You’ve created a business plan for an idea you firmly believe in, and you’re now prepared to take the plunge and start your own business.
Designing your logo, developing a website, or developing a product prototype may be on your top of mind right now; however, choosing the correct business structure is an essential too for positioning your firm for success—or at the very least, protecting you from potential legal frustrations during tax season.
This is true because your business structure has a direct bearing on your tax obligations, amount of risk and liability, ownership structure, capacity for investor financing, and other factors.
Which business structure therefore makes the most sense for your company?
Here are 5 questions to help your decision-making.
Three main types of business structures in Canada
A business structure determines an organization’s legal structure, which influences how businesses report their income and the sort of tax returns they file. There are 3 main structures in Canada:
- 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 kind of business you want to launch one you could run on your own for a long time? Or, if all goes according to plan, will it develop tentacles that will necessitate a more complex structure?
A sole proprietorship is typically the quickest and simplest way to get your business up and operating if you’re launching the kind of business where you pretty much ARE the business. You have the option of operating under your own name, and setup charges are minimal.
The following professions are typical examples of sole proprietorships: writer, graphic designer, web developer, tax preparer, jewelry designer, consultant, property manager, tutor, dog walker, and online fashion reseller.
The CRA views you and your business as a single entity, thus your earnings are transferred directly into your personal bank account for you to oversee, manage, and pay taxes on. You only need to submit a T2125 form to report your business’s income and expenses; no separate tax return is required.
Q2. Does your business have more than one owner?
A partnership structure is simple to set up and manage from a tax and legal standpoint if you’re starting a business with others. Partners simply draft a contract outlining the distribution of revenues, responsibilities, and expenses.
All business profits are distributed directly to partners, although they are taxed at their respective personal tax rates. Partners are individually responsible if something goes wrong, just like sole proprietors are.
Q3. How much risk are you willing to accept?
The primary legal purpose for incorporation for many business owners is to shield themselves from personal liability. When you incorporate, your responsibility is limited to the amount you’ve contributed to the business.
There is no distinction between your business and personal assets when you are a sole proprietor. Thus, they may seize your personal assets, such as cash, a car, and even your home, if you ever had financial difficulties or if someone sued your business.
Q4. Will you be earning more than you spend?
All of your profits as a sole proprietor are subject to personal income tax. If your income is modest enough to put you in a reasonable tax rate, this is OK. Your tax rate could increase to 33% once you reach a certain earning level.
It might make sense to incorporate at this stage.
The financial benefits you’ll get, like getting to pick the most tax-efficient way to pay yourself, will probably outweigh the costs of incorporation in terms of both legal and accounting services.
This is especially true if you’re motivated to reduce your taxable income and increase the runway for your business.
Q5. How big are you planning to build your venture?
Are you trying to expand and scale your business? increase brand trust and recognition? Maybe perhaps sell it one day? Look for outside financing, grants, or investments?
Then incorporating can simplify all of these things!
Even though significant decisions like selecting the ideal business structure can seem final, keep in mind that no structure is set in stone. Future adjustments are always possible. So, whenever you’re unsure or concerned about making the wrong decision, you can ask a tax professional at IDM for guidance in real-time.