Will becoming incorporated protect me from the debt of my business?

_{By Bromwich+Smith Staff | 762 words | Reading Time: 3 minutes and 48 seconds | Date: 2022/10/18}

With small business month under way, lets take time to look at common misconceptions about business debt starting with one we hear often- I didn’t know I was personally responsible for my business debt.

Often, when an entrepreneur starts up a new business, they need a business loan to get started. In most cases, they will need to personally guarantee the loan. In this way, the bank or lender is protecting themselves if the business ceases to operate and they can no longer pursue the company for the debt or loan payments, they can go directly to the business owner or whoever guaranteed the loan. When signing or co-signing a loan it is important to review the small print on your loan documents, as you could be liable for the debt even if the company shuts down.

Many individuals will tend to be advised by legal counsel and accountants to incorporate their business.  An incorporation creates a separate legal entity from the individual so in many ways this can be beneficial to the business owner.  Where there may be personal liability is for Director’s liability and personal guarantees.

What is Directors Liability?

Directors of a corporation have personal liability for certain statutory debts to CRA namely GST owed by the corporation, and payroll source remittances of the corporation.  Directors are not necessarily liable for the corporate income tax although it has happened where a director has been assessed personally for corporate income tax liability when they have taken dividends out of the company.  In essence if the company has debt for tax, there should not be any dividends payable until after that debt has been paid.  This can be common for individuals as they tend to take dividends out of the corporation instead of a regular paycheque because the tax consequence is less to the individual.

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What happens if my business needs to close?

Starting a new business can be a risky move, recent research has shown that over 20% of new businesses fail within the first year. With so many factors outside of anyone’s control- including the Pandemic, tumultuous weather and inflation and threat of recession starting a new business can be risky. So, what happens if you need to shut down your business? Typically, if a corporation has debt and no assets of value it can simply shut down and the debt dies with the corporation.  The question usually becomes what debt does the individual have accruing to them as personal debt for example director’s liability if they are a director or any corporate debts they may have guaranteed. This will all vary, depending on your loan agreements and what you have personally guaranteed. Before you make the step to close down, invest in a lawyer who can help review any documents with you. There may be benefit to selling parts of the business, equipment, stock or subleasing a rental space.

Business Bankruptcy vs Personal Bankruptcy

It is important to keep in mind, that as a small business owner, A “business” bankruptcy is not separate from your own personal finances, if the business is not incorporated and you are the sole proprietor (i.e. a farmer, an electrical contractor, or a construction subcontractor who is not incorporated.  A great way of illustrating this is by looking at the personal tax return of the individual.  A sole proprietor will have a statement of business activities included in their personal tax return.  It is not separate; it is simply their self-employed income.  If the business is incorporated, the corporation will have a separate tax return as it is a separate entity as noted above.

If your business is run as a non-incorporated Business, all debt the business incurs, will be seen as your own personal debt and will not be separated.

It is important to make sure you do all the research when starting up your business. By having a great team to support you, including financial experts, and a great lawyer like the Legal team at LITCO LAW, you can set your business- and yourself up- for years of success.

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No two financial stories are the same, and because of that Bromwich+Smith has a number of debt relief strategies to help you regain control of your finances and get your life back on track. Reach out today for a free, confidential, no obligation consultation. Bromwich+Smith’s Debt Relief Specialists are available by phone at 1.855.884.9243, or request a call back at contact us page. We want to see you flourish!