As far as almost everybody knows, there are three main forms of business organization: a Sole Proprietorship, a Partnership and a Corporation. But what precisely are the differences between them? What about responsibilities, liabilities or tax implications? So, let us start from the beginning.
Advantages, Disadvantages & Tax Implications of:
1. SOLE PROPRIETORSHIPS
Generally, this is the simplest type of business to start. A sole proprietorship is a business that is owned by one person. There are a few important features of it. First, the business and the owner are considered to be one entity under the law. Second, all of the assets of the business are personally owned by the sole proprietor. Third, the sole proprietor is not considered an employee of the business. Because of this, he is not eligible for employment insurance if the business fails. The sole proprietor is not paid a salary, but instead can take money from the business through personal drawings.
- You are the owner. You are a sole proprietor. You can be your own boss and can make business decisions without having to ask anyone else.
- You get to keep the profits from the business and you can end your business whenever you want.
- Although, you need to keep separate accounting records for the business, you only need to file one tax return.
- You are personally responsible for all aspects of the business. If the business is being sued, so are you. If the business owes money, you may have to use your personal assets to pay off the debts and if you are not able to do so, you may have to claim personal bankruptcy.
- The only way to transfer the ownership of a sole proprietorship is to sell the entire business to someone else.
- The life of the business ends when the sole proprietor dies.
Net business income from a sole proprietorship must be included as part of your personal income. However, if the business suffered a loss, you can deduct the loss from other income you have received for that year. This will lower your overall taxable income and reduce the amount of personal income tax that must be paid. If the business made a profit, the profits are taxed at your personal income tax rate. Generally, it is better from a tax standpoint to be a sole proprietor if you expect the business to lose money in its early years and you have income from another source, such as employment income. Normally, sole proprietorships are best for businesses earning a small profit which do not have significant liability concerns.
A partnership is an unincorporated business that is carried on by two or more people who intend to share the business profits. Partnerships have at least five important features. First, a partnership can be created by an express agreement or it can be created if the people are simply acting in a way that seems like a partnership. Second, the partners can be held responsible for the actions and business debts of the other partners. Third, all the assets of the business are personally owned by the partners. Fourth, there are two main types of partnerships: general partnerships, where all the partners share the profits and losses of the business; and limited partnerships, where the limited partners are not involved in the daily operations and are only responsible for losses up to the amount they contributed to the business. Fifth, partners are not considered employees of the business. Because of this, partners are not eligible for employment insurance if the business fails. Partners are not paid a salary, but they can take money from the business through personal drawings.
It is a good idea to put a partnership agreement in place because it will outline issues such as how the profits or losses will be divided among the partners, and it will describe any limits to the legal responsibility of the partners.
- A partnership allows two or more people to work together and bring different skills and resources to the business.
- A partnership is fairly easy to establish. The actual registration of a partnership is not expensive or complicated.
- If the partnership suffers a loss but the partners have other employment income, the loss can be used to reduce their taxable income, thereby lowering the income tax payable by the partner.
- Because the partnership is not considered to be separate from its owners, the partners are personally responsible for liabilities of the partnership.
- Because each partner is an agent for the business and for the other partners, each partner is personally responsible for the actions of the other partners. If one of the partners makes a bad business decision, or acts negligently which results in the partnership owing a debt, all of the other partners are personally responsible to pay it back.
- Because a partnership is based on the individual partners, and it is not a separate legal entity, if one of the partners dies, the partnership ends. This means that the remaining partners have to re-establish the partnership.
- Because a partnership is not a separate legal entity, it is difficult to buy or sell a partnership interest. Buying or selling a partnership interest will involve rewriting the partnership agreement and determining exactly how the partnership will change.
- Although the resolution of disagreements amongst partners is generally covered under a partnership agreement or case law, it usually is very difficult. There is no Act that exists which sets out the rules for settling partnership disputes. If the disagreements are not resolved by the partners themselves, they will usually have to turn to outside help which can be time consuming and costly.
First, the business income of a partnership is divided between the partners and included on each partners’ personal income tax form; the partnership does not file a separate tax form. Second, if the business has suffered a loss, the partners can deduct the loss from any other employment income they receive. This will lower the overall income of an individual partner and reduce the amount of income tax he or she must pay. Third, if the business has made a profit, the profits are taxed at each partners’ personal income tax rate. Fourth, because the partnership is not a separate legal entity, the partners cannot take advantage of income splitting or tax deferral opportunities available with corporations.
The main feature that makes corporations different from sole proprietorships and partnerships is that corporations are legal entities separate from their owners. As a result, the corporation is responsible for its own debts, assets, and lawsuits. The legal responsibility of the shareholders, directors, officers and employees of the corporation is limited, which means that, with few exceptions, these people cannot be held personally responsible for the debts and obligations of the corporation. This is the reason that one of the words Limited, Incorporated, Corporation, or one of their abbreviations must be included in the full legal name of the corporation. These words give notice to the public that the business is a corporation and therefore its owners, directors, officers and employees have limited liability.
Corporations are owned by shareholders, who own a percentage of the entire corporation through their shares. Shares can generally be bought and sold fairly easily, unless restrictions have been placed on the transfer of shares.
There are many advantages to incorporating a business:
- The shareholders of the corporation cannot be held responsible for the debts and obligations of the corporation unless they provided a personal guarantee. By comparison, in a sole proprietorship or a partnership, the owner or partner is personally liable for all of the obligations of the business. This means that the owner’s personal assets, including their home, car, and personal savings can be taken to pay for the debts of the business.
- A corporation has an unlimited life. Because the corporation is a separate legal entity, the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes.
- The corporate form of business makes it easier for a business to grow and expand. Through the issuance of shares, corporations may be able to access the money they will need for expansion. This makes the corporate form of business more suitable for large business ventures than sole proprietorships or partnerships.
- There may be tax advantages to running your business as a corporation. Examples of corporate tax advantages are tax deferral strategies and income splitting.
- A corporation may appear more stable and sophisticated to the public. This may help you acquire new business.
- You will have to file two tax returns, one for the business and one for your personal income. Unlike sole proprietorships and partnerships, any losses from the corporation cannot be deducted from the personal income of the owner.
- The registration and set up fees for a corporation are higher than the set up fees for a sole proprietorship or a partnership. Incorporating a business is also a more complicated process than starting a sole proprietorship or partnership. You should contact a lawyer to help you incorporate your business.
- The Government requires corporations to maintain proper corporate records, called a minute book. A minute book contains the corporate bylaws and minutes from annual meetings.
To determine which form of business entity to choose, should you incorporate your business or not, you may consult a lawyer who can help you in this process. Also, in many banks small business advisors are ready to give you an advice for free. And remember, business taxation can be very complicated, and it is usually a good idea to contact an accountant to have a clear picture of the tax implications of your particular situation.References: www.mgs.gov.on.ca/ – Ontario Ministry of Government Services www.canadabusiness.ca/ – Canada Business – Services for Entrepreneurs www.serviceontario.ca/ – Service Ontario www.ontario.ca/economy – Ontario Ministry of Economic Development www.cra.gc.ca/ – Canada Revenue Agency