Incorporation vs Sole Proprietorship – When to Incorporate

by | Jul 6, 2021

Are you starting a new business and overwhelmed with the options of sole proprietorship or incorporation? There are certainly pros and cons to incorporating, as well as a sole proprietorship. It depends on your personal situation, and what’s right for you might not be the best fit for the next person. It can cost quite a bit more to become incorporated vs sole proprietorship, but when is it a better idea? Some businesses also choose to start out as a sole proprietorship and change to an incorporation as they grow, but what’s best for your new business?

Legal Structure:  The big difference between the two is the legal structure of how they’re set up. Simply put, if you are a sole proprietor, you own it all. You file one tax return because you are your business. Getting started with a sole proprietorship usually means low fees, total control and an instant start date. You receive all the profits, claim all losses, and are responsible for all the risk. Incorporations on the other hand means you are registering your business with the Canadian government as a separate legal entity. It is a complicated business structure that comes with protections. Your taxes will be a bit more complicated than a sole proprietorship – with the separate legal entity being created there will be 2 levels of taxation.  Corporate taxes and personal taxes.  Because the corporation is a separate legal entity there are liability protections that are not available for a proprietorship.  These considerations are discussed in more detail  below

Upfront Cost:  From a dollar standpoint, becoming a sole proprietorship is typically much cheaper than an incorporation at around $250 with professional help. Setting up and administering a sole proprietorship is usually easier than an incorporation as well. If you want to get incorporated, be prepared for costs of approximately  $1,500 if getting professional help. You can set it up on your own for under $400, but there is a lot more to it than just an online application, and it’s recommended to have a professional assist to ensure the company is set up properly to avoid issues like the government potentially owning your company. Incorporations also have to file an annual report with BC Registries each year which can be done under $40 if preparing by yourself or for around $300/year if using a professional. Ongoing annual costs also include filing a  corporate income tax return (the accounting fees for a corporate year-end are much higher than a sole proprietorship), personal income tax returns as well as T4/T5 filings. Proprietorships only have personal taxes, and possibly T4 filings if you have staff. GST/PST/WCB may also be required under both options. 

Liability: One of the main perks of an incorporation is limited liability. A sole proprietor assumes ALL liability for their business. This means that all of your personal assets (home, vehicles, etc) could possibly be seized. With an incorporation, an individual is NOT responsible for the debts of the corporation, unless you’ve given some sort of personal guarantee. The liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation.  This can protect against lawsuits except where a director/owner has been found to be grossly negligent or acted in a fraudulent manner.  However insurance is still recommended to help protect your assets even when you are incorporated and is highly recommended if operating as a sole proprietor.

Less Paperwork is also a benefit of a sole proprietorship. Being incorporated brings with it extra accounting and paperwork, as incorporations must maintain updated minute books (generally done by the lawyer but you may do yourself) Bookkeeping requirements also differ and corporations have more stringent requirements as full financial statements are reported to the CRA as opposed to just the income statement and capital assets as done in the proprietorship reporting. 

There are of course Tax Benefits as well. Your tax burden can often be reduced by earning income through your corporation, vs personally as a sole proprietor. Income tax rates are lower for corporations vs the personal income received by sole proprietors, which are based on your marginal tax rates.  You also, to a degree, have the option as an incorporation to determine when you personally receive income. This allows you to report your income at a time when you will pay less tax. Keep in mind though, that monies taken out of the company and used personally are taken into income.  The deferral and tax savings are from monies left in the corporation.  Corporations have the option to choose their year-end, and not be restricted to a calendar year, which is a tax planning opportunity for more deferrals.   Salary vs Dividends and splitting income are also considerations that we will discuss in more detail in another article.  There are some key pitfalls that you need to be aware of such as Personal Service Businesses and Tax on Split Income and income sharing between Connected Corporations or Associated Businesses. Each of these can actually create as much or higher taxes than operating as a sole proprietor.  It is important to seek professional advice to ensure you are onside with the tax laws and not falling into one of these tax traps.

So, should you incorporate your business? This is a big decision, and we just scratched the surface here. Weigh all the needs and objectives of your new business against the risks, benefits, and requirements of the two different types. For more help, consult your accountant or contact us here.

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