by Michael A. Mann
Written by Michael A. Mann, this article identifies and explains the advantages and disadvantages of operating your business as a sole proprietorship or as a corporation.
If you own a business, you know how much time, effort and money that it takes to start it up and to keep it running effectively. Your business may require you to spend seemingly endless hours at your job so that your customers are satisfied and so that your bills will be paid. In addition, you may have had to allocate significant personal assets to your business in order to buy equipment, inventory or supplies or to contribute to start-up costs. If these examples are familiar to you, and if you are a sole proprietor, then you should read on.
The purpose of this paper is to identify a few of the advantages and disadvantages of either operating your business as a sole proprietorship or as a corporation.
Being a sole proprietor means that all of the financial benefits of the business belong to you personally. The assets of the business are yours to do with as you please; and the profits of the business are your profits and are reportable as your personal income. If your business is not initially profitable, you will be able to use the net losses of the business to reduce other personal income tax owing. Once the business is profitable, that extra income could increase the marginal tax rate that you are subject to. More of your hard-earned revenues will therefore go to the government. An effective way to deal with this situation may be to incorporate. A “Small Business” (loosely defined as a business which generates less than $200,000 in profits annually) is taxed on revenues at a fixed rate of tax. If your financial situation permits you to keep the assets of the business within the company, you will be able to lessen the impact on your personal tax situation by having the corporation pay tax at its fixed rate, and by decreasing the level of your personal income.
Aside from the discussion of personal tax liability, you will also want some assurance that your personal assets continue to be yours even in the event that the business begins to fail financially or is subject to claims by creditors. As mentioned above, the assets and benefits of a sole proprietorship belong to the owner personally. The same is true for the debts, liabilities and obligations of that sole proprietorship. If the business is sued and a judgment is obtained against the business, then the successful party can attach its judgment to the personal assets of the business owner. This is probably the single largest deterrent to carrying on business in the form of a sole proprietorship; and ways to avoid that risk include obtaining adequate insurance (although insurance will not generally protect the business if it breaks a contract) or incorporating your business.
By incorporating a company and becoming a shareholder, your liability is limited to the value of the cash and property that you contributed to the company. Your personal assets, including your personal bank accounts, cars, and real property, are “shielded” from creditors. (Note: the law in Ontario relating to the liability of directors and officers seems to be changing and the trend is to find them personally liable for their actions if they have been negligent; however, from a shareholder’s perspective, the advantage clearly rests with incorporating if creditors could potentially make claims against your business).
There are several other advantages to incorporating which are beyond the scope of this paper, suffice it to say that you should seek the assistance of professional legal, tax and financial advisors before making a decision. Incorporating is not appropriate for every business; however, if, by incorporating, you can decrease your tax liability, ensure the retention of your personal assets in spite of the success or failure of your business, and do all of this while maintaining flexibility and control over the direction that your business will take, you will be a success.