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Last updated: Dec. 22, 2023
Congratulations! You’ve decided to start your own business. There’s probably a million different things running through your head right now. And before you order business cards and a World’s Best Boss mug for your desk, you’ll have to give some thought to business structure.
Sole proprietorships, partnerships and corporations are the three most common for-profit business structures in Canada. Doing your homework and understanding the pros and cons of each ownership structure can save you time, money, and sleepless nights. Each has important and distinct characteristics that will have an impact on taxation and liability.
Sole proprietorship
Most small businesses start off as a sole proprietorship. It’s the most basic business structure. One person (you) owns the business, makes all the decisions, keeps all the profits, and assumes the risks of the business.
Advantages of sole proprietorship
It’s easy to set-up and dissolve, has low-start-up costs and fewer regulations than other structures. With this structure, you have only one tax return to file – any profit from the business is declared on your individual income tax return.
Disadvantages of sole proprietorship
As a sole proprietor, the Canada Revenue Agency views the business and owner/operator as being one and the same, which means if you’re sued by a customer, your personal assets could be liable. You’ll also be relying on your own credit rating and existing contacts to raise capital. Plus, your income is taxed at the personal rate, which means you could be placed in a higher tax bracket if you’re making a decent amount of money.
Partnership
A partnership is a non-incorporated business that is formed between two or more people. Like a sole proprietorship, a partnership has no legal structure. We recommend that partners have an agreement that stipulates how the business is structured with regards to revenue, profits, expenses and liabilities. This is beneficial come tax time, as each partner understands what percentage of income and expenses applies to them.
Advantages of a partnership
It’s simple to form and dissolve and has low start-up costs. Each partner is responsible for filing their own income tax return and claiming their share of the partnership’s profits or losses. Since more than one person is involved in the business, there’s a stronger potential to access capital as your network is wider.
Disadvantages of a partnership
Like a sole proprietorship, there is no legal difference between you and the business. As a result, each partner is responsible for filing their own income tax return and claiming the agreed upon share of the partnership’s profits or losses.
Because there is no difference between you, as a partner, and the business, one of the key risks of forming a partnership is that each partner becomes liable for the actions of the other partners.
While most people starting up a business partnership think it’s a good idea to consult a lawyer to help draw up the agreement, it’s important to understand that lawyers are generally not experts on taxes. If you’re thinking
of drawing up a partnership agreement, contact tax professionals.
It also has limited life, and there’s a possibility of disputes and conflicts when you’re working with someone else.
Featured Resource: Ultimate Guide to Incorporated Small Business in Canada
Corporation
A corporation is a formal business arrangement that brings into existence a legal entity separate from you. For this reason, being incorporated provides small business owners in Canada with the most tax and liability advantages.
Regardless of the business structure you start with, as your business grows, the time will come when you want to consider incorporating. This usually happens when the business is generating surplus profits and you as a business owner have more revenue than you need to cover personal expenses.
Incorporating a business can be done federally or provincially. If you’re going to stick to operating your business in one province, it makes sense to incorporate on the provincial level. If you want to operate in more than one province in the future, you’ll need to get a license for every province you want to operate in. So think about federal incorporation if you want to operate across the country.
Advantages of incorporation
Limited liability: The most important benefit of a corporation is the protection it provides by limiting the liability of the owners. Since a corporation is its own legal entity, it pays taxes, incurs debt and can be sued, which means in most cases your personal assets are protected if legal action is taken against the business (talk to a tax professional about exceptions). The liability of the corporation does not extend to you.
Low tax rates: Businesses that operate as sole-proprietorships or partnerships, pay the personal income tax rate on profits. Corporations can take advantage of the small business tax deduction and pay a lower tax rate on the first $500,000 of active business income. (Since January, 2019 businesses that hold in excess of $50,000 of passive investment income will see a reduction in the amount that their active income is eligible for the small business tax rate. In 2022, personal income is taxed as follows:
- 15% on the first $50,197 of taxable income, plus
20.5% on the next $50,195 of taxable income (on the portion of taxable income over $50,197 up to $100,392), plus
26% on the next $55,233 of taxable income (on the portion of taxable income over $100,392 up to $155,625), plus
29% on the next $66,083 of taxable income (on the portion of taxable income over $155,625 up to $221,708), plus
33% of taxable income over $221,708
Income tax deferral: Surplus profit can be reinvested back into the business or used for other investments, allowing you to defer personal taxes on withdrawals.
Transferring your business: Greater flexibility for your exit strategy and transferring operations to the generation, you can make your children shareholders and gradually increase their stake in the business.
Income control: Multiple options for determining the most tax-efficient way to pay yourself – dividends, salary, bonuses or a combination.
More opportunities to raise capital: The corporation can issue bonds, sell stocks and borrow.
Income splitting: May be a tax saving option if specific conditions are met. Read more on income splitting but always consult with your tax professional to see if income splitting is right for you.
Lifetime capital gains exemption (LCGE): could reduce taxes due on capital gains arising from the disposition of certain properties (small business corporation shares and qualified farm and fishing properties).
Extended life: The corporation continues as independent entity after you pass on.
Disadvantages of incorporation
While there are many advantages to incorporating a business, there are also higher start-up costs, you have to file a separate tax return, you won’t have personal tax credits, closing the business is more difficult and liability may not be completely limited. Corporations also need to keep meticulous records and report their financial statements. If you think incorporation might be right for you, talk to a tax professional who will analyze your business and personal circumstances and make a recommendation.
Paying less tax is often the motivation for incorporating but it is only wise when other real and administrative costs don’t offset those gains.
Free Download: The Ultimate Guide to Incorporated Small Business in Canada
Many incorporated business owners feel intimidated by the demands of tax season and the corporate filing requirements of the Canada Revenue Agency (CRA). This is completely natural.
While there are numerous benefits to incorporation, it also comes with complex obligations. The complexity and administrative burden of these requirements leave many businesses struggling to keep up.
That’s why we’ve created “The Ultimate Guide to Incorporated Small Business in Canada”. Not only will it help you get organized for tax season, but it will help you make sense of your obligations under a corporate structure and to take advantage of the benefits!
Before you decide, check with the experts
Knowing when to incorporate and how to get it done is a big decision. If you think now is the right time to incorporate your business talk to us.
We’ve been working with Canada’s small business owners for more than three generations. We know and understand the Canadian tax system and the tax implications unique to each business structure. With more than 65 years of Canadian tax experience, we offer unlimited corporate tax preparation help, support and tax advice for one flat fee. Our tax experts will run the numbers to create a custom T2 corporate tax return that helps minimize headaches and maximize your tax savings.
Leave your unique tax situation to us. We’ll get you every dollar you deserve.
