Sole Proprietorship vs Corporation

Sole proprietors often ask whether they should incorporate their business. Continue reading below to understand the benefits of each business structure.

Sole proprietorship

Let’s first define what is a sole proprietorship. The Canada Revenue Agency (CRA) defines a sole proprietorship as an ‘unincorporated business that is owned by one individual. It is the simplest kind of business structure.’ To put it differently, if you earn income from self-employment, such as being a software developer or running a consulting practice without incorporating, you are essentially operating as a sole proprietorship.

Let’s jump into the advantages and disadvantages of having a sole proprietorship

Advantages:

• Affordable: Starting a sole proprietorship can have no cost or a minimal cost if a business name needs to be registered.
  

• Simplified and Less Expensive Tax Filing: For income tax purposes, all earnings are treated as personal income, streamlining the process and requiring only the filing of a personal income tax return.
  

• Reduced Paperwork: Operating as a sole proprietorship entails fewer annual filings and diminished reporting obligations, minimizing the paperwork involved.

Disadvantages:

• No Liability Protection: As the owner of the sole proprietorship you are solely liable for the debts of the business. There is also no legal protection. Consequently, sole proprietors assume full accountability for legal issues.
  

• Higher Taxation: Typically, corporate tax rates are lower than personal income tax rates. Therefore, operating as a sole proprietorship may result in a higher tax liability.
  

• Limited Financing Opportunities: Unlike incorporated businesses, sole proprietorships do not enjoy access to most government grants and incentives. Securing financing and business credit is also more challenging for sole proprietors.
  

Corporation

In simple terms, incorporations is a legal process used to to establish a company as a distinct legal entity independent of its owner(s).

Advantage:

• Limited Personal Liability: The corporation functions as an independent legal entity, ensuring that shareholders/owners bear no liability for the company's debts. This protection shields shareholders from legal consequences and personal bankruptcy.
  

• Grants and Financing Opportunities: Incorporated businesses enjoy improved prospects for obtaining grants and financing from banks due to their perceived credibility.
  

• Reduced Taxation: Corporate tax rates are generally lower than personal income tax rate.

Disadvantage:

• Incorporation Cost and Complexity: The cost of incorporating is more expensive than starting a sole proprietorship. The expenses vary based on whether you opt for provincial or federal incorporation. Federal incorporation alone may range from $200 to $300 for the application. It's occasionally beneficial to enlist an accountant or lawyer to prepare the articles of incorporation.
  

• Ongoing Costs: Regular payment of annual filing fees is mandatory.. Furthermore, the complexity and cost of corporate tax preparation and filing are increased, necessitating the expertise of an accountant.
  

• Increased Paperwork: There are a lot more filing and paperwork that needs to be done and sent to CRA. For instance, if you intend to claim employment income the preparation of a T4 is essential. Bookkeeping will need to be done on a periodic basis.

Tie-Breaker

If after going through the advantages and disadvantages of each business structure you are still undecided, the example below may provide more insight.

If your business earns more income beyond your personal needs, incorporating is recommended. Here’s an example to get a better understanding.

Assume your sole proprietorship earns $150K in profit for the year, but you only need $100K to live comfortably and save for retirement. In this situation the full $150K is taxed at the personal tax rate, which we’ve determined is generally higher than the corporate tax rate.

Now let’s assume your incorporated businesses earns $150K in profit for the year and you decide to pay yourself a salary or dividends of $100K. Only $100K will be taxed at the higher personal tax rate.

Hence, it’s generally better to incorporate if you earn more income than you need live and save comfortably. Keep in mind that this was a simplified example and every situation is different. 

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