When Should You Incorporate Your Business?
This is a guest post from True North Accounting, a trusted partner of Goodlawyer. With knowledgeable CPAs and bookkeepers in Calgary and Okotoks, True North helps make life easier for small business owners with bookkeeping, accounting and tax advice. Their streamlined process and clear, all-in pricing helps business owners save time and money.
When you start your business, you’ll need to decide if you want to be a sole proprietor or if you want to incorporate.
Sole Proprietorship vs. Incorporation
A sole proprietor is the default category when you start on your own as a freelance consultant or self-employed trade or professional. You are your business, and there’s no separation between you and your business. You report your business income on your personal taxes.
A corporation is a legal entity that’s separate from you. A corporation makes its own money, owns its own assets, has its own liabilities and pays its own taxes. The corporation operates the business, earns the income and then pays you. You can choose to be paid as an employee with a salary, or as a shareholder/owner through dividends.
Sole Proprietorship
Advantages of Sole Proprietorship
- It costs nothing to start
- You could literally start today — whether that’s painting fences or selling logos — and you would be considered a sole proprietor. If you want to be more intentional about it, you can register your business name and location with a registry. Next, go to the bank and get a business chequing account and a credit card. If there is any risk or danger involved, don’t forget to get insurance. You’re ready to go.
- Unlimited personal liability
- Because there’s no separation between you and your business, you assume all the risks. That means 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.
- Lower cost
- Your set-up fee is nominal. You don’t need to hire a lawyer or accountant if you don't want to. It's cheaper to start up and maintain each year.
Disadvantages of Sole Proprietorship
- 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, (i.e. make more than you spend), because that excess cash is taxed at your highest tax rate.
- File one tax return
- Because your business income goes directly to you, you can file your profits and losses on your personal tax return. If your business has losses, it may potentially bring down your tax owing for the year. The rules for GST accounts and payroll accounts with the CRA are the same for sole proprietors and corporations.
- 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 and equitable. It can be more difficult to keep organized as there is no separation between you and your business.
Being a Sole Proprietor is ideal 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
Incorporation
Advantages of Incorporating
- 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 survive you and even exist in perpetuity if it's kept up to date.
- Start-up costs
- Setting up a corporation will cost you about $1000 if you use a lawyer. Or you can walk into your nearest Alberta registry and do it for about $485. 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 a year.
- 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 instead of paying tax on it as personal income. 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.
Disadvantages of Incorporating
- Paperwork
- You will need to file a personal AND a corporate tax return, usually with accompanying Notice To Reader financial statements. (We can help with that.) You also need to file a return at the registries each year. It can also be a bit more confusing when you have so many CRA accounts: Personal Tax, Corporate Tax, GST, Investment and Payroll Accounts.
- Financing options
- 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.
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
Quick Note on Partnerships
Another way to operate your business (if you have more people at the table) is through a partnership. Partnerships have many of the same advantages and disadvantages of a Sole Proprietorship but you can create more structure through the use of Partnership Agreements. These agreements can lay out the roles and responsibilities of each partner, and how much each partner is set to contribute to the partnership.
There are different types of partnerships as well:
- General Partnership are the most common, which is simply two or more persons carrying on business together with a view to profit;
- Limited Liability Partnerships are reserved for certain professions like doctors, accountants, and lawyers. These partnerships get to enjoy the corporate benefit of limited liability; and
- Limited Partnerships are a sort-of hybrid between the first two. At least one partner is must be a General (Managing) Partner and will be exposed to unlimited liability. The other partners in the partnership can enjoy limited liability as Limited Partners.
Ready to take that side gig and make it the real deal? Want to know if you should incorporate? Just want to stop reading and talk to a real person instead? You can book a call with our team to chat.
