Sole Proprietorship vs Incorporation: Which is better?

As an entrepreneur, choosing a structure is one of the hardest decisions you will ever make. Plus, the structure you desire might change depending on where you’re at in your business and where you plan to go. At some point, you will have to decide between sole proprietorship vs incorporation, the two most commonly used business structures in Canada. Whichever option you go with will have unique benefits for your business. That is, depending on your immediate and long-term goals. Our job is to ensure you understand your options and help you make the best choice. So, let’s start by explaining the differences between sole proprietorship and incorporation.   

Sole Proprietorship vs Incorporation

Sole Proprietorship vs Incorporation: Know the Difference

Sole proprietorship vs incorporation — these are two of the most common business structures for entrepreneurs worldwide. But what do they mean, and how are they different from each other?

A sole proprietorship is an easy business structure to set up. On the other hand, incorporating a business can be challenging and complex. To properly explain the differences between both, we will explain them one after the other. Let us first define what a sole proprietorship entails.

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What is a sole proprietorship?

This business is exactly what it sounds like — one with a sole owner. This sole owner makes all the decisions and bares all the risks as a consequence. Sole proprietorship remains the simplest business structure known in the business world.

If you decide to be a sole proprietor, here’s what you should know. You will run your business as a one-person-army. There will be no investors, shareholders, or business partners. You will become personally responsible for the business. The implication is that you will enjoy all the profits and risk the losses. Further, your tax situation becomes more personalized. Most sole proprietors are considered to be self-employed.

Now, let’s break down some of the basic characteristics of a sole proprietorship:

  • Ownership is by one person, who we can call the sole proprietor
  • This sole proprietor has unlimited liability and is responsible for all business risks
  • A sole proprietorship does not require formal legal documentation
  • As a sole proprietor, you must report all income generated via the business on your tax returns. The business does not pay a separate income tax — it’s consolidated within a personal tax return.

Overall, sole proprietorship is a perfect fit for small-scale businesses. You can explore other options as your business grows. 

Related Reading: Self Employed Tax Deductions Canada

What is a corporation?

Once you incorporate a business, you officially separate yourself from it. Here, you and your business become two separate legal entities. In the same way, your personal finances are separate from business money. So, you will pay corporate income tax on top of personal income tax. That is, instead of strictly personal income tax like with a sole proprietorship. 

A corporation is a separate individual in the eyes of the law with clear legal rights, responsibilities, and liabilities. It can own property, enter contracts, do business, sue, and be sued. A distinct feature of a corporation is its limited liability for the owner. Furthermore, your personal assets are safe from the company’s debts. We can contrast this with a sole proprietorship or even a partnership where your assets as an owner are at risk.

Another thing that sets a corporation apart is that it can sell stocks. When people buy these stocks, they become shareholders, owning a part of the company. The sale of these stocks is even one of the primary ways that a corporation can raise capital.

Advantages and Disadvantages of Sole Proprietorship vs Incorporation

Here, we will look at the pros and cons of sole proprietorship vs incorporation. It is important to consider these factors before choosing the best fit for your business — let’s start with analyzing sole proprietorship.

Advantages of Sole Proprietorship

SimplicityA sole proprietorship is easy to set up and inexpensive to manage.
Better ControlThe sole proprietor has full control over business operations. They are also responsible for making all business decisions. 
Simplified Tax ReportingThe owner reports business income on their personal taxes in a sole proprietorship. This cuts out the stress of tracking and filing separate taxes.
FlexibilityAs a sole proprietor, you can easily change your business direction as you wish. Plus, you can make immediate business decisions. There’s no need to wait for a board to confirm.
Reduced CostsA sole proprietorship has lower legal and administrative costs. That is when compared to other business structures, you pay less.
Direct ProfitSole proprietors can enjoy profits without sharing with shareholders or business partners. 
PrivacyWith a sole proprietorship, your business decisions and financial information are private. 
No FormalitiesYou don’t need any legal documentation when you run a sole proprietorship.

