Sole Proprietorship vs. Incorporation: When to Switch?
As your business grows, you might wonder if it's time to incorporate. We analyze the tax deferral advantages and administrative costs.
Sole Proprietorship vs. Incorporation: When to Switch?
Starting as a sole proprietor is easy and cheap. But as your profits grow, the tax bite can become painful. Is it time to incorporate?
Sole Proprietorship
- Pros: Simple setup, low cost, easy tax filing (T2125 form on personal return).
- Cons: Unlimited liability (your personal assets are at risk), high personal tax rates on high income.
Incorporation
- Pros: Limited liability (legal separation), Tax Deferral.
- Cons: Higher setup costs, annual legal filings, separate corporate tax return (T2).
The Tipping Point
The main tax reason to incorporate is Tax Deferral. Small businesses pay a low corporate tax rate (approx. 12.2% in Ontario, varies by province) on active business income up to $500,000.
Compare this to the top personal marginal rate (over 53% in some provinces).
The Rule of Thumb: If you are earning more money than you need to live on, and can leave significant savings inside the corporation to invest or grow the business, incorporation makes sense. If you pull out every dollar you earn to pay for personal living expenses, incorporation rarely saves you tax and costs more to maintain.