A recurrent primary question that most self-employed, entrepreneurs, and businesspeople ask is “What is the difference between Incorporating a business and Sole-Proprietor (self- employment).”
Sole Proprietor is defined as:
A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest kind of business structure.
The owner of a sole proprietorship has sole responsibility for making decisions, receives all the profits, claims all losses, and does not have separate legal status from the business. If you are a sole proprietor, you also assume all the risks of the business.
The risks extend even to your personal property and assets. If you are a sole proprietor, you pay personal income tax on the net income generated by your business.
Corporation is defined as:
A form of business operation that declares the business as a separate, legal entity guided by a group of officers known as the board of directors. Corporations, if properly formed, capitalized and operated (including appropriate annual meetings of shareholders and directors) limit the liability of their shareholders.
Even if the corporation is not successful or is held liable for damages in a lawsuit, the most a shareholder can lose is his or her investment in the stock. The shareholder’s personal assets are not on the line for corporate liabilities.
While the whole notion of Incorporating your business seems overwhelming, it is very straightforward if you take a step back and analyze it from a different perspective.
The leading difference is that a business that is incorporated is a legal entity separate from the owner of the business. Some would casually call it “your baby”. When you Incorporate your business, your personal intellectual property and business assets are separate. Anything owing by you, and any debts owed by the corporation are also separate. It is in fact a legal being detached from the owner. Due to the nature of this, your personal property cannot be taken or seized to pay any debts of the business.
Even though keeping the incorporated business’ debts away from personal assets it is not always possible, there are ways that you can protect your personal assets where you do not have to incorporate the business. I always advise my clients to visualize where they plan to bring their business in the next 5 years and to reflect on that thought.
I am going to summarize a few main distinctions that can help lead you to the best path for your current business needs:
Having a corporation, you are taxed at a different rate by CRA than a sole proprietor. Whether Incorporated or Personal, we all must pay both Federal and Provincial taxes calculated at a percentage of income. The difference here is Corporations are taxed on profit at a flat rate anywhere from 11.5-16%. That specific percentage stays the same no matter how high the profits are. Withdrawals or paying dividends are a different topic that will be discussed in another blog)
But, as an individual – the more you earn and report, the higher the percentage. Federal rates stay the same throughout the country while provincial rate varies from province to province. Any profits from your business at a sole proprietary taxable income are taxed at a rate of possibly up to 54%. However, any losses can be used to deduct from personal income.
The Organization and Ownership:
The amount of paperwork associated with a corporation is far greater than a sole proprietor. The set-up of a corporation is expensive, not only are their government registration fees but to maintain corporate records, pay any employees or yourself and remit source deductions, hold meetings and file other government documents can be a bit much. Sole-proprietor operations are little to no setup expenses, ultimately – just register with the provincial government.
The Limited liability that is associated with a Corporation helps if you run into financial troubles. For example, borrowing money and being unable to pay it back to the financial institution or lender. They can sue only the company and not you personally. You can protect yourself if you decide not to incorporate and remain self-employed which you can discuss further with your accountant.
Tax planning and discussing your current income position is the best thing you can do. I highly recommend having an in-depth conversation with an Accountant to review what is suited more to your needs. It can be complex but once the choice has been made – you get to move on to doing what you do best.
Once you have made that primary decision, to be a sole proprietor or Incorporate your business, here a few things to consider:
- Look into the required permits, licenses, and government requirements that are essential •
- Sign up for Canada Revenue services such as payroll, GST/HST, Business number and statements – Keep these documents in a safe place accessible at any given moment.
- Have monthly meetings and document everything by taking minutes.
- Use an accounting software such as QuickBooks, Sage, Xero– while eCommerce payment solutions track and deposit the financials of your revenue, it isn’t an effective way to track bank transactions, profit/losses, your liabilities, anything to depreciate, any assets that are owing on account of the revenues of the period in which it was earned. This information required by the government and handy if you ever get audited. Once you have been audited – it is more so guilty until proven innocent.
- Always keep receipts of anything you purchase and anything you earn.
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