What is Sole Proprietorship?
If you’re a sole proprietor, you operate your business personally.
This means that you’re operating as a “one-man-band” with no shareholders or partners, and you’re personally tied to your business, meaning that you take on responsibility for all financial profits and losses. Your income is included on your personal tax return, and taxed at personal rates.
| Benefits | Drawbacks |
|---|---|
| Getting started is relatively easy, and costs for setting up a sole proprietorship are generally lower than incorporating a business. | You’re fully liable for your business, including all debts and losses. For example, if you were to be sued, your personal assets could be at risk. |
| As business losses can be written off against other income, you can remain in a lower personal income tax bracket. | If your business starts to become very profitable however, this may mean you pay more in personal taxes, as these rates tend to be higher than corporate tax rates. |
| You’re in charge! You get to make all the decisions, with no need for approvals from shareholders or board members. | If you need or want to raise capital for your business, this might be harder to do as a sole proprietor. Many investors or banks would only lend to or invest in an incorporated business. |
| Proprietorships are regulated by the provincial/territorial governments, but generally to a lesser extent than corporations. | You’ll have to have a succession plan for your business if you want it to keep operating after you’re gone, as net business assets can pass to your heirs, but valuable leases and contracts may not. |
What is a Corporation?
When you form or ‘incorporate’ a business, you become legally separate from it.
This means that unlike being a sole proprietor, you and the business are 2 different entities, and so are the financials. The corporation issues shares to the owner(s) of the company, known as shareholders, and pays corporate income tax instead of personal.
You’ll need to incorporate your business by providing ‘articles of corporation’ to the Government of Canada. These are documents that describe the share structure of your business, and help ensure that the way you set up and run your company is compliant with government rules.
You may want to think about incorporating if your small business starts to grow and becomes very profitable, or if you want to protect your personal income and assets in case things don’t go so well. As always, there are pros and cons to think about when it comes to forming a business:
| Benefits | Drawbacks |
|---|---|
| As your assets are separate from that of the company, they’re protected from lawsuits against the corporation. This provides some security in that if your business doesn’t work out, you won’t also lose your home or savings. | Incorporating is less straightforward than becoming a sole proprietor, as you’ll need to set up things like issuing shares to the shareholder(s), what kind of shares you’ll own and choose directors and officers.In some cases, shareholders who are also directors may be legally liable for some company debts. If in doubt, you can get professional advice to help with setting up your company. |
| If you need a loan or an investment, being incorporated may help you raise the capital you need. | Along with being more a complicated process, incorporating a business is a more expensive one, too. |
| There are tax advantages available to businesses, as corporate tax rates are generally lower than personal income rates. | You can’t write off business losses against your income, and you must be clear about expense claims. Failing to keep receipts and paperwork for expenses could result in your business being audited. |
| If you want to retire or no longer want to run your business but don’t want to see it close, you can sell your company and transfer ownership. | There’s more paperwork and admin associated with running a business, including filing annual reports and corporate tax returns (on top of your personal tax return).If you want to hire someone to take care of your company admin, you’ll need to factor in this ongoing expense into the company budget. |
There are other things to consider when it comes to working for yourself, such as health coverage and retirement planning.
If you’re a sole proprietor, you may look at purchasing some individual health coverage to bridge the gap between what’s covered by provincial and territorial plans, and what you pay out of pocket.
If you incorporate a business and start hiring employees, you may want to look at offering a workplace benefits plan to provide your staff with health and dental coverage, and/or workplace wellness plans.
If you’re self-employed and not contributing to a workplace pension plan, you may look at setting up a Registered Retirement Savings Plan. To help you put aside for the long-term. If you run a business, you could look at offering your employees a retirement and savings plan.
One more key thing to think about is protecting your business and/or your business partners in the event something happened to you. Life insurance for your business can be personally or corporately owned, and provides a one-time, tax-free payout for your business if you die.
What’s next?
Whether to incorporate or become a sole proprietor is a personal and big decision that will depend on several factors.
If you have business partners or want to have another person join your business, forming a partnership could be another option.
If you’re unsure about tax and legal implications when choosing how to structure your business, speaking to a CPA can help.
