Have 5 seconds? Here’s the short answer.
As a sole-proprietor, you are your business; when you incorporate, it’s you and your business. To determine which is right for you, consider how much income you’re earning and the risk of being sued by a client.
Have 5 minutes? Here’s what you really to know.
What’s the difference?
The main difference between a sole-proprietor and a corporation is identity. As a sole-proprietor, your business income is earned by you personally; when you incorporate, you create a separate entity (the corporation) to earn income, which then pays it out to you.
In this way, incorporation is kind of like creating an alter-ego of yourself for a special purpose … the Sasha Fierce to your Beyoncé, if you will. Like Sasha Fierce, whose sole purpose is to be, well, fierce, your alter-ego’s sole purpose is to be your business; to earn income, pay expenses and create profit. This separation comes along with some sweet financial and legal benefits. More on those in a moment.
But what about business expenses?
You may have heard that you should incorporate so that you can claim business expenses against the income you earn and reduce the amount of tax you pay. This statement is technically true, but it’s a bit misleading. Yes, corporations can claim business expenses, but so can sole-proprietors … it’s employees that are not eligible for this tax break.
Check out this great explanation of employee vs self-employed from FreshBooks if you’re not sure that you qualify as self-employed for tax purposes.
So, should I incorporate?
Before you go ahead with Me, Inc., there are two questions to ask yourself to make sure it’s the right move.
Am I earning more income in my business than I need to support my personal life? If you spend everything that you earn – which most of us will in our first few years of business – then there isn’t a compelling financial benefit to incorporating. Income earned in a small business is taxed at a much lower rate than when it’s earned personally, but if you’re paying everything out to yourself then your corporation’s income will be zero … putting you in essentially the same place as if you were a sole-proprietor, with a lot more work involved.
Is there a risk that I will be sued by my clients? I like to think positively and assume things will generally turn out well, but it’s important to be realistic and protect yourself from the worst-case scenario. A corporation creates a legal separation between your business assets and your personal assets, so if something goes wrong and you are sued by a client you can sleep easy knowing your house and life-savings won’t get caught in the middle.
Sounds great, but….
Given the time and costs required to maintain a corporation it might not be worth the effort to create one. If it does make sense to incorporate, you’ll want to make sure you set up the right systems and processes (bookkeeping, tax remittances, annual filings) to make the process as smooth and simple as possible.
As with most tax and personal finance question, the right answer for you will depend on your specific circumstances. I’m happy to help you figure out if you’re ready to incorporate. Book a Clarity Call with me and let’s talk!
Lisa Zamparo is a financial strategist and lifestyle optimist, as well as a Chartered Professional Accountant (CPA), business coach and personal finance expert in Toronto who helps people make intentional decisions with their money. As a one-on- one coach, her personalized approach to financial planning helps her clients achieve their goals by aligning their spending with their priorities. As an inspirational educator, Lisa leads workshops that infuse mindfulness principles with financial concepts delivered in a fun and approachable style.