When you become self-employed, you need to decide which structure you are going to use for your business. The 2 most common types in Canada are sole proprietorship and corporation.
Let’s look at the pros and cons of both.
- Quick and cheap: creating a sole proprietorship is very easy. You only need to file in a couple of forms, pay a modest fee and you are in business
- Little regulations and requirements: a sole proprietorship is not a distinct legal entity and has way less regulations than a corporation
- If the business looses money, the loss can be offset against other incomes of the proprietor, lowering taxes owed
- Unlimited liability: the owner of the business is responsible for all the debts of the business and is personally liable
- Higher tax rates: income from the business is on the individual tax return and taxed at the personal rates, higher than corporation rates. CPP contributions are also double, as CRA considers a sole proprietor both the employer and the employee
- More paperwork and more expensive: incorporating requires way more paperwork than a sole-proprietorship. You need to create articles and a share structure, nominate officers and directors etc…The fees are also higher.
- More regulations and requirements: because a corporation is a distinct, separate legal entity it needs more record keeping. There are ongoing fees as well.
- Limited liability: the personal assets of the owner are protected.
- Lower tax rates: small businesses are less taxed than individuals. Corporations can also take advantage of business tax credits.
- Dividend payment: instead of paying themselves a salary, owners can pay themselves dividends. Dividends are not considered “regular income” by CRA. They are taxed at a lower rate and exempt from CPP and EI. Dividends are not included in the calculation of the RRSP contribution limit.
A sole proprietorship is fine if the income generated by the business is very low or a side to a full-time job. Personally, if I chose to become self-employed again, I would incorporate my business. The tax advantages largely outweigh the paperwork requirements.