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Disadvantages of Sole Proprietorship

Unlimited LiabilityA sole proprietor is responsible for business debts and all legal obligations. So, the owner’s assets can be used to settle these debts and obligations.
Limited GrowthWith a sole proprietorship, there is limited access to external funding. This can, over time, keep the business stuck with no expansion.
Limited ExpertiseThe success of a sole proprietorship depends on the owner’s skill and expertise. This can limit business growth, as one person cannot know it all.
Business ContinuityThe sole proprietor’s absence, sickness, or death can affect business operations. The business cannot go on whenever the owner is unavailable or incapacitated.
Less ProfessionalA sole proprietorship has a less professional outlook. That is when compared to large, incorporated businesses. 
Tax LimitationsA sole proprietorship has lesser opportunities for tax deductions, credits and other tax benefits.
Raising CapitalRaising capital is often the biggest challenge of sole proprietorship. The business owner often has to rely on their private resources, which may be limited.
Employee BenefitsSole proprietorships cannot offer their employees better benefits. These include stock options and pension plans. The business may not be making enough to reward employees in that manner.
Succession PlanningThe business typically dies with the owner and does not transfer to a new owner. The process is often more complex, even when the sole proprietor wants to transfer or sell.

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Advantages of Incorporation

Limited LiabilityBusiness owners and shareholders are safe from corporate liabilities. This is because their assets are separate from the company’s.
Raising CapitalThis type of business can easily raise capital. All they have to do is issue shares to potential investors. It is generally easier to raise debt financing as well.
Separate Legal EntityA corporation is a legal entity separate from its owners.
Continuity of BusinessThe business continues even if the ownership changes or an owner dies. This way, there is better stability of the business.
ProfessionalismA corporation has a more professional outlook. This is an advantage, especially when dealing with clients and potential investors.
Tax BenefitsCorporations enjoy tax deductions and other benefits on their operations and expenses.
Employee BenefitsThis type of business can offer its employees better benefits. These include stock options, health insurance, and pension plans.
Ownership TransferTransfer of ownership is easy here because of the buying and selling of shares. The highest shareholder often has the final say in business decisions. 
Growth PotentialThis business has better chances of external funding. As a result, there are better chances of business growth here.
Risk DistributionThis type of business typically has several shareholders. These shareholders divide the business risk. So, there is a lower individual risk here compared to a sole proprietorship.

Disadvantages of Incorporation

ComplexityThere are more administrative tasks and legal obligations that accompany a corporation.
Costs The incorporation costs and ongoing fees are high compared to other structures.
Slower Decision-makingDecision-making typically involves a board of directors and all shareholders. This takes more time than a sole proprietorship, where decisions are instant. 
RegulationUnlike a sole proprietorship, this type of business is subject to more regulations. It must keep the right financial records and comply with strict rules.
Tax ReportingIt requires the filing of separate taxes for the corporation. This can be tedious.
Less PrivacyBusiness records and decisions are subject to public disclosure.
Ownership DilutionBy issuing shares, this business dilutes its ownership control. It may require approval from all shareholders to make decisions.
Shareholder ConflictsThe presence of many shareholders can cause business interests to clash.
Initial FormalitiesSetting up this type of business involves too much bureaucracy. There are legal documentations and bylaws to make. The company will also have to create an article of association.
Double TaxationThe company pays tax on profits. Shareholders also pay taxes on dividends paid to them from these profits.

Related Reading: Stocks vs Real Estate: Which is better to invest in?

At what income level should I incorporate?

You may consider incorporating your business once it becomes successful and very profitable. This will help protect your money and assets if things don’t go well. Remember that with incorporation, your business becomes a separate entity. So, your assets are unaffected if there is a bad business deal or the business is in debt. 

Will I pay less taxes if I incorporate?

We can’t deny that incorporating a business has potential tax benefits. Corporations also have different tax rules from sole proprietorships. But whether or not you pay less taxes depends on various factors, such as:

  • The splitting of profits with shareholders can reduce the overall tax burden.
  • Unlike sole proprietors, a corporation can deduct expenses for salaries, benefits, and more. This counts towards its overall tax burden.

While these are some ways corporations pay less tax, the story is not exactly rosy. Corporations have additional obligations like accounting fees and corporate tax returns. So, before deciding based on taxes, we recommend speaking with a financial advisor. These professionals can analyze your situation and provide personalized advice.

Is it better to be a sole proprietor or incorporated?

Sole proprietorship vs incorporation? The decision depends on your business’s financial situation, goals, and legal factors. Choosing a side is a personal decision that must match your business goals.

Consider a consult with legal and financial professionals for the guidance you need. Remember, there is no one-size-fits-all answer. The best choice for you is one that can help push your business to success. 

Read More: Guaranteed Investment Certificate: Advantages and Disadvantages

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