Sole proprietor, partnership, or corporation? Ways to structure your small business
There’s nothing quite like being your own boss. Understandably, when you’re launching your business, the structure you choose may not be a top priority. But it plays an important role—from decision-making to tax implications to liability. Here are some tips on how to pick a business entity that can work for you.
Different types of small businesses entities
Choosing the right legal structure for your business requires a bit of know-how: You need to understand your line of work inside and out, know your business goals, and have a good grasp of the tax laws, including provincial and/or territorial, as well as federal, income tax. However, if your tax knowledge is spotty, seek the advice of an expert. Here’s the lowdown on the most common business structures:
What it is: If you want to launch your business right away, you can do so as a sole proprietor. Since there’s no legal separation, think of your business as an extension of yourself.
What you need to know: Although a sole proprietor needs to make all the business decisions, you get to keep all the profits for yourself. You get to run your business how you want to.
Operating a sole proprietorship is easy since there’s limited paperwork, and you are taxed based on your individual tax rates.
The main concern of this structure is liability. The business liabilities carry over to the individual, so you could be sued for your personal assets.
What it is: If there are two or more people involved as business owners, a partnership is a structure to consider since you’ll share the work, profits, and losses. If you have investors or mentors who don’t want to be involved in the day-to-day work, a limited partnership is another option. The main partner maintains most of the company control, but also assumes most of the risk.
What you need to know: in a partnership, owners can pool their resources and share the responsibilities, including the liabilities. Since there’s more than one owner, important decisions need to be made together. This may be challenging if some people don’t immediately agree.
From a tax perspective, each partner is taxed individually based on their share. For example, if your business has two partners, the income and expense reporting would be split 50/50. There is no need for a tax return for the business when in a partnership. (Source)
What it is: Creating a corporation, or incorporating, separates owners legally from their business. It comes with more complicated paperwork and taxes, but worth it to know that the business liabilities do not impact the business owner as an individual.
What you need to know: If you’re operating your business as a side hustle or a hobby, you likely don’t need to incorporate until you’re earning at least $30,000 in income a year.
A big benefit of incorporating—and one of the main reasons to do so—is the personal liability protection that comes along with it. In a corporation, the owners and shareholders would not be personally liable for corporate or legal debts—even if the business doesn’t have the assets to cover those obligations. That means creditors of a corporation generally can only seek payment from the assets of the business and not seize your personal property or savings.
There’s more paperwork and costs involved with incorporating, however, since you will have both legal and tax filings each year. These expenses may be worthwhile if there are notable tax advantages to structuring your business as a corporation versus operating as a sole proprietorship or partnership.
Don’t forget the formalities
When registering your business, you can choose your own name or a formal name that you’ve given your business.
In addition, you’ll need to have a Business Number (BN) for access to a CRA program account and/or if you plan on applying for a Goods and Service Tax or Harmonized Sales Tax (GST/HST) account. A GST/HST account number is part of your BN. Government programs, such as the Canada Emergency Business Account (CEBA), sometimes require a Business Number and personal bank account in order to qualify. If you don’t have a BN, you will receive one when you register for a GST/HST account.
The last step? Be sure to set up a business bank account, as it’ll allow you to manage your finances and give you access to additional business services.
Consider future growth advantages
It’s often thought that choosing a business structure is done for tax reasons only. But there are other benefits to a legal structure that business owners often overlook, like flexibility, protection, and control. Consider how you want your business to be run and how much time you have to manage it before making a decision. In the end, the best choice should offer you advantages that will suit your specific situation, save you money, and help your business grow.