You knew you wanted to start a business – fast. Jump and build it on your way down. Sound about right?
You went with the simplest and fastest method – a sole proprietorship. Now your business is growing, growing, growing. As much as you’re happy that it is, you think it may be time to rethink your business structure. Perhaps you should switch your sole proprietorship to a corporation.
You’re likely intimidated by the thought of changing your business. It doesn’t need to be a foreign thought, and it doesn’t need to be as complicated as most would think. So, why would you even bother incorporating now?
There are many advantages to incorporating your business. You might even discover you’re losing money by not incorporating. Alternatively, you might find you’re right where you should be. Either way, it’s worth a second look to determine what’s best for you and your business.
Sole Proprietorship v. Corporation – What’s the Difference?
Before deciding whether or not you should switch your sole proprietorship to a corporation, it’s essential to understand the difference between the two and the advantages and disadvantages of each.
What is a Sole Proprietorship?
A sole proprietorship is, as the name suggests, when you are the sole owner of your business. You are your business, which means you take on all of the risks, profits, and liabilities of your business. You are your business, and your business is you. Simple.
What are the Advantages of a Sole Proprietorship?
1. Simple Registration Process/Low Start-Up Cost
Registering a sole proprietorship is very simple and low cost. At the time of writing this article, the fee to register a business in Ontario is $60. You can complete the whole process online in under an hour.
If you’re doing business with a specific trade name, that would also need to be registered. If you’re living in Ontario and haven’t yet set up your business, click here to find out more.
2. Simple Ongoing Process
When you have a sole proprietorship, the ongoing business paperwork is minimal. As long as you renew your business license when it comes due, you’re good to go! Your biggest worry is keeping your bookkeeping tasks up to date – but this can easily be handled by a professional.
3. Tax Advantage
When you have a sole proprietorship, you’re able to write off any business losses on your personal income tax, putting you in a lower tax bracket.
What are the Disadvantages of a Sole Proprietorship?
1. Unlimited Liability
When you have a sole proprietorship, you are completely responsible for everything that happens in your business. You are personally liable for your business’s debt and any lawsuits brought against you.
2. Tax Disadvantage
As a sole proprietor, you won’t get the tax advantages that come with incorporation. Your personal tax return will include your business income, which will result in higher taxes.
3. Calendar Year-End
As a sole proprietorship, you don’t have the flexibility to decide when your year-end takes place. It will need to correspond to the calendar year, which will prevent you from completing your year-end tasks during your slow season.
What is a Corporation?
Unlike a sole proprietorship, a corporation is its own legal entity. An incorporated business stands on its own. It has its own financials in terms of profits, losses, and debts, and, it, therefore, protects your personal assets.
What are the Advantages of Incorporation?
1. Limited Liability
As previously mentioned, when incorporating your company, your personal assets are protected as your business is independent. This means if someone were to sue you, they’re suing your business alone and not you personally, providing you with peace of mind when doing business.
2. Lending/Raising Capital Options
As corporations are their own separate entity, they can lend and borrow money through financing. Corporations also have the option of raising capital by selling stocks to investors.
3. Life Span
A corporation can have an infinite life span, and passing on the ownership can be done by selling a stake in the company. A corporation can be built, nurtured, outlived, and passed on by you if that’s your goal.
4. Splitting Income Potential
Income splitting was once very lucrative and was one of the main reasons people chose to incorporate a business. It allowed business owners to save taxes by splitting dividend income with a family member (usually in a lower tax bracket).
As of January 2018, new rules apply to limit the tax advantages of the tax on split income (TOSI) benefit. “TOSI removes split income tax benefits by:
Identifying some specific methods of income splitting that had previously reduced taxes, and
Taxing that split income at the taxpayer’s highest marginal rate”.
The TOSI rules would not apply in certain circumstances, such as when an “excluded business” or “excluded shares” exception applies.
5. Tax Benefits/Tax Planning
Taxes for small businesses are at a lower rate than personal taxes, so it’s possible that, depending on your circumstances, you could end up paying less tax. The benefit lies in the flexibility of the timing of income, resulting in paying less tax.
Not only that, but if you’re lucky enough to make more money than you need, you can also choose to leave some income in your corporation to grow your equity. This amount will be taxed at a lower percentage and can be used for investments or to buy other assets.
Everyone knows it. Corporations are perceived as being more stable, established, and professional than a sole proprietorship. It doesn’t mean they are; it’s just how it goes. And, therefore, incorporating your business may allow you to boost your revenue in the long run based on image and reputation alone.
What are the Disadvantages of Incorporation?
Firstly, although the cost is not steep, there is a fee to incorporating your business. If you choose to hire a professional to complete your articles of incorporation, you can incur even higher costs.
2. Multiple Tax Returns
As your corporation is a separate legal entity, you would be required to do two separate tax filings (one personal, one corporate). This can be time-consuming and costly if you choose to hire a professional to complete your return.
3. Administrative Burden
A corporation has annual filing requirements and other rules that must be adhered to regularly. These are necessary to keep a corporation in good standing and can be time-consuming for business owners.
What’s Your Vision for the Future?
Now that you know the difference between a sole proprietorship and a corporation, it’s time to think about what best suits your needs right now and your vision for the future.
Are you looking to grow your business and hire more employees? Or are you happy with how your business is growing and you’re currently spending all of the revenue your business is bringing in? Is your business risky and requires protection, or is it relatively low risk, and you’re not worried about any harmful exposure?
More importantly, where do you want your business to go? Will you be operating locally, within the province, or are you looking to expand nationally or even globally? You may want to consider incorporating provincially or federally in that case.
Whatever you choose, know that incorporating your business might seem like the way to go; however, there are situations where a sole proprietorship is a better way to go. You should speak to a professional to provide clarification and advice on your circumstances if you’re unsure.
We can be that professional! Schedule a complimentary consultation with us today. We can help you incorporate your business, file your corporate tax return, and we can take care of your bookkeeping tasks.