible for personal tax credits. Every dollar a corporation earned is taxed. As a sole proprietor, you may be able to claim tax credits a corporation could not.
4. Less Tax Flexibility
A corporation doesn't have the same flexibility in handling business losses as a sole proprietorship or a partnership. As a sole proprietor, if your business experiences operating losses, you could use these to reduce other types of personal income in the year the losses occur. See "8 Tax strategies to Maximize Your Business Tax Deductions". In a corporation, however, these losses can only be carried forward or back to reduce the corporation's income from other years.
5. Liability May Not Be As Limited As You Think
The prime advantage of incorporating, limited liability, may be undercut by personal guarantees and/or credit agreements. The corporation's much vaunted limited liability is irrelevant if no one will give the corporation credit. When a corporation has what lending institutions consider to be insufficient assets to secure a loan, they often insist on personal guarantees from the business owner(s). So although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can't meet its repayment obligations.
6. Registering A Corporation is Expensive
A further disadvantage of incorporating is that corporations are more expensive to set up. A corporation is a more complex legal structure than a sole proprietorship or partnership, so it's logical that creating one would be more complicated and costly.
Fees for incorporating a small business either provincially or federally range in the hundreds of dollars - and that's just for the set up. I've already mentioned the increased maintenance and related fees, such as increased accounting costs.
Should you incorporate your small business? I've outlined the advantages and disadvantages of incorporating in this article, and you can find more information about how to incorporate your business in my Incorporating A Business library of links, but I strongly recommend that you discuss your personal situation with your accountant and lawyer before you decide. He or she will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.