Incorporation vs Sole Proprietor – have you been struggling with the decision on which type of company is right for your company? Check out our attached guide to some of the nuances between Corporations and Sole Proprietors.
Organization differences between Incorporation vs Sole Proprietor
A sole proprietor is the simplest business organization. You can still register a Sole Proprietor in Ontario for $58.00. With a sole proprietor, ultimately you are the business – the debts, obligations and legal responsibility fall on the owner. When the owner passes away, a sole proprietorship also ceases to exist.
A Corporation is a legal entity created by the Directors via enabling provincial or federal legislation. Government registration fees are currently $400 provincially (Ontario) and $200 federally. Additionally, the corporation will need to appoint at least one Directors. We recommend talking to a CPA before setting up your Equity and Debt structure. A corporation can have as little as one shareholder and an unlimited maximum number of shareholders. We note that although the federal is $200 less expensive, there is an annual filing requirement that quickly eliminate any cost advantage. If a shareholder passes away – it has no impact on the operations of the corporation – the share become part of the deceased’s estate.
The debts and obligations of a Sole Proprietor as the owner’s debt. Debts and obligations of a corporation are the debts of the company. (Although directors are liable for outstanding payroll taxes and sales taxes.)
Incorporation vs Sole Proprietor The Tax Differences
The business results of a sole proprietor are reported on the T2125 Statement of Business activities and included in the T1 Personal Tax Return. Business income is just another line included in your total personal income and subsequently taxed at your marginal tax rate.
Corporate results are reported on the T2 Corporate Income Tax Return. Corporate income may be eligible for the small business deduction and pay combined rates as low as 12%. Owner withdrawals can be taken as dividends or payroll and reported on the owner’s T1.
Fund available to reinvest into the business
Due to the small business deduction, the corporation provides more after-tax cash flow to reinvest in the business. Approximately 78 cents of after-tax income can be reinvested vs approximately 50 cents of each dollar as a sole proprietor.
Owner Compensation
In a sole proprietor, all of the income is taxed as self-employed income; CPP will be added when calculating taxes owing. The corporation can pay via Dividends or Salary. Some owners prefer to receive their income in dividends and not participate in the CPP program. We only support this strategy for very strong savers with advanced investment knowledge.
Dividends
Dividends allow the owner of a closely held company the ability to set the timing of when they will receive their income. Retained earnings can be retained or disbursed when cashflows allow and when it suits the owner presenting planning opportunities.
Administration
An incorporation is going to cost more to administer. The expectation for record keeping is increased, a more complicated tax return is required, financial statements may be required, a minute book is required and the corporation must have annual meetings.
Here’s a Cheat Sheet to review some of the differences:
| Sole Proprietor vs Incorporation Cheat Sheet | ||
| Sole Proprietor | Incorporation | |
| Legal Liability | Unlimited | Limited |
| Liabilities | Owner | Limited |
| CRA Liabilities | Owner | Directors |
| Tax Returns | Personal T1 Return | Corporate T2 Return |
| Tax Rates | ~50% | Small Business Rate 12% to $500K |
| Reinvestment | ~50% | ~88% |
| Income Timing / Flexibility | No | Yes |
| Payroll | No – included in personal income tax | Yes – choice between payroll and dividends |
| Dividends | No | Yes |
| Paperwork | Minimal | Complicated |
Sole Proprietor
Does deciding between incorporation vs sole proprietor sound confusing? We can help you select the right organization and structure for your company and help you incorporate if that’s right for you. We’re here to help. Give us a call to book a consultation.
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The preceding analysis is for general information only and not a replacement for Legal and Accounting counsel. You should see advice before undertaking any planned organization.