Sole proprietorship

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Sole proprietorship definition

A sole proprietorship is a business with a single owner who is solely responsible for all liabilities. In the eyes of legal and tax authorities, the business and the operator are one and the same.

A sole proprietorship is a business owned by an individual. A sole proprietor works for themselves rather than being employed by a company and takes on all legal and financial responsibilities for the business.

A sole proprietor can be a freelancer, running a one-person operation, but they can also subcontract or employ other people.

Sole proprietorship is one of the three most common ways of organizing a business in Canada. The other two are general partnership and incorporation. Each of these has its own operational, accounting, tax and legal requirements.

A sole proprietorship is informal and easily created, which is why it is the most common structure chosen by new businesses.

However, sole proprietorships have a downside in that the proprietor is personally liable for all functions and debts of the business.

“There is a difference in legal liability when I am a sole proprietor versus my running a corporation. When something goes wrong as a sole proprietor, the liabilities are on me as the business owner. If something goes wrong with the company and it’s incorporated, then it’s the company that is legally responsible, though certain exceptions may apply” says Steve Kos, a Canada Revenue Agency (CRA) liaison officer in the Quebec region.

Pros and cons of sole proprietorship

The chart below lays out the implications—from an operating, accounting, taxation and legal standpoint—of creating a sole proprietorship.

Features Pros and cons
Operating
Single ownership of assets and liabilities with low administrative costs and limited formalities.
 
The owner of a sole proprietorship must raise all necessary capital alone, but has full decision-making powers.
Accounting
Only simple accounting software packages are needed for tracking revenues and expenses. (Though some small sole proprietorships, like convenience stores, require more complex software)
 No public reporting is necessary. A sole proprietor needs only basic financial knowledge to run the company and satisfy banks, vendors, tax collectors, etc.
Taxation
The company’s earnings before tax (EBT) is the taxable income of the sole proprietor.
 
A sole proprietor’s income is taxed at the personal tax rates of the individual. This type of company is limited when it comes to deducting expenses and sheltering income.
Legal
The liabilities of the sole proprietorship are also the liabilities of the individual, so the owner has full legal responsibility for all of the company’s dealings.
 
If sued, the business and personal assets of a sole proprietor can be seized to settle claims.

What is an example of a sole proprietor?

There are numerous examples of sole proprietors, including business consultants, landscapers, freelance editors, electricians, computer repair people, tutors, financial advisors, photographers and social media specialists. A sole proprietor refers to anyone who is the owner of an unincorporated business.

With sole proprietors, what we often notice is that their business and their personal lives end up being very intertwined, certainly from a taxation perspective.

How do you start a sole proprietorship?

Anyone can start a sole proprietorship in Canada. Most sole proprietorships begin with people doing freelance work.

If you are doing business under your legal name and have revenues under $30,000 a year, then you probably do not need to register it at the provincial, territorial or federal level.

Once a sole proprietorship has been established, the business and its owner are considered the same from a tax and legal standpoint. Because of this, owners of sole proprietorships sometimes use lawyers as well as tax and accounting professionals to help with the legal and financial aspects of running the company.

Do I need to register a sole proprietorship?

If you are doing business under a name other than your own, you will need to register a trade name with your provincial or territorial government, unless you are in Newfoundland and Labrador where sole proprietorships do not need to be registered.

Sole proprietorships making more than $30,000 in annual revenue might need to obtain a business number (depending on the industry) with the federal government and be required to pay sales taxes. You will also need to register a business number if your business pays employees or wants to benefit from government programs.

Depending on your activities, you may also need permits and licenses from the federal, provincial, territorial or municipal government. Canada’s various governments have created the BizPal platform to help entrepreneurs determine what permits and licenses they need to operate their business.

Registering a sole proprietorship will allow you to access CRA programs, to open a business bank account and to apply for a business credit card or a business loan.

Kos explains that while sole proprietors do not necessarily need to register their business, doing so can make things easier if you plan on doing business with a bank.

Sole proprietorship vs. incorporation

While incorporation comes with many advantages over sole proprietorship, incorporation is by far the preferable structure if you want to grow and hire people.

These are some of the advantages that incorporation offers over sole proprietorships:

  • owners benefit from limited liability
  • ownership interests are easier to transfer
  • the life of the corporation can extend beyond those of the founders
  • credibility is boosted in the eyes of partners
  • financing and grants are easier to access
  • tax rates are lower

Tax implications of sole proprietorship

Canadian tax law treats a sole proprietorship as an income source for the proprietor. It requires that the business’s financial details be listed on their personal income tax form, but in a separate section.

“With sole proprietors, what we often notice is that their business and their personal lives end up being very intertwined, certainly from a taxation perspective,” says Kos.

This presents some advantages for the sole proprietor. If the business generates a loss, for instance, that loss can be applied to reduce income gained from other sources. That is why most part-time businesses are sole proprietorships.

Sole proprietors can also deduct business expenses from their income for tax purposes.
“Some expenses are common to both personal life and business,” says Kos. “I may have a home office so I can write off a portion of my mortgage interest, or maybe I’m a real estate agent and I keep a vehicle log that shows my business mileage.”

How to file taxes as a sole proprietor?

In Canada, sole proprietors’ business income will be recorded on a T1 income tax, but if they’re incorporated, it will go on a T2 return.

“A corporation is a separate legal entity altogether. If an individual decides to incorporate, everything that happens within the business goes on the corporate income tax return,” says Kos.

He says incorporation can benefit those whose income is sporadic from year to year, since the corporate tax rate is much lower than the personal one, especially when earnings are above $100,000.

“There are certain points when professionals will recommend that a person incorporate.” He also recommends incorporation for most entrepreneurs who are thinking about their business succession.

Can sole proprietors pay themselves a salary?

A sole proprietor is not paid a salary, nor can they pay themselves one. The profit of the business acts as your salary. That means that all your income, minus expenses, make up your gross salary, or taxable income. Your net income is calculated from your personal tax return, once your allowable expenses and necessary government contributions have been factored in.

Can I use my personal bank account to run a sole proprietorship?

A sole proprietor can use their personal bank account for their business operations— but Kos advises against it.

He says the mixing of personal and business expenses, the intrusiveness of a possible audit and the greater chance of auditors turning up a bad bookkeeping practice or a questionable expense make this problematic.

“I often like to remind people that everything goes through your bank account. So, if there is an audit, they are going to see into your personal life,” says Kos.

He also says that the personal expenses, from family vacations to car payments, add that much more for an auditor to look through and question.

A business account, as opposed to a personal bank account, also looks more professional to potential lenders, says Kos. “From your bank’s point of view, they might not appreciate a business owner using their personal bank account for business activities.”

Can a sole proprietorship have two owners?

A sole proprietorship is, by definition, a business owned by one person. But that’s not to say that as a sole proprietor you can’t work with other people, says Kos. “Say, I decided to hire my friend to work with me. I’m still the sole proprietor, but now he’s an employee.”

A business established by two or more owners is a general partnership. In that situation, the owners work out a partnership agreement that outlines their respective powers, ownership share and capital contribution, as well as the profit distribution and operating procedures for the business.

Is there a difference between being sole proprietor and self-employed?

They are essentially the same thing. A self-employed person, or a freelancer, runs their own business, which is a sole proprietorship.

Next step

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