Sole Proprietorship or Corporation? Which is Right for Your Business?

When starting a business, one of the first decisions you have to make is how to register your business. The two most common options are a sole proprietorship and corporation. And the choice you make will determine how you manage the business. This includes everything from legal implications to tax filing. There are several variables when making this decision, and here are a few things to consider.

Sole Proprietorship

A sole proprietorship is the most common type of business model, especially for first time business owners. The income is included on the personal tax return of the owner and is taxed at personal tax rates.

Pros:

  • In this structure, one person owns and controls the business and the cost to register is low, with minimal paperwork. Keep in mind that the cost to open a brick and mortar store will be the same, regardless of what type of business registration you choose.
  • It’s easier to file your taxes because you only have to process one set of paperwork – for you and the company combined.
  • Business losses may be used to reduce your overall income from other sources.

Cons: 

  • While setting up a sole proprietorship is the simplest structure for a business, there are liability risks associated with this business structure. Since the business owner and the business are considered to be one single entity, the owner is personally responsible for anything that goes wrong, for example a lawsuit against the business.
  • If the business owner is sued, the payout to the claimant could potentially extend to the business owner’s personal property and savings.
  • If the business is profitable, the individual tax rate could be higher than the 15% corporate tax rate.

Corporations

Corporations are separate legal entities owned by one or more shareholders. Funding is done by the selling of shares or borrowing money. Quite often in small corporations, the shareholders are also directors.

Pros:

  • One of the biggest advantages is limited liability.
  • Generally, business owners may not be at risk of losing personal assets in the event of a claim against the company.*
  • The corporate income tax rate of 15% on the first $500,000 of income is typically lower than the personal income tax rate.

Cons: 

  • Setting up a corporation can be complicated and expensive. Legal advice is recommended, as it’s important to ensure the share structure is properly established.
  • If a shareholder co-signs a loan for the corporation, the shareholder could be held liable if the corporation defaults.
  • Shareholders who are directors can be held legally liable for the CRA debts of the corporation.
  • Business losses can not be used to reduce your personal income.

In summary, the decision to register your business as a sole proprietorship or a corporation depends on several factors. A business owner must weigh the benefits and challenges related to accountability, financing, taxation, and liability.

*Each situation is unique and there are some scenarios where there may be exceptions to the general rule. This blog is intended as an introduction to the topic and there are several other considerations when making this very important decision. If you need more detailed insight into incorporating your business, contact Pam at pam@pamlittlecpa.com.

 

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