Are you wondering whether you should incorporate your business or stay a sole proprietor in Canada? Today I’m going to share the pros and cons of incorporating and explain why it may actually be a big waste of money.
Back in 2021, I incorporated my business after running it as a sole proprietorship for 5 1/2 years. This was a big decision for me, which is why it took me so long to decide when the time was right. That’s also why I want to share the pros and cons of incorporating your business in Canada in this blog post (and video), so I can hopefully alleviate some of the confusion and stress that goes into making such an important decision as a small business owner.
But first, what’s the difference between being a sole proprietor versus an incorporated business?
A sole proprietorship is the simplest kind of business structure in Canada. It means you’re running an unincorporated business and that business is owned by an individual (you). It also means that this individual is liable for all the debt and risk associated with the business.
A corporation, as opposed to a sole proprietorship, is its own legal entity separate from its owner. This means the corporation becomes libel rather than the individual that owns it.
So, with that in mind, why might you want to incorporate your business rather than stay a sole proprietor?
When you’re a sole proprietor, you become personally responsible for all liabilities and obligations relating to the business. In other words, personal and business are one and the same.
That means that if someone sues you, such as your employees, customers, or vendors, they could go after your personal assets. Whereas a corporation is its own legal entity, so if someone sues your business, they sue the corporation, not you personally.
With this in mind, I’d highly recommend getting liability insurance whether you’re a corporation or sole proprietor for added protection.
Better Selling Potential
If you have plans to grow the business and potentially one day sell it, then it’s a lot easier to do that if you’re incorporated. Not only that, but you could also take advantage of the lifetime capital gains exemption when selling your corporation, which could eliminate or significantly reduce any capital gains tax you’d have to pay on the sale of your business.
If you are running a business and hope to one day pass it on to your children, a corporation would be the logical business structure for you. When you die, the corporation lives on after you because it’s a separate legal entity. Whereas if you’re a sole proprietor and you die, so does the business.
If you incorporate, you receive name protection for your business in the jurisdiction in which you choose to incorporate. You can choose to incorporate your business within just your province or federally. If you register your business as a sole proprietorship, you don’t have the same name protection. Although it could prevent other sole proprietors from registering the same business name, a business that wishes to use your business name as the name for their corporation may still get approved. The only other protection you could seek out is getting your business name trademarked.
When you incorporate your business, it does give your business more credibility. I’ve personally felt that clients take me more seriously knowing that I have an incorporated business.
You only have to incorporate once and pay those startup costs once. When you’re a sole proprietor, you have to renew your business registration every 5 years and there is a cost to that.
If you’re incorporated, it might be easier to get a loan from the bank for your business. Typically banks will also give better rates to corporations than sole proprietors.
When you’re a small proprietor, after business expenses everything your business earns is taxed at your personal marginal tax rate. This isn’t a big deal if your business generates a modest income and you’re not in a high tax bracket. But if it grows and you’re earning 6-figures (or more), that could be a big tax bill.
The recommendations I’ve seen about income levels and incorporating is if you’re earning $100,000 or more after business expenses, then it may make financial sense to incorporate, most especially if you don’t actually need all that money to live off of. Instead, a better idea could be to incorporate, pay yourself a salary that keeps you in a lower tax bracket, and the excess can remain in the corporation and be taxed at the corporation’s much lower tax rate. You can also choose to pay yourself dividends which also have favourable tax treatment.
Like everything in life, most decisions lead back to money and cost. So, here are some questions to ask yourself about your current business. Is your business simple and low risk? How much does it earn and what is its earning potential? Are you sure if the business is going to succeed and become profitable?
The cost of actually incorporating either using Ownr or Law Depot is between $300 to $400. And if you were to use a lawyer, it could cost anywhere between $1,000 to $2,000. There are also ongoing costs such as an annual filing by a lawyer and filing both a corporate and personal tax return. As a reference, it can cost close to $1,500 to $2,000 to file just your corporate tax return using an accountant.
My Decision to Incorporate
In June 2021, I took the plunge and incorporated my business. I had been considering it for a few years, mostly because I felt a lot of pressure to do so from other business owners. But after consulting with my accountant, I waited until I was 100% ready.
I came to my decision to incorporate my business after reaching two big milestones.
First, I waited until I consistently earned 6-figures in business revenue. This is because there are extra costs to running an incorporated business and I wanted to be sure that I was earning enough in my business to make those costs worth it.
Secondly, I had maxed out my RRSP contribution room. As a sole proprietor, each year I would contribute as much as I could to my RRSP so I could use those tax deductions to lower my personal marginal tax rate and thus lower my tax bill. But in 2021, I maxed out my RRSP room early in the year and based on my projections, it looked like I was finally going to earn over $200,000 in business revenue. With my available RRSP tax deductions, I knew I needed another strategy to keep my personal income tax bill low, and incorporating my business could help with that.
Another thing to note, when I did incorporate, some of my business costs shot up. I had very minimal costs as a sole proprietor. Between doing my own bookkeeping and using my accountant very minimally to help file my taxes, I spent on average $835/year on administrative costs.
When I incorporated, I decided to hire a bookkeeper (I use Weste Management Services) to free up my time so I could focus on more income-generating tasks. With that said, I pay about $500/month for my bookkeeper. My costs at tax time are also higher since I have to file a corporate tax return and a personal tax return. This year it cost me $3,000.
And lastly, there’s the cost of actually setting up your corporation. You can do this on your own for much cheaper using a platform like Ownr. But for me, I wanted to save time and get some valuable advice while setting up my corporation, so I opted to hire a lawyer (Elena Favaro Viana specifically). That cost me about $1,500 to get everything set up properly.
One-year Post Incorporation
It has been a little over a year since I incorporated my business and I’m really glad I did it. But it is not as simple as running a sole proprietorship and sometimes I really miss that simplicity. There was definitely a learning curve at first, but once you go through all four quarters of a business cycle, it does get easier. And honestly I love the fact that I can get creative with my accountant in determining my salary, bonuses, and dividends throughout the year to make sure we’re being smart with different tax strategies.
As you can see, there is a lot to consider before you make the leap to incorporate your business. Leave me any comments or questions down below, I’m always happy to answer.