If you are starting a new business as a small contractor, you might be wondering whether you should incorporate or stay a sole proprietor. There are pros and cons to both options, and the best choice depends on your personal and business goals, tax situation, liability risk, and administrative preferences. In this blog post, we will explain the main differences between incorporation and sole proprietorship, and help you decide which one suits your needs better.
What is incorporation?
Incorporation is the process of creating a separate legal entity for your business. This means that your business has its own name, identity, assets, liabilities, and tax obligations, distinct from your personal ones. You can incorporate your business at the federal or provincial level, depending on where you operate and what kind of activities you do. There are different types of corporations, such as C corporations, S corporations, and limited liability companies (LLCs), each with its own advantages and disadvantages.
What is sole proprietorship?
A sole proprietorship is the simplest and most common form of business ownership. It means that you are the only owner and operator of your business, and you are personally responsible for all aspects of it. You do not need to register your business name or file any special documents to start a sole proprietorship unless you use a trade name that is different from your own name. You report your business income and expenses on your personal tax return, and you pay taxes at your individual tax rate.
What are the benefits of incorporation?
- Incorporation can provide limited liability protection, which means that you are not personally liable for the debts and obligations of your business, unless you have signed a personal guarantee or acted fraudulently or negligently. This can protect your personal assets, such as your home, car, and savings, from creditors and lawsuits.
- Incorporation can offer tax advantages, such as lower corporate tax rates, tax deferral, income splitting, and access to various tax credits and deductions. Depending on your income level and tax bracket, you might be able to save money by paying less taxes as a corporation than as a sole proprietor.
- Incorporation can enhance your credibility and professionalism, as it shows that you are serious and committed to your business. It can also make it easier to raise capital, attract investors, and secure financing, as lenders and investors might prefer to deal with a corporation than a sole proprietor.
What are the drawbacks of incorporation?
- Incorporation can involve higher costs and more paperwork, as you need to pay fees to register and maintain your corporation, file annual reports and tax returns, and keep proper records and books. You might also need to hire a lawyer, an accountant, or a bookkeeper to help you with the legal and financial aspects of running a corporation. ·
- Incorporation can create more complexity and compliance, as you need to follow the rules and regulations that govern corporations, such as holding meetings, issuing shares, and maintaining a registered office. You might also face double taxation, which means that you pay taxes on your corporate income and then again on your personal income when you withdraw money from your corporation. ·
- Incorporation can reduce your flexibility and control, as you might have to share ownership and decision-making power with other shareholders, directors, or officers. You might also have to deal with more restrictions and limitations on how you can use and distribute your corporate funds and assets.
How to choose between incorporation and sole proprietorship?
There is no definitive answer to whether you should incorporate or stay a sole proprietor, as it depends on your specific situation and preferences. However, some general factors that you might want to consider are:
- Your income level and tax bracket: If you earn a high income and pay a high tax rate, you might benefit from incorporating and paying lower corporate taxes. However, if you earn a low income and pay a low tax rate, you might not see much difference or even pay more taxes as a corporation.
- Your liability risk and asset protection: If you face a high risk of being sued or owing debts, you might want to incorporate and limit your personal liability. However, if you have adequate insurance and low liability exposure, you might not need to incorporate and incur the extra costs and hassles.
- Your growth potential and financing needs: If you plan to expand your business and seek external funding, you might find it easier to incorporate and access more sources of capital. However, if you intend to keep your business small and self-funded, you might prefer to stay a sole proprietor and avoid the additional complexity and compliance.
Ultimately, the decision to incorporate or stay a sole proprietor is a personal one that requires careful research and planning. You should consult a professional advisor, such as a lawyer or an accountant, before making any changes to your business structure. They can help you weigh the pros and cons of each option and guide you through the process of incorporation or sole proprietorship.