When you start your business, you’ll need to decide if you want to be a sole proprietor or if you want to incorporate. Not sure which is right for you? Let’s define and look at the pros and cons of both.
What is a sole proprietor?
Sole proprietor is the default category if you just start on your own as a freelance consultant or self-employed trade or professional. There is no separation between you and your business. You are your business. You report your business income on your personal tax return.
What is a corporation?
When you incorporate, you create a legal entity that is separate from you: a corporation. A corporation makes its own money, owns its own assets, is responsible for its own liabilities and pays its own taxes. The corporation operates the business, earns the income and then pays you. You can get paid either as an employee of your corporation (wages) or as a shareholder/owner of your corporation (dividends).
Pros of sole proprietor
To Start: Do Nothing
You can literally start painting fences, or selling logos today and you would be considered a sole proprietor. If you are more intentional about it, you would register your business name and location the Alberta Registries. Then go to the bank and get a business chequing account and a credit card. Don't forget to get insurance if there's any risk or danger at all. Boom. You’re ready to go.
Your set up fee is nominal. You don’t need to hire a lawyer or accountant if you don't want to. Its cheaper to start up, and to maintain each year.
One Less Tax Return To File
All of the business's income goes right to you, so you just file your profits and losses on your personal tax return. If your business does have losses, it may potentially bring down your tax owing for the year. However, the rules for GST accounts and Payroll Accounts with the CRA are the same for sole proprietors and corporations.
Cons of sole proprietor
Unlimited Personal Liability
Because there’s no separation between you and your business, you assume all the risks. That means, all of your business AND personal assets are at stake if someone tries to sue you, or a lender calls for their loan. When you take on a partner, or investor, you form a Partnership, and your partners assume the unlimited liability risk too.
Taxed On Every Dollar
All profits go right to you, which means you’ll pay taxes on every penny. This makes it much harder to grow your bank account, (ie, make more than you spend), because that excess cash is taxed at your highest tax rate.
Growth Is More Difficult
You can’t really take on equity investors and it can be harder to keep Partnerships (two sole proprietors in business together) fair & equitable. It can be more difficult to keep organized as there is no separation between you and your business. Your business dies with you.
Sole proprietor is probably best for you if:
- You don’t have big ambitions to grow your business (or your bank account)
- You will be spending every penny your business will make
- There isn’t much liability exposure or financial risks involved with your business
The pros of incorporation
Protect Your Nest Egg
Protect your home and retirement savings from creditors and lawsuits by operating through a corporation. They can only come after the assets owned by the corporation. Use a lawyer and consult with an accountant to make sure you’re set up properly. Your corporation will also survive you, and even exist in perpetuity if it's kept up to date.
Tax Planning: Choose How Much Tax To Pay
When you’re lucky enough to have made more money than you needed for living expenses, you can choose to leave that extra cash in the corporation, rather than bringing it all into personal income and paying tax on it. Whatever you leave in the corporation is only taxed at 11%. You can leave this in the corporation as a rainy day fund, invest it, or buy equipment (including vehicles) with it. This is called Tax Planning.
A corporation can build equity, which is good for business credit and may give you more borrowing options from lenders, investors, and partners. When it comes to government grants, incorporating will open up more options as well.
The cons of incorporation
Start Up Costs
Setting up a corporation will cost you about $1000 if you use a lawyer. You can walk into your nearest Alberta Registries and do it for about $485. I would exercise caution, but I’ve seen websites claiming to do it for cheaper.
Once the incorporation is set up, you’ll pay about $300 annually to maintain your minute books with a lawyer. Alternatively, you can file your Corporate Annual Return yourself at the registries for about $85/year.
You will need to file a personal AND a corporate tax return, usually with accompanying Notice To Reader financial statements. But that’s what we are here for! You also need to file a return at the registries each year - like registering your car. It can also be a bit more confusing when you have so many CRA accounts: Personal Tax, Corporate Tax, GST, Investment and Payroll Accounts.
Incorporation is probably best for you if:
- You want to grow your business and make more money than you need
- You will need to hire employees or raise money
- You will be selling anything other than your own freelance/consultant services
- There is some degree of danger or financial risk in your business
Call us if you are ready to take that side hustle and make it the real deal. We'll let you know if incorporation is right for you, give us a call at 403-938-4064 or appointment right here: