Today I wanted to talk about the choices we have for business structures in Canada. I have noticed that there is a strong presence of sole proprietors in the female online community and not many corporations. I don't want it to be because of a lack of information because incorporating in Canada isn't hard and it can provide some great opportunities.
In Canada there are 2 main options for business structures - sole proprietor or a corporation. I am going to go over some of the differences to make it easier to decide what is best for your business.
Liability is being held responsible for something. As a sole proprietor you have unlimited liability meaning you are personally liable for any lawsuit against your business. This means that if your business was sued and had to pay damages but there were not sufficient funds or assets in the business to pay it then your personal assets like you home or savings account will be used to pay the business debt. This is because as a sole proprietor you and your business are considered to be the same legal entity. Even if you have registered your business and are operating under a different name that does not separate the two legally.
As a corporation you have limited liability because the individual owner and the corporation are considered 2 separate legal entities. Therefore, if your business is sued the individual owners are protected personally and would not be held responsible for paying the corporations debts out of their personal pockets. The corporation would simply pay out all debts they can and go out of business.
Hearing that you could be held personally liable can sound a but scary but that doesn't mean all businesses need to be a corporation because all businesses have different levels of risk. You need to consider if your business is high risk of being involved in a lawsuit. If so you also need to consider how high the potential dollar amount would be and if your business could afford it. Lastly you may already have liability insurance that would cover any issue that may arise.
The other main difference between a sole proprietor and a corporation is going to be the way you are taxed.
As a sole proprietor all of your business income is taxed on your personal tax return. Even if you are operating under a separate business name other than your personal name it is still considered to be personal business income and included on your personal tax return. The tax rate you pay will be determined based on what tax bracket you fall into personally.
As a corporation the processes to do your taxes are more complicated. Since the corporation is a separate entity from you as the individual it files its own corporate tax return and you still have to file your individual return. All income that the business earns goes on the corporate return and any money you take out of the corporation in the form of dividends or wages goes on your personal tax return.
The tax rate in a corporation is usually lower than your personal tax rate. For example the federal tax rate is 11% and provincial tax rates vary from 2% to 16% so when added together the tax rates are much lower that your personal tax rate. As I mentioned earlier any money you are taking out of the corporation for personal use is going to be taxed on your personal tax return, if you take out every dollar you earn in the company you will not be receiving any tax advantages of having a corporation because that money will be taxed in the corporation and then again on your personal return . If your income in the business is relatively low and you need that money to live personally then there may not be any tax advantage of having a corporation.
Having a corporation also allows you do do some tax planning by income splitting and income deferral. By income splitting you can divide the income that you take out of the company and split it between you and a spouse. This can be beneficial especially if your spouse is in a lower tax bracket and by splitting the income it can lower your tax bracket and save on personal taxes. You can also defer income by leaving it in the company and letting it grow in there at a lower tax rate and then withdrawal the money personally at a later point in time.
Lets go over a very basic example of a business in Alberta to further show the differences.
$50,000 in business income, need $50,000 for personal expenses.
$100,000 in business income, need $50,000 for personal expenses.
As you can see the more money you make the more tax you can save. However, the more money you take out of the corporation the money tax you pay personally. You must remember though that it will cost you between $1,200 and $2,000 to get a corporate tax return done each year.
Here is a breakdown of the main differences between the two.
In summary, when deciding whether to become a corporation you need to evaluate your business and what your goals are for it. I also want to note that many businesses start off as sole proprietors and then transition to a corporation at a later point. This is a relatively easy process to do especially if you are just a service based business with not may assets, but it is a bit more complex when you own a large amount of assets. This is something you need your accountant to file an election for but don't be feel like if you choose to start out as sole proprietor you are stuck there.