You’ve written the business plan for an idea you truly believe in and are ready to take the leap and launch your own venture.
While designing your logo, building a website, or creating a product prototype may be top of mind, choosing the right business structure is crucial for setting your company up for success– or at least saving you from potential legal headaches during tax season.
This is because your business structure directly impacts how much you’ll pay in taxes, your level of risk and liability, defining ownership, your ability to fundraise from investors, and more.
So which business structure makes the most sense for your company?
Here are 5 questions to help you decide.
- The type of business you’re in, whether you have a partner, and your big picture plans are factors to consider when choosing a business structure.
- 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.
There are three main types of business structures
A business structure defines the legal structure of an organization which affects the way companies report their income and the type of tax returns they file. In Canada, there are 3 main structures:
- Sole proprietorship: a business with a single owner who alone is responsible for all liabilities
- Partnership: two or more people who combine resources for the business and share profits and losses
- Corporation: a legal structure that’s separate and distinct from its owners.
Q1. Is your business a one-person show?
Is the type of business you want to start something you’d operate yourself for the long haul? Or will it grow tentacles that’ll require a more sophisticated structure if all goes to plan?
If you’re starting the type of business where you pretty-much ARE the business, a sole proprietorship is generally the fastest and easiest way to get up and running. Set-up costs are minimal, and you have the option of operating under your own name.
Tip: Classic examples of sole proprietorships include writer, graphic designer, web developer, tax preparer, jewelry designer, consultant, property manager, tax preparer, tutor, dogwalker, and online fashion reseller.
Because the CRA sees you and your business as one, your revenue goes right into your personal bank account for you to control, manage, and pay taxes on. When reporting your business income and expenses, you don’t even have to file a separate tax return, just a T2125 form.
Q2. Does your business have more than one owner?
If you’re starting a business with others, you may want to consider a partnership structure which is easy to set up and maintain from a tax and legal perspective. Partners simply draw up a contractual agreement that lays out the sharing of revenues, tasks, and expenses.
Partners receive all of the business’ profits directly, but the income is taxable at each individual’s personal tax rate. Like sole proprietors, partners are personally liable if anything goes wrong.
Q3. How much risk are you willing to accept?
The main legal reason many business owners incorporate is to protect themselves from personal liability. When you incorporate, your liability is restricted to the amount of money you’ve invested in the company.
For example: Say you spend $15,000 on equipment for your production business. The Airbnb you rented to shoot a music video sues you for damage to the property. The maximum you’d be liable for is $15,000.
When you’re a sole proprietor, there’s no separation between your business and personal assets. So if you were to ever run into financial troubles, or if anyone sues your business, they could go after your personal assets including your cash, your car, and even your house.
Q4. Will you be earning more than you spend?
As a sole proprietor, all your profits get taxed as personal income. This is fine if your earnings are low enough that you’re in a reasonable tax bracket. Past a certain income, your tax rate could soar as high as 33%.
At this point, it may make sense to incorporate.
The tax advantages you’ll enjoy – such as choosing the most tax-efficient way to pay yourself—will likely be greater than the legal and accounting costs of incorporating.
This is especially true if you’re keen on minimizing your taxable income and extending your company’s runway with the extra capital.
Q5. How big are you planning to build your venture?
Are you on a mission to grow and scale your business? Build brand-name recognition and credibility? Seek outside financing, grants or investments, or even sell it one day?
In that case, incorporating can make all of these things easier!
Important decisions like choosing the right business structure can feel final, but know that no structure is written in stone. It’s always possible to make changes down the road. So if you’re ever not sure or worried about making the wrong call, you can ask a TurboTax tax expert for advice in real-time.
Let an expert take taxes off your plate
Whether you decide to file as a sole proprietor, partner or corporation, have a dedicated tax expert handle everything, from start to finish.