Sole Proprietorship vs. Corporation: 4 Questions to Help You Decide

When you’re ready to turn your idea into an official business, the question of business structure comes up fast. Maybe you've heard horror stories of people losing personal assets because they didn’t set up the right structure. Or perhaps you've seen others struggle under the weight of corporate formalities and fees without understanding if it was worth it. How do you choose the right one – sole proprietorship or corporation – to grow your business and protect yourself?

Take Greg, for example. He started his contracting business with a few thousand dollars and a truck. Intending to keep it a simple, he opted for a sole proprietorship because it was easy and inexpensive. But as his business grew, his income increased, and so did his personal taxes meaning he had less left over to invest in the company. On top of all that, a dissatisfied client threatened legal action, and Greg's personal assets were suddenly at risk.

Greg's journey led him to re-evaluate his business structure. He ultimately decided to incorporate, giving him peace of mind, tax deferral, and new growth opportunities. But if he had more insight at the start, he could have saved time, money, and stress.

Moral of the story - don't be Greg. This guide breaks down the 5 key differences between a sole proprietorship and a corporation as well as the key advantages and disadvantages of each. You’ll walk away knowing your options and the questions to ask yourself to determine what’s right for you.

👤 Sole Proprietorship vs. Corporation - What Are They?

Before diving into the pros and cons of each, let’s break down what a sole proprietorship and a corporation actually are. Understanding their basic definitions will help you see which might align better with your business goals.

What is a Sole Proprietorship?

A sole proprietorship is the simplest business structure. You, as the owner, are the business. There’s no separation between your personal and business finances, which means you’re personally responsible for everything the business does.

• Legal Definition: A business owned and operated by one individual with no legal distinction between the person and the business.
• Key Features:
  • Simple to set up and operate.
  • All profits flow directly to the owner, and taxes are filed as part of the owner’s personal income.
  • The owner has unlimited personal liability for debts and obligations.
• Who It’s For: Freelancers, independent contractors, and small business owners who are starting small or testing a business idea.

Example:

Sarah is a freelance graphic designer. She decides to operate as a sole proprietor because it’s quick and easy. She registers her business name with her local government for a small fee and starts working with clients. At tax time, she includes her business earnings as part of her personal tax return.

What is a Corporation?

A corporation is a separate legal entity from its owners (called shareholders). It can own assets, incur liabilities, enter into contracts, and conduct business, all independently of its owners.

• Legal Definition: A business structure where the company is a separate entity, offering limited liability to its shareholders.
• Key Features:
  • More complex to set up, with formalities like articles of incorporation, share issuance, and board meetings.
  • Provides limited liability protection, meaning the owners’ personal assets are generally shielded from business debts.
  • Profits can be retained in the corporation or distributed to shareholders as dividends.
• Who It’s For: Business owners looking to grow, attract investors, or shield personal assets from risk.

Example:

Marcus runs a growing electrical services business. He incorporates his company to protect his personal assets in case of lawsuits or debt. This setup also allows him to attract investors by selling shares in the corporation, enabling him to scale his operations.

Key Differences Between Sole Proprietorship and Corporation

⚠️ 1. Liability Protection: Personal Risk vs. Limited Liability

Every business involves some risk, but the right structure can help shield your personal assets from liability.

Sole Proprietorship: Full Personal Responsibility

• Unlimited Personal Liability: In a sole proprietorship, you are personally liable for any debts or lawsuits against your business. This means your personal assets – home, car, savings – could be at risk if something goes wrong.
  • Example: Eric, a personal trainer, operated as a sole proprietor. When a client was injured during a workout, Eric was personally responsible for covering the medical costs since his business and personal assets were legally inseparable.
  • Note: In any physical business if you think your liability is limited - chances are it isnt. If you choose to go this route, get really good insurance to protect your personal assets from business risks.
• Not Ideal for High-Risk Ventures: If your business is in a high-liability field, like construction, finance, or legal advice, a sole proprietorship may not offer enough protection.
  • Example: Alicia, a home renovation contractor, transitioned from a sole proprietorship to a corporation to protect her personal assets. This move was crucial after seeing a peer lose personal assets in a lawsuit.

Corporation: Limited Liability Protection

• Shielding Personal Assets: A corporation legally separates your personal assets from your business’s obligations. This means that, in most cases, your personal assets are protected from business debts or lawsuits.
  • Example: Marcus, an electrician, incorporated his business after seeing how a corporation could protect him. When a client sued for faulty wiring, his personal assets were protected, reducing his financial exposure.
• Peace of Mind for Higher-Risk Ventures: For businesses that face regular or potential legal challenges, incorporation offers a protective barrier between personal and business finances.

Guiding Question: Does your business involve significant risk, and would liability protection offer you peace of mind?

💵 2. Tax Implications: Direct Income vs. Tax Deferral and Flexibility

Business structure can have a big impact on what you pay and when.

Sole Proprietorship: Direct Income and Simplicity

• All Income as Personal Income: With a sole proprietorship, all earnings are reported on your personal tax return, which simplifies tax filing but limits your flexibility for tax planning and potential tax advantages.
  • Example: Linda, a photographer, appreciates that her business income flows directly to her personal return, keeping her taxes simple and low-cost to manage. She only makes as much as just enough left over to save in an RRSP or TFSA (which have tax benefits). If she had more left over it may be beneficial to start a corporation and pay the corporate tax rates on the remaining income (see below).

