Sole proprietorship or Corporation? (Part I)

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I was asked this question many times. What is the best form to do business? The answer is that there are advantages and disadvantages of both:

1. Sole proprietorship is taxed at the personal level. This means that all your income is added together with your net income (profit) from sole proprietorship and taxed for the corresponding level of your income.

The personal tax rate starts at 25%. The good thing about this form of business is that the loss from your business is combined with your income from  other sources (e.g. salary, dividend etc.) and you are allowed to deduct your basic personal amount overall ($9,405) and the loss will reduce your tax payable or even help you to receive a tax refund.

The reverse of the coin is that if you have a profit, this profit is added up with your other sources of income and your tax rate could increase up to 46%.

Situation A – sole proprietor

Revenue          $50,000

Expenses         $10,000

Net income      $40,000

Tax                    $7,679

Amount remained for business owner: $40,000 – $7,679= $32,320

2. Corporation is taxed with 15.5% for the first $500,000 income.  This tax rate is much lower than 25% or more as in the case of sole proprietorship.

At a first glance now this appears to be the best option. But things are not always as they seem. This tax rate (15.5%) applies only if you leave your money in the company. If you take them out then you are taxed at the personal level (25% and up) for the amount withdrawn.

So in this scenario you will have a double taxation: for corporation 15.5% and personal tax (25% and up).

I present you bellow two scenarios from the corporation approach:

Situation B- Corporation

Revenue          $50,000

Expenses         $10,000

Net income      $40,000

Tax @15.5%     $6,200

Amount remained for business owner: $40,000 – $6,200 = $33,800

Amount taxable for owner at personal level: $33,800

Tax:   $6,123

Net amount remained for business owner: $33,800 – $6,123= $27,676

Total taxes paid: $6,200 + $6,123= $12,323

Situation C – Corporation

Revenue          $50,000

Expenses         $10,000

Salary              $40,000

Net income                 0

Tax @15.5%              0

Amount remained for business owner: $40,000

Amount taxable for owner at personal level: $40,000

Tax: $7,679

Net amount remained for business owner: $40,000 – $7,679= $32,320

Total taxes paid: 0 + $7,679= $7,679

Let’s see all the scenarios in a snap shot:

  Situation A Situation B Situation C
Revenue $50,000 $50,000 $50,000
Expenses $10,000 $10,000 $10,000
Salary $40,000 $40,000
Tax -total $7,679 $12,123 $7,679
Net amount remained $32,320 $27,676 $32,320

Recommendations:

1. As long as the profit of your business is under $60,000 – $65,000 per year I advise you to do your activity as a sole proprietor because generally this money is needed in a household nowadays so you have to withdraw this amount for your own needs.

2. If you have more than $100,000 as a profit and you want to develop your business even more I advise you to operate your activity as a corporation.

3. To reduce the taxes from the corporation pay yourself a salary and in this way you will minimize your overall taxes.

For more information you can contact me at: info@cpa4toronto.com

To be continued