Sole Proprietorship vs. Corporation

In the previous, we have talked about step by step how to open a business. But did you think about what kind of business will work for you? There are four different business structures which you can consider. Sole Proprietorships, Partnerships (2 people or more), Cooperatives and Corporations.

We will be looking into two structures today. Sole Proprietorships vs Corporations!

Let’s talk some business, shall we.

First of all what is Proprietorship and corporation?

Sole proprietorship, also known as the sole trader is a type of enterprise that is owned and operated by one person and which there is no legal distinction between the owner and the business itself.

Corporation, is a company where there can be more than 1 people which can be authorized to act as a single entity and recognized as such in law. Simply corporations are owned by their shareholders whom then share the profits and/or losses generated through the company’s operation.

Corporations have many advantages over partnerships and sole proprietorships as well as some disadvantages to consider. In a sole proprietorships, the owner is personally liable for business debts. If the assets of the proprietorship is not enough to pay for the debts, creditors can go after the owner’s personal assets such as house, car, bank accounts, etc. But if a corporation runs out of money and isn’t able to pay its debts, shareholders (owners) are not liable to some extent (that’s if the shareholder doesn’t personally guarantees the debt of the corporation, you might want to check director’s liability).

Profits from a sole proprietorship are subject to self-employment taxes which means all business financial activity is recorded on the form T2125 – Statement of Business Activities on your personal tax return and the owner pays for the taxes owed depending on the person’ tax rate plus your own Canada Pension Plan contribution at a rate of 9.9% for self-employed to a maximum contribution up to $5,088.60 (2017).

However, corporations can pay the shareholder in few different ways. 1. Salary / Bonuses – which is the most preferred methods if you are actively working for the business and can be done in Sole Proprietorship as well. In this case the corporation will deduct and remit source deductions to CRA. I should add only CPP and Income taxes are deducted on the shareholder salary. 2. Dividends – corporation can pay its shareholders the profits of the corporation in the form of dividends. T5 slip is filed for the amount that is paid to its shareholder with the 17% grossed-up amount. You can earn up to $50K dividends in 2017 and pay no tax. Disadvantages of this method is that Dividends paid to its shareholders are not deductible on the corporation which means the corporation will pay the taxes which still might be an advantage since corporation only pays 15.50% for the first half-million profit and sole proprietorship owner would have paid 20.50% on that $50K profit. I should note that Dividends do not count as earned income and therefore do not contribute to your RRSP contribution room. So if you are looking into retirement savings, consider doing some of both Salary and Dividends.

A new start up corporation usually have a shareholder loan account, which is a form of financing provided by the shareholder to operate the business in addition to all future contributions to the corporation and all purchases made on behalf of the corporation using personal funds and the corporation will have to start paying this money back to its shareholder. Shareholders do not need to pay any taxes on this loan payment back to them as long as they do not withdraw more than they contributed.

Capital dividend represents a tax-free distribution of corporate excess to a shareholder, paid from the corporation’s capital dividend account. Share capital represents a shareholder’s equity in a corporation and a means by which a corporation can raise capital or equity to fund business operations.