If you are thinking of incorporating your enterprise, carefully weigh all the factors that go into determining if being a corporation is the right legal structure for your organisation.
In addition to incorporation, there are three other commonly used company setups: sole traders, partnerships and trusts. This article deals with the differences between corporations and sole traders, particularly in terms of:
- Income taxes;
- Relationships with other entities; and
- Protection from creditors.
Tax Considerations
Sole trader is the most popular entity, primarily because of its simplicity. Sole traders are quick and inexpensive to set up and earnings are taxed as personal income. That means you may be able to deduct tax losses from personal income. That is not possible with a corporate setup.
However, enterprises often quickly outgrow this simple setup and may find incorporation to be advantageous. One of the main benefits of being a corporation is lower taxes. Corporations typically pay a flat 30 percent tax rate. Sole traders, on the other hand, often pay more in taxes because personal income is taxed progressively.
One tax disadvantage for corporations is that they are not eligible for the basic $6,000 tax-free threshold. Losing this threshold can potentially offset the benefits of the lower headline tax rate, especially for small businesses or large enterprises going through difficult periods.
Also, for the owners of sole traders that have accumulated significant tax losses, the prospect of not being able to deduct those losses on personal income tax returns may be sufficient incentive to delay incorporating the enterprise.
Non-Tax Considerations
Incorporating offers other advantages over sole traders that are not related to taxation. Among them are:
- Protection of business assets from creditors: Corporate creditors are restricted to making claims against only the assets of the company when they seek recourse for unpaid debts. That is, they generally cannot pursue the owner’s personal assets unless a directions guarantee has been signed or a director was proven negligent. This can be a significant advantage for individuals who have accumulated personal wealth and businesses that employ debt financing and have potentially volatile income streams. With a sole trader setup, the owner is liable for all debts which means personal property may be vulnerable.
- Access to Capital: The corporate setup provides an efficient mechanism from a legal perspective to raise capital from multiple parties. Large sums of capital are less likely to be available to a sole trader.
- Legal obligations: Choosing to incorporate can create various legal obligations that the owner must satisfy as an officer of the company. Generally, sole trader owners are responsible only to themselves for business decisions.
- Incorporation Fees: There are various initial and ongoing costs related to incorporating a business that do not apply to setting up a sole trader.
Consult with your adviser to determine which business structure works best for your organisation.
