Have you been thinking about starting your own side-hustle? Or maybe you are going to leap in completely to the world of business ownership?
First of all, congratulations!
Secondly, I recognize that there is a lot to learn, and that owning your own business is very different from being a salaried employee. One of the most common questions I get asked by new business owners is how they should structure their business.
Although there are many different ways to structure your business, the four main types of business structures are as follows:
- Sole proprietorship
- Joint Venture
Over the next few articles, I will provide an overview of each of these business structures, including how they are taxed, and things to keep in mind when choosing what structure you want to implement.
Let’s get started with business structure #1 – “Sole Proprietorship”.
What is a sole proprietorship?
A sole proprietorship is the simplest form of business structure. It is not a separate legal entity. Essentially, it is “you”. You are the person who owns the business and responsible for the debts of the business.
It is possible for you to operate the business under your own name, or a registered business name. For example, pretend that I decided to open a cupcake business. I wanted a catchy name that people would remember, so I decided to market myself under the name “The Cupcake Queen”.
The business is still “me”. I am still personally responsible for debts of the business, and I am signing all contracts. It would be advisable for me to register my business name with the province, and also to obtain a business license showing that I am “operating as” The Cupcake Queen.
How is a sole proprietorship taxed?
Taxation of sole proprietorships is quite simple. All income is taxed in the hands of the owner on their personal T1 income tax and benefit return.
Depending on the nature of your business, you may also need to file GST/HST and/or PST returns.
When you file your tax return, you need to include a Form T2125, “Statement of Business or Professional Activities”.
Unless you are a farmer, a fisher or a self-employed commissioned agent, you are required to report your income using the accrual method. What is the accrual method? It requires you to report income in the year that you earn it – regardless of when you receive it. In addition, you have to deduct expenses in the year that you incur the expense, regardless of whether you paid the expense in the period.
Here is an example:
The Cupcake Queen got a huge order for 500 cupcakes to be delivered on January 10, 2021. She sent out an invoice for payment of the order on December 31, 2020, and was paid in full on January 8, 2021.
Under the accrual method, The Cupcake Queen would need to report the income in the 2020 year, even though she did not receive it until 2021.
Canada Revenue Agency provides an excellent guidebook for self-employed businesses, find it here.
What are the advantages and disadvantages to a sole proprietorship?
Here are the pros and cons of choosing to operate your business as a sole proprietorship:
- It is a simple structure. It does not require you to incur the costs of creating a separate legal entity. You can “create” your sole proprietorship immediately.
- It does not require you to file a separate tax return – you can report all income and expenses as part of your personal T1 income tax return.
- It is easy to “unwind”. If you decide you no longer want to continue your business venture there is no separate legal entity to dissolve.
- It is simple. Yes, this is both a pro and a con! Sometimes, I have clients who view the structure as being so simple that they fail to separate the business from their personal life. You should still open a separate bank account for all your business transactions, and track your business expenses separate from your personal expenses. For example, if you are going to Costco and picking up both business and personal items, separate them when going through the checkout so that it is easy for you to record the business expense later.
- There is no liability protection for the owner. Because “you” are the business owner in this scenario, you are personally responsible for the debts of the business, and for completing material contracts. If the business fails, your personal assets could be at risk of seizure.
If you would like to hear more on this topic, I encourage you to listen to Episode 4 of The Tax Chick Podcast, “A candid discussion on business structures”, with my guest Jared Pilon.
The information in this article is not legal advice. We encourage you to consult with your legal advisor for advice specific to you.
(Also available on Apple Podcasts, Spotify, Stitcher, Podbean, Pocketcast, and Amazon Music)