Should I incorporate? Weighing the pros and cons of sole proprietorships and incorporation

Entrepreneurs starting and operating a business in Canada are faced with the choice of how they want to legally structure their business. There are four main options available to Canadian entrepreneurs: sole proprietorships, partnerships, corporations, and co-operatives. While each option has its advantages and disadvantages, this article will focus on comparing the two most prevalent choices for new entrepreneurs - sole proprietorship and corporation.

It is important to note that selecting which structure is best for your business is ultimately a very context-sensitive matter; you must consider the size and income of your business, the scope of operation (whether you intend to operate just in Ontario, in multiple Canadian provinces, or internationally), your business plan, and so much more. While the list below covers the most important points you need to know, it is not an exhaustive list. As such, it is always a good idea to get professional consulting before making the decision to incorporate.

Sole Proprietorship

A sole proprietorship refers to an unincorporated business operated by one person. Sole proprietorships appear in many industries, and common examples include various home-based businesses such as freelance writers, financial planners, and tutors. Other sole proprietors, such as caterers, housecleaners, and landscapers, operate in person.

In a sole proprietorship, you own the whole business. This means you are solely responsible for making business decisions, collecting profits, claiming losses, and everything else that goes into operating a business. It also means you assume all the risks associated with operating your business - and these risks extend to your personal property and assets.

Sole proprietorships are a common first step for new entrepreneurs as they are relatively easy to start up and operate. Remember that since you are the sole decisionmaker, incorporating your sole proprietorship is typically an easier process than the reverse.

Pros of a Sole Proprietorship

• Easy setup and low setup costs: if you plan to operate under your own name, registration may not be required. But, even if you do want to register a unique name, the process is very quick and costs as little as $60 in Ontario. Just make sure the name you have in mind isn't already registered!
• Simpler regulations and less administration: aside from the possible registration paperwork, there is very little you have to keep track of, freeing you to focus on operating your business.
• Simpler tax reporting: tying in to the lower burden of administration above, sole proprietors have a very straightforward tax reporting process. You do not have to file separate taxes for the business; the only difference is that you must fill out the T2125 Form to report your business or professional income and expenses.
• Complete control: As you fully own your business, you do not need consent from partners or officers to make business decisions. As such, you have the flexibility to take the business in any direction you wish.

Cons of a Sole Proprietorship

• Unlimited liability: as with complete control, you bear the sole responsibility for your business. You are personally liable for all the debts and other liabilities you incur in the course of operating your business. This means that your personal assets are at risk if, for example, the business is sued.
• Potentially higher taxes: while the exact rates vary by province, the taxes you will pay in a sole proprietorship will usually be higher than those paid by incorporated businesses, especially if your profits put your income into a higher tax bracket.

Corporation

Unlike a sole proprietorship, a corporation is a separate legal entity. Incorporation refers to the legal process required to form a corporate entity. Aside from the more common types of corporations we interact with on a daily basis, such as Amazon, many regulated professions can also incorporate, including lawyers, accountants, and most recently, real estate agents.

Canadian entrepreneurs looking to incorporate may do so through a federal incorporation or provincial incorporation. While both options allow you to operate in other provinces provided you registered with them, only a federal incorporation secures your name across Canada. However, federal incorporation may also be more costly than incorporating within your province.

With the exception of the above name protection, the pros and cons of incorporation remain largely the same whether you decide to go with provincial or federal incorporation.

Pros of a Corporation

• Income tax: a major reason small businesses incorporate is the better income tax rates corporations enjoy. As of February 2021, the Ontario corporate tax rate is as low as 12.2% for the first $500,000 the business makes thanks to the small business deduction. Most other provinces and territories have a similar lower rate.
• Limited liability: since the corporation is its own legal entity, it is entirely responsible for its actions, debts, and other liabilities. This means that your assets are not considered a part of the corporation, and thus not at risk if, for example, the business is sued. Note that there are exceptions to this, such as if you have made a personal guarantee.
• More pathways to funding: corporations have access to better funding options from financial institutions than sole proprietors, and Investors are more likely to invest in corporations. You also have the ability to sell securities, such as shares, to raise capital.

Cons of a Corporation

• Setup costs: incorporation is typically more expensive and complex than starting a sole proprietorship. Since incorporation is a complex legal structure, ensuring compliance typically requires professional legal advice, which may lead further increase costs
• More complex administration: as a separate legal entity, a corporation requires the filing of separate corporate tax returns and annual reports. The compliance requirements for corporate entities are also stricter. This means you must maintain additional records, and your annual accounting and administration costs for processing this information may be higher.

Which option is right for your business?

The decision between a sole proprietorship and a corporation depend on many factors unique to you and your business. While incorporation provides many benefits, it also comes with additional costs and stricter compliance. Many new entrepreneurs opt to start a sole proprietorship first, but this does not mean that this is always the correct choice.

When and whether you incorporate is a complex but very important decision, and we hope this article helped give you an initial overview of the pros and cons of doing so. If you would like to get more tailored support to help you decide which option is best for you, get in touch today. We will happily work with you to determine what path is right for your business's success.