How to choose the right legal structure for your business and what they mean Part 2: Sole Proprietorships

Continuing from part one, we continue to explore the types of legal structure to consider setting up when starting a business.  In this issue, we look at sole proprietorship.

Sole Proprietorship

The sole proprietorship is the simplest form of business organization because there is only one owner.  Ultimate control lies in the hands of the owner, whether the business is operated in the owner’s name or through a trade name.  All of the assets, responsibilities, rights and obligations belong to that individual owner.  This personal responsibility means that the sole proprietor’s personal assets may be seized to meet the claims of the business’s creditors.  The assets of a sole proprietorship are the assets of the owner, meaning that the business has no separate legal personality from its owner, as is the case with a corporation.

While there is no commercial legislation strictly regulating sole proprietorships, a sole proprietor will, depending on the nature of the business, have to comply with federal, provincial and municipal regulations affecting trade and commerce, registration and licensing.  In some cases the sole proprietor may be required to register under another regulatory scheme, once again depending on the nature of the business.

The business income and the owner’s personal income are considered the same for tax purposes.  Therefore business profits are reported on the owner’s personal income tax return, based on federal and provincial income tax schedules.  Business expenses and losses are deductible.  It is advisable, though, to keep personal and business bank accounts separate.  For instance, you should pay yourself a salary from your business account and deposit it into your personal account for your personal needs (food, clothing, lodging, personal savings).  A proprietor is personally responsible for all debts or liabilities of the business.

Advantages

Minimal start-up costs and compliance procedures.

The owner is in direct control of the decision-making and does not have to report to shareholders or directors.

Relative freedom from regulation.

All the profits are for the benefit of the owner.

The personal tax rate is lower than the rate for corporations in certain situations.  (Therefore, during the early phases of the business, it may be more advantageous to remain a sole proprietorship or partnership).

Sole proprietorships are relatively easy to roll over into an incorporated company at some point in the future.

Non-capital start-up losses can be offset against the owner’s income from other sources.

Disadvantages

The owner is personally liable for all debts and obligations of the business.

It is difficult to raise capital apart from conventional loans.

The business can only be transferred by selling the assets.

Some government loan, subsidy or guarantee programs are available only to limited companies (corporations).