You’re ready to take the plunge. Maybe you’ve written a full-fledged business plan or maybe you’ve just made some notes on your iPad, but you truly believe in your idea. And you’re committed to launching your own business. In the excitement of getting started, you’ve probably even begun designing your website and logo.
While all these things are important, thinking about your business structure should be at the top of the list. Choosing the right business structure has a major impact on the tax implications of creating a successful venture. The legal business structure you choose directly affects how much you’ll pay in taxes each year. It also defines the type of ownership your business has, affects your ability to raise funds, and defines how much personal risk and responsibility you take on.
This article covers 5 key things you need to know about structuring your business in Canada, so that you can decide how best to set up your new company.
- Choosing a business structure depends on what kind of business you have, whether you have a partner, and your big-picture plans.
- A sole proprietor can claim their business income on their personal tax return.
- Incorporating protects you from personal liability in a way partnerships and sole proprietorships don’t.
How your business structure affects your taxes: a breakdown
The business structure you choose is important because it affects your tax obligations and how you file. Self-employed individuals report their business income and personal income on the same income tax return, and sometimes partnerships do too. Corporations must report business income on other forms.
Let’s look at each business structure type in more detail.
1. What is sole proprietorship?
Sole proprietors file taxes individually. They are owner-operated businesses. The single owner is the person who provides the goods or services of the business, collects all the income, and is responsible for all liabilities. This is a common business structure for gig workers, including:
- Consultants
- Dog walkers
- Freelance writers
- Rideshare drivers
- Tutors
- Website designers
- YouTube producers
As a sole proprietor, you file business and personal taxes together, using Form T2125 to report business income and expenses.
2. What is a general partnership?
Business partnerships consist of two or more owners. Perhaps the most common partnership scenario is when a husband and wife operate a small local storefront together. But a partnership can be between friends, too. Maybe you want to open a boutique coffee shop with your neighbour or start a 3D print shop with your roommate from university.
From a tax and legal standpoint, a partnership is similar to a sole proprietorship. The business income is split between the partners, and each pays their individual tax rate on their share of the income, using Form T2125.
If the business is large enough to have $5,000,000 or more in assets, however, then a Form T5013 must be filed. This income is then filed on each partner’s individual income tax return.
3. What is a corporation?
A corporation is a business structure that is completely separate from its owner(s). While this type of company can be started and owned by an individual, it’s common for corporations to have multiple owners. In legal terms, these owners are shareholders.
A corporation can enter into legally binding contracts and own property; it is also responsible for paying taxes separately from its owners. Corporate entities pay income taxes using the T2 corporation income tax return.
Corporations are popular from a liability standpoint because they limit or remove personal liability risks for individual owners.
4. What is the difference between proprietor, partnership, and corporation?
The main differences between business structures lie in tax and legal implications. Proprietors and partnerships report their business income alongside their personal income, while corporations are separate legal entities and report taxes separately.
Sole Proprietor | Partnership | Corporation | |
Owned by | One person | Two or more people | One or more people |
Taxes | Reported and paid with personal income | Each entity reports their share with personal income | The corporation is a stand-alone entity taxed separately from owner(s) |
Legal | Personally liable | Shares potential liability with other partners | Only the corporation and its assets are liable |
5. Which one should I choose?
When starting a business, it can be difficult to decide which structure makes the most sense for your needs. To help with that, consider the following:
- Type of business: If you intend to be a gig worker, freelancer, artist, or other solo entrepreneur, then the simplest business structure is sole proprietor.
- Ownership: Whether you want to start that family business with your son or you plan to team up with your two best friends, shared ownership is quick and easy to establish with a partnership structure.
- Personal liability: Just because you can operate as a sole proprietor or partnership doesn’t mean you should. From doctors to handymen, personal liability risk can be a concern. In these cases, establishing your business as a corporation may be best.
- Tax advantages: Incorporated companies have the advantage of potentially saving money on income taxes due to lower tax rates. And, if your corporation has the potential to be sold as a qualified small business corporation, shareholders may benefit from the LCGE.
- Size of business: If you hope to grow your company substantially in the future—and especially if you’d like to take it public—creating a corporation is the best first step.
While choosing a business structure feels complicated, it’s the first step to truly getting started. Now that you know the ins and outs of different business structures and how they affect your tax filing, you can now make an informed decision about which one is right for your new venture.
Your self-employed tax situation, covered
Whether you’re a freelancer, side-gigger, independent contractor, or just have multiple sources of income, TurboTax can handle your return.
