Sole Proprietorship Vs. Corporation: What’s the Difference?
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Sole Proprietorship Vs. Corporation: What’s the Difference?
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The world is changing; rapidly. Maybe you’re a small business owner worrying about the future and want to make sure you and your family are well prepared for the future. Maybe you’re a new corporation wondering if you made the right decision amidst everything that is going on in the world today.
In this post, we will be looking at two options for new business owners: sole proprietorship and corporations and try to help you make a decision that is best for your situation–and your family.
Sole Proprietor: You are the Business
If, and when, you choose to start a freelance business or sell goods and services in any capacity with the view of making a profit, you are considered a sole proprietor. The biggest point to note with sole proprietorship is that you are the business, thus you are personally liable.
In addition, this also means that you pay tax on anything your business does. You personally claim all expenses and all profits on your tax returns. You might be thinking, why would someone want a business setup like this?
Benefits of Sole Proprietorship
While there are many limitations to having the simplest business structure, there are also many benefits. Let’s quickly look at a few of them.
Generally speaking, running and starting a sole proprietorship is inexpensive. You do not necessarily need a lawyer or an accountant to help get your business up and running, thus, it is very cost-effective to simply be your own business.
Because the structure of your business is less complex than that of a corporation, you will have much less paperwork to complete. That means less time spent on administrative tasks, and more time racking up billable hours.
Hit the Ground Running
One of the major benefits of having a sole proprietorship is that you can immediately start your business without having to work through any red tape. Because all that is required to be considered an SP is to be the single owner of a business (to carry on with an activity to profit, with evidence of your intention) then you simply start your business by selling your services or goods.
What's a Corporation?
So far, we have discussed a business model where there is no differentiation between you as the owner and the business. However, this is where a corporation differs vastly from a sole proprietorship: liability.
When you incorporate, you create a separate legal entity that is its person and thus has its own assets and liabilities, pays its own taxes, has its own income, and can enter into contracts on its own. While you are still the owner of the business you are no longer personally liable for anything your corporation does, and you no longer pay yourself; your corporation pays you.
Benefits of Incorporating
Given the complexity of such an entity, some great benefits can be realized through this business structure. Let’s examine the most common ones.
In contrast to a sole prop., the owner of a corporation does not carry liability for the actions of the corporation, except in the case of special circumstances, such as a personal guarantee. To illustrate, say you own a construction corporation. If you build a road that is defective and causes an accident, your corporation could be sued for damages. However, you will not be sued. Corporations provide a layer of financial and legal security for the owner.
Tax Deferrals and Savings
One of the major benefits of owning a corporation is the ability to defer taxes and realize other tax savings by utilizing corporate tax rates for Canadian corporations. In contrast to personal tax rates that you would pay as a sole proprietor, these tax rates are quite low. Furthermore, operating as a corporation allows you to choose how much income you take out of your business in a given year, allowing you to lower your income tax bracket.
One thing to note, however, is that deferring tax is not the same as avoiding it. If you choose to not pay yourself out all of your profits in a given year, you will still have to pay taxes on the remaining balance when you decide to take it out. On the other hand, if you decide to use those funds to invest in the business by purchasing assets, you will never have to pay personal taxes.
More Financing Options
As starting up a new business can be emotionally and financially taxing (pun intended), having a corporation allows you to mitigate those consequences by having more options for earning funds. You will have more options for various small business grants, and you will be able to build equity as a corporation, allowing you to improve credit and increase your funds through loans or investors.
Moreover, there is the huge bonus of being to access the Lifetime Capital Gains Exemption (LGCE) for Canadian-controlled small businesses (most corporations in Canada). This allows qualified businesses to claim up to $866,912 in tax-free capital gains from the sale of the corporation’s shares or other assets. It is important to note that there are a few requirements that must be met to realize this benefit. More information on those criteria can be found here.
Deciding What is Best for Your Business
Covering the benefits of each type of business can be a lot of information to suggest, so we highly suggest discussing your options with a lawyer or one of our accountants. To help guide you in the right direction, here are some crucial questions you should be asking yourself when deciding how to operate your business:
Are you looking to borrow funds? Procure investors?
Does your business carry large inherent legal risks that need to be mitigated?
Are you looking to expand your business or keep it where it is?
Is your business currently generating more profit than you use per year?
Do you have the funds to start a more complex entity?
Regardless of your decision to incorporate your business or not, we are here to give you the financial advice you need. If you have questions about the content in this article be sure to reach out to one of our trusted accountants here.
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