Corporation: Flexible Tax Strategies

• Options for Tax Deferral: Corporations allow you to retain earnings within the company, taxed at lower corporate rates, which can be reinvested or deferred.
  • Example: Emily, who owns a software business, only needs $60,000 for personal expenses from her $150,000 income. She retains the rest within the corporation at a lower corporate tax rate, freeing up capital to reinvest.
• Flexible Owner Compensation: Corporations give you the option to choose between salary, dividends, and paying back shareholder loans. This flexibility allows you to optimize how you take money out of the business and when you are taxed for it.

Decision Point: Do you make more than you need AND more than your TFSA + RRSP contribution room?

📈 3. Long-Term Goals: Planning for Growth, Transfer, or Sale

Consider your growth and exit strategy. Your business structure can impact how you sell or expand.

Sole Proprietorship: Limited Growth Potential

• Short-Term Focus: Ideal for ventures where growth and investment aren’t the main focus.
  • Example: Julie operates a small consulting agency. She’s happy running it as a sole proprietorship because she isn’t planning to scale beyond her current operation.
• Limited Transfer Options: Since a sole proprietorship isn’t a separate entity, it’s harder to transfer or sell.
  • Example: Alex, a yoga instructor, wants to retire in five years. Selling her sole proprietorship would mean transferring assets individually, which complicates the process (i.e. ups the cost) and limits flexibility.

Corporation: Built for Growth and Sale

• Growth and Access to Capital: Corporations can issue shares and attract capital from investors, making them suitable for businesses with growth aspirations.
• Tax Benefits on Sale (Lifetime Capital Gains Exemption): Corporations allow business owners to sell tax-free up to a certain amount using the Life Time Capital Gains Exemption (LCGE).
  • Example: Chris sold his tech company and used the LCGE to avoid taxes on a portion of the sale, maximizing his profits.

Guiding Question: Are you planning to expand, bring on investors, or sell your business in the future?

📚 4. Administrative Costs and Compliance Requirements

Running a business brings ongoing compliance and paperwork. Here’s how each structure compares.

Sole Proprietorship: Low-Cost Simplicity

• Minimal Compliance Requirements: With a sole proprietorship, you won’t need to file separate corporate taxes or maintain formal records.
  • Example: Anne runs a pet-sitting business. Her sole proprietorship allows her to handle taxes herself, keeping expenses low and time requirements manageable.
• Lower Ongoing Costs: Legal and accounting costs are generally minimal, as there’s no need for separate corporate returns.

Corporation: Added Compliance Costs

• Annual Filings and Legal Requirements: Corporations require an annual T2 corporate tax return and may also need to file payroll taxes for the owner.
  • Example: Lisa incorporated her bakery and now uses an accountant to handle bookkeeping, reports, and taxes, saving her time and ensuring she stays compliant.
• Affordable Compliance Options: If you’re worried about the complexity, services like Ownr can streamline compliance at a lower cost.

Decision Point: Do you NEED to add the administrative overhead considering all the other points here?

🤔 Special Considerations: When a Sole Proprietorship Might Be Better

For some, the simplicity of a sole proprietorship is the better choice.

Starting Up with Expected Losses

If you’re in a phase where losses are expected, a sole proprietorship can be helpful, as losses offset personal income.

• Example: Sara, starting a new restaurant, uses early-stage losses to offset her other income.

Testing the Waters

For new or unproven businesses, a sole proprietorship allows you to get started without the commitment of incorporating - however if your business is high liability you may still want to consider incorporating from the start or getting really goof insurance.

✅ Checklist: Choosing Your Structure

Consider these questions to zero in on your ideal structure:

1. Do you face significant liability exposure in your business?
   • IF YES: Corporation
   • IF NO: Sole Proprietorship
2. Will your business generate more income than you need personally, allowing tax deferral?
   • IF YES: Corporation
   • IF NO: Sole Proprietorship
     
3. Are you planning to expand, involve investors, or sell in the future?
   • IF YES: Corporation
   • IF NO: Sole Proprietorship
     
4. If everything else was a NO - are you ready for the additional administrative requirements of a corporation?
   • IF YES: Corporation
   • IF NO: Sole Proprietorship
     

Download our interactive checklist to guide your decision.

Conclusion: Choose the Structure That Fits Your Goals

Hopefully by now - you have a decent idea of what business structure is right for you. While this guide should give you the in depth view - it simply comes down to liability, tax deferral opportunities, and what you want to do with the business in the future (e.g. sell).

Now that you know what type of business makes most sense for you - you're probably ready to start it! Here are a couple resources that might help:

• How to Start a Business in Canada
• When to Start a Business, and When NOT to

❓ FAQs

1. Can I switch from a sole proprietorship to a corporation later?

• Yes, many start as sole proprietorships and incorporate as they grow. However, it’s essential to understand the tax and legal implications of switching.

2. Are there industries or a type of business where sole proprietorships aren’t recommended?

• High legal liability industries, like construction, finance, and law, often benefit from the liability protection of incorporation.

4. What’s the biggest benefit of incorporation?

• Liability protection and tax flexibility. For businesses with high income or risk, these can be game-changers.