Sole Proprietorship vs. Corporation: Which One is the Right Choice for Your Business?

As a business owner or a potential entrepreneur, the choice between operating as a sole proprietorship or a corporation can have a significant impact on your business's accounting and taxation.

“The decision whether to go the sole proprietor route or the corporation route isn't a one-size-fits-all decision,” Graham Thiessen, Partner with Summit Path points out. “It should be carefully considered based on your specific circumstances.” Here we discuss the key advantages of each structure, their accounting implications, and how factors like growth projections, long-term goals, and succession planning come into play.

Advantages of Structuring as a Sole Proprietorship

Sole proprietorships are a popular choice for small businesses and startups, in part due to their simplicity and cost-effectiveness in terms of setup and maintenance. If you have a small, straightforward business and don't want the administrative burden associated with a corporation, a sole proprietorship may be the right choice.

“Tax-wise, there isn’t really much advantage to a sole proprietorship except for the fact that the first $20,000 net income isn’t taxed if you have no other income,” Thiessen shares. “However this can be pretty valuable for small start-ups or part-time businesses as it allows you to keep more of your earnings.”

Sole proprietorships require minimal paperwork and formalities. You, as the sole owner, have complete control over the business, and there is no need to involve a board of directors or shareholders in decision-making.

Accounting and record-keeping activities are also much more straight-forward with a sole proprietorship. In this structure, you only need to keep track of your revenues and expenses throughout the year. This simplicity can be appealing for small businesses with straightforward financial transactions.

And finally, in the event your business needs to be closed or dissolved, winding up a sole proprietorship is typically way simpler and less expensive compared to a corporation. This can be advantageous for businesses with a limited lifespan or for those that are testing the waters before committing to a more complex structure.

Advantages of Structuring as a Corporation

On the other hand, incorporating your business provides distinct advantages, especially from an accounting and taxation standpoint. Here's a closer look at why businesses may choose to opt for this structure over a sole proprietorship:

Tax Flexibility: One of the most significant advantages of incorporating is the flexibility it offers for tax planning. Corporate tax rates are generally lower than personal income tax rates after $20,000 of net income. This allows you to manage when and how you claim income personally from the corporation, thereby optimizing your tax liability.

Robust Bookkeeping: Corporations require more comprehensive bookkeeping, which ultimately helps you build a more informative balance sheet. This detailed financial data empowers you to make better decisions regarding your business's assets and liabilities, contributing to sound financial management.

Reinvestment and Growth: For businesses that have excess funds that the owner doesn't need for personal expenses, a corporation makes more sense. By leaving money within the company, you can leverage the tax advantages of a corporation, allowing you to reinvest in the business and support growth.

Choosing the Right Structure for Your Business

When deciding between a sole proprietorship and a corporation, several factors should be considered, primarily from a tax planning perspective:

Reinvestment Capability: can you leave funds in the company to reinvest in the business? If you plan to reinvest profits for growth, a corporation's structure becomes more advantageous.

Personal Spend Rate: consider your personal spending needs. Is your personal spending rate lower than the net income of the corporation? If so, you might benefit from a corporation's tax advantages.

Long-Term Goals: if your long-term goal involves selling your business, a corporation presents significant tax benefits. When structured properly and meeting the CRA requirements, you can sell your corporation for a substantial amount, potentially tax-free.

Succession Planning - if you are contemplating succession planning, a sole proprietorship can trigger significant taxes upon the transition of the business. In contrast, a corporation offers more flexibility in passing on your business while minimizing tax liabilities.

“A pretty straight-forward litmus test I like to use for determining whether a sole proprietorship or corporation is the right move is to consider whether the business will have excess funds that the owner does not need for personal living,” Thiessen shares. “In this instance, they would be better suited to a corporation. If the owner is just going to take all of the funds out of the company, then it doesn’t make sense to incorporate. You need to leave money in the company to gain the tax advantages of a corporation from an accounting standpoint.”

Fortunately, the sole proprietor vs corporation decision isn’t one that you need to make on your own. Consulting with your trusted accountant can help you make an informed decision that aligns with your specific needs and aspirations. They can guide you through the nuances of each business structure and ensure your accounting and taxation strategies are optimized for your business's success. As a true partner in your personal and professional success, your accountant is invested in helping to ensure that your business starts off on the right foot.

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A member of the Integrated Advisory Network, Graham Thiessen is a Partner and Co-Founder with Summit Path LLP. Graham is passionate about educating his clients, enjoys being a sounding board for them, and is deliberate about asking the right questions to show them a different way to look at their business. Graham’s driving purpose is to leverage his client relationships to make a positive difference in the lives of others.

The Integrated Advisory Network consists of progressive CPA firms, along with best-in-class professional advisors, service, and product specialists, who work together to deliver an elevated and holistic client experience. One that optimizes both their personal and professional lives with an integrated financial strategy designed to help clients reach their goals.