Financial Accounting

Incorporate or not? That is the question

In this writing, we will look at a single owner deciding to either be a sole proprietor or to incorporate their company.

Disclaimer: This article is not intended be used as professional legal advice. For professional legal advice, please consult a tax or legal advisor.

More often than not, getting a business incorporated seems like a default choice. Whenever one wants to start a new business, it seems that most people will immediately get incorporated and that’s what we hear quite often; and unfortunately, this happens without doing a proper evaluation on the pros and cons of the different business structures. Though there are certainly attractive reasons for one to get incorporated, when those reasons don’t apply, it would make more sense to be a sole proprietor.

In this writing, we will look at a single owner deciding to either be a sole proprietor or to incorporate their company. Both have their advantages and disadvantages so its important to consider all important aspects to make an informed decision.

Sole proprietors are by far the easiest and least costly business structure to set up. The process is straight forward with a name reservation and registration form. Further, it has the least amount of regulatory requirements. As all profits earned are directly added to the income of the owner, sole proprietors file T1 Personal Tax Return similarly as with all other individuals. As such, annual filing is both less work and less costly. The downside of structuring a sole proprietorship is that the owner assumes full liability of the business. This means that creditors with a claim against a sole proprietor would have a right to the personal assets of the owner as there is unlimited liability. Similarly, any legal action against the business would also be sought against the owner directly. Additionally, there is no tax shelter mechanism with sole proprietors. All income earned would be taxed accordingly at the progressive individual tax rates.

Comparatively, corporations have their own set of advantages and disadvantages that are almost in opposition to those of sole proprietors. Corporations have slightly more requirements in the setup phase and cost more as well. They are significantly more regulated requiring further annual requirements. These include annual report filings and T2 Corporate Tax Return which are much more thorough and detailed than the T1 Personal Tax Return. The upside with corporations is that as a separate legal entity, creditors are only allowed to claim the assets of the corporation and not of those personally belonging to the shareholder(s)/owner(s). Similarly, legal action brought against the corporation will remain against the corporation only and generally does not call for legal action against the shareholder(s)/owner(s) as well. Additionally, there can be significant tax advantages with incorporating a business. Corporations can claim the small business deduction not available elsewhere and, most importantly, corporations can legally be used as tax shelter mechanisms where money earned that is not paid out to the owner(s) can be taxed at much lower corporate tax rates than personal rates. A corporate tax shelter mechanism also allows for strategic tax planning.

In summary, the decision to incorporate or not and remain as a sole proprietor can be tabled along the following premise. If one anticipates that their earnings in the business will exceed their personal needs; they will be able to save money and keep it in the corporation; and they will need to obtain credit for the business, then getting the company incorporated would be the most suitable option. On the other hand, if all income earned in the business is needed to fulfil the personal obligations of the owner; credit is not being sought; and the business operates in a low risk environment, then not getting incorporated and remaining as a sole proprietor would likely be the best business structure. Ultimately, for the best advice on establishing the right business structure, or even transferring from one structure to another, it is important to seek the right advice from a professional tax or legal advisor; and the benefits of sound advice can lead to significant cost savings.