Running your own business can be time consuming, stressful, and above all very expensive. That being said, business owners are able to minimize unnecessary costs and taxes owing, mainly through incorporation.
The difference between a Sole Proprietorship and a Corporation
The profits of a sole proprietorship are claimed as income by the owner through self employment. This means that income from the business is taxed as the individual’s personal earnings.
A corporation, however, is an entity separate from its owner(s) which follows different tax rules and rates. As the owner of an incorporated business, you are required to file a Corporate Tax return, separate from your individual return. As you read on, you will learn about the benefits of doing so.
Pros of a Sole Proprietorship
Operating at a loss: If a business is operating at a loss, this can be used to lower the individual’s income on their tax return, meaning less tax owing overall.
Low registration fees: the fees of registration are far lower than that of corporation, sitting at roughly $60 for 5 years.
Easy to setup: along with being less expensive to set up, a sole proprietorship also requires less administration.
Cons of a Sole Proprietorship
Unlimited liability: Sole proprietors are liable for their businesses. This means that if the company is sued, the owner’s personal assets can be taken as forced payment.
High tax rates: unincorporated businesses cannot take advantage of tax reductions such as the Federal Small Business Deduction, which results in extremely high tax rates.
Pros of a Corporation
Tax benefits: incorporated businesses are taxed at a much lower rate than unincorporated businesses. Furthermore, shareholders can make further use of these tax benefits by paying themselves in dividends.
Limited liability: since corporations are separate entities, the liability of the business on its directors is limited, which in turn protects the individuals from most debt incurred by their business.
Ability to acquire financing: corporations are considered separate entities, meaning that they can borrow and lend money, and acquire their own financing which can lead to increased growth. Corporations can also raise capital through equity financing by selling stocks to investors.
Transferable ownership: the potential number of different owners for an incorporated business does not have a limit. Ownership in a corporation is more desirable than in other businesses, as shareholders are only liable for their stake in the company, based on how much they have invested. Additionally, ownership of a corporation is very easily transferable, as it only involves the acquisition and sale of shares between owners.
Improved image: corporations tend to appear much larger in size and operations than their non-incorporated competitors. They also have more of a sense of legitimacy in the eyes of potential customers.
Cons of a Corporation
Initial setup costs: when looking at the cost of incorporating alone, the setup fees can appear quite high in comparison to a sole proprietorship. The initial setup costs for a corporation can range from $1,000 to $1,500, depending on the business.
An extra return to file: as mentioned earlier, corporations are required to file their own Income Tax Return. This involves some extra time and administration.
If your business is earning more than $50,000.00 in annual income, it may be time to consider incorporating. While this may seem costly at first, the long-term benefit is far greater than the impact of initial cost.