The main reason many business owners decide to incorporate, is because the corporate tax rate is less than the personal tax rate. Paying less tax allows owners to put more money back into their business.
One situation in which this can be extremely beneficial is if the company is taking on large debt. For example, if you are purchasing a large asset for your business. Let’s go over some of the benefits of incorporating when your business has large debt.
How Does This Concept Work?
Let’s say you’re purchasing a piece of equipment for your business, so you’re taking out a large loan. When you pay back this loan, the money leaves your account, but it’s actually not an expense. This is considered to be a transfer of assets. You owe the bank less, but your asset is “more paid for” than before. Therefore, paying your loan doesn’t lower your taxable income. So, if you’re being taxed at a high percentage, it will take longer to have the cash to pay your loan. Also, your payments aren’t lowering your taxes. If you’re incorporated, your tax rate is much lower. Therefore, although you’re still paying down your loan, you keep more in the bank.
For a worked through example of how this works, check out our video below. We show the difference between paying back a $12,000/year loan while being taxed at a personal rate vs. a corporate rate. In today’s world this would be considered a small loan. So, the difference being incorporated can make is actually much larger than what is shown in our example. This is why you may want to consider incorporating when your business is taking on large debt.
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