Sole Proprietor vs. Incorporation: When Should You Incorporate?

Should you keep it simple or take the next step? Here's how to know when it's time to incorporate.

Sole Proprietor:

• You report your income and expenses on your personal tax return (T2125)

• You pay personal income tax on your profit, which ranges from