What is the difference between a sole proprietorship and an incorporated business? Which is the best business structure for you?
I hope to demystify some of the advantages and disadvantages of both sole proprietorships and corporations so you can make a great decision business decision.
Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.
Many incorporation questions come from not knowing the differences between business structures which hinders your ability to pick the best setup.
Now, there is a TON of misinformation out there provided by well-meaning acquaintances that can send you careening down a terrible path.
One client of mine that we’ll call Jeremy has spent years paying extra accounting and legal fees for an incorporation he isn’t valuing from.
When Incorporation Isn't The Right Choice For Your Small Business
Jeremy mentioned to a friend that he was starting his own business.
The friend, who is a successful business owner, insisted Jeremy become incorporated.
Jeremy took their advice without fully understanding the considerations that surround an incorporation decision.
This decision still plagues Jeremy, adding extra administration tasks and expenses without providing tax benefits.
Luckily there is a solution.
Jeremy can choose to go through the process of closing down a corporation and operating as a sole proprietorship instead.
Almost every week I have a new business owner sitting in my office terrified to make the wrong business decision. They are paralyzed and unable to move forward with their new venture because they don’t want to make the wrong move.
Incorporation is a big decision.
It can be unnecessarily expensive, and it significantly affects your business and tax experiences down the road. It can also be tremendously beneficial in the right circumstance.
In our incorporation series, we go through the things you’ll want to consider BEFORE and DURING incorporation to ensure you avoid making the wrong choice.
So let’s start with what incorporation isn’t - what is a sole-proprietorship?
What is a Sole-Proprietorship?
A sole proprietorship is when you are operating a business that has NOT gone through the formal process of incorporation with a government body. In other words – you haven’t incorporated.
Some of their advantages:
They are easy to set up
They are less regulated than corporations
They have fewer bookkeeping requirements
And if things don’t initially go well, losses can be offset against personal income like employment earnings.
Some of their disadvantages:
There is unlimited liability in a sole proprietorship
There are extremely limited tax deferrals or planning options
Mostly limited to RRSPs / expense timing
And there is no ability to use the lifetime capital gains exemption if you sell your business
Next, let’s talk about corporations.
What is an Incorporation?
An incorporation comes into existence when you go through the legal drudgery of formally incorporating with a government body.
Incorporating is a reasonably lengthy legal process – so before you dive in - let’s go through some of the advantages and disadvantages.
Their advantages:
There is reduced or limited personal liability
There are more tax planning and more tax deferral options
And you may be able to utilize the lifetime capital gains exemption if you sell your business
Disadvantages:
It’s expensive – there are high setup costs and annual maintenance fees both from your lawyer and accountant if you are doing it properly.
There are also extra administrative hurdles every year
It is difficult to close down and wind up a corporation if things don’t go as planned
And business losses CANNOT be written off against personal income unless the corporation formally closes.
"An incorporation comes into existence when you go through the legal drudgery of formally incorporating with a government body."– Jillian Battaglio, CPA, CA
What's The Best Choice For Your Small Business?
Incorporation is a huge topic and each of the considerations I mentioned has a multitude of details that are beneficial for you to know about when deciding your business’s future.
I hope this article has helped demystify some of the advantages and disadvantages of both sole-proprietorships and incorporations, so you no longer have to rely on well-meaning acquaintances.
If this topic has interested you, be sure to check out our other blog articles and consider subscribing to one of our membership plans so you can be a well-informed business owner.
Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.