Whether you’re thinking about starting a side hustle for extra income or making the leap to becoming your own boss, there’s a lot to consider when starting a small business. One of the first decisions to make is the type of business structure you need. In Canada, your business can operate as a sole proprietorship, a partnership, or a corporation.
There are pros and cons to each option, but important differences in terms of startup costs, liability, tax rates, and estate planning should be considered before making a decision. Understanding the key differences between proprietorship, partnership, and incorporation can help ensure your small business starts off on the right foot.
Sole proprietorship
In a sole proprietorship, one person operates a business without forming a partnership or corporation. Any income earned from the business is considered self-employment income and is taxed at personal income tax rates on the business owner’s personal income tax return.
Benefits of a sole proprietorship:
– Simple, inexpensive registration process
– Fairly minimal reporting requirements include:
– Annual personal tax return
– Payroll remittances and filings for any employees
– Can deduct losses from your personal income
– Can deduct expenses including prorated amounts for office and vehicle costs
– Proprietor controls all decision making and receives all profits
Disadvantages of a sole proprietorship
– As sole proprietor, you are personally liable for all debts and any other business liabilities — creditors may make claims against any business or personal assets to pay off debts
– Fewer funding opportunities and may be more challenging to raise capital to help build and grow the business
– Not easily transferable or inheritable in the event of the proprietor’s death
Partnership
Similar to a proprietorship, a partnership is unincorporated but two or more entities are partners in the business, and business decisions are agreed upon together. A partnership agreement will outline the terms of the partnership and how any disagreements or dissolution will be resolved. In the absence of such an agreement, provincial or territorial laws will determine the terms of the partnership.
Benefits of a partnership
– Partnerships enjoy many of the same advantages as a sole proprietorship including relatively low setup costs, expense deductions, minimal reporting requirements, and ability to deduct losses from personal income
– A more experienced business partner can provide valuable guidance and mentorship to a less experienced business owner
– Startup costs are shared among partners
Disadvantages of a partnership
– Consensus is required for all business decisions
– Like a proprietorship, partnerships are subject to unlimited liability — all personal and business assets can be targeted by creditors
– A partner’s liability does not end even after death or retirement for debts and obligations of the partnership that were incurred prior to the death or retirement
Unlike a proprietorship or partnership, a corporation is a legal entity that is separate from its shareholders. As such, a corporation pays corporate income tax, which is calculated separately from the shareholders’ personal income tax.
Benefits of a corporation
– Shareholders are not personally liable for debts or obligations of the corporation
– More government funding options to help build and grow your business
– Can write off certain business expenses and may also benefit from additional tax advantages
– A corporation exists in perpetuity and ownership is transferable
Disadvantages of a corporation
– Higher startup fees which may include legal fees for articles of incorporation, federal and provincial incorporation fees
– Higher accounting fees for filing an annual corporate income tax return and any additional bookkeeping or tax planning consultancy
– Additional reporting requirements include:
– Corporate records which must be held for six years
– An annual corporate income tax return including detailed financial statements
– Payroll remittances and filings for any employees
No matter which type of business structure you choose, some common rules apply. Firstly, there’s no escaping the Canada Revenue Agency. Whether you end up paying personal tax rates or corporate tax rates, tax happens! Also, if your revenue exceeds $30,000, you will need to register for GST/HST and track all sales tax paid and collected.
Each business situation is unique and choosing between a sole proprietorship or a corporation can be a difficult decision. While tax savings, limited liability, and greater capital-raising opportunities make incorporating an appealing option, higher administrative costs, additional compliance burden, and more complex reporting requirements might lean in the favour of sole proprietorship particularly if your small business has a relatively low operating risk and a net income under $50,000.
Consulting with an accountant and/or lawyer before launching your business is a wise choice and can save you money and frustration in the long haul. A good corporate lawyer and a professional accountant that specializes in tax planning services can be valuable members of your small business team.
Author: ChamberPlan.ca
