Sole Proprietorship vs. Corporation

The traditional comparison: sole proprietorships versus corporations. A sole proprietorship is simple to set up, but you and your business are legally one. This means your business income is reported on your personal tax return and any losses can be applied against your other income. However, the major drawback is that you have unlimited liability for any debts or lawsuits incurred by the business.

A corporation is a separate legal entity from its owners. This means that the corporation itself is liable for its debts and obligations, not the owners. This provides personal asset protection for the owners. However, incorporating your business involves more legal complexities and formalities.

When to Consider Incorporating

Here are some of the reasons why you might want to incorporate your business:

• Limited Liability: This is the primary reason for incorporating. If you are sued or your business goes bankrupt, your personal assets like your house or car are generally protected.
• Tax Advantages: Corporations have different tax rates than individuals. In Canada, the small business corporate tax rate is currently 12.2%, which can be much lower than the top marginal personal rate. However, this tax advantage only applies to the money that is left inside the corporation and not withdrawn by the owners.
• Income Smoothing: If your income is erratic from year to year, incorporating can be helpful. You can set your salary as a fixed amount and the corporation can retain the rest of the profits. This income is then taxed at the corporate rate and can be withdrawn later at a potentially lower tax rate.
• Selling Your Business: If you plan on selling your business one day, incorporating can be advantageous. In Canada, there is a lifetime capital gains exemption that applies to qualified small business shares. This means that you can sell your shares in the corporation and not pay tax on the capital gain.

Drawbacks of Incorporating

There are also some drawbacks to incorporating to consider:

• Cost: Incorporating your business involves legal fees and ongoing costs for maintaining the corporation, such as annual filings and minute book updates.
• Complexity: There are more legal formalities involved in running a corporation compared to a sole proprietorship. You will need to hold annual meetings and keep detailed records of your corporate activities.

Who Shouldn’t Incorporate?

Incorporating isn’t always the best choice for every business. If you are a new business with low profits, the cost and complexity of incorporating may outweigh the benefits. Also, if you are a home-based business with limited liability risks and steady income, you might be better off as a sole proprietorship.

How to Incorporate

The advice presented here is to use a lawyer to incorporate your business. While there are online incorporation services, they may not provide all the legal advice and documentation you need. A lawyer can help you choose the right corporate structure, set up your minute book, and ensure you comply with all the legal requirements.

Conclusion

The decision of whether or not to incorporate your business depends on your specific circumstances. Weigh the pros and cons carefully and consult with a professional advisor before making a decision.

 

Sources

Photo by Sora Shimazaki

Article courtesy of Jeff Brown of Bouris Wilson LLP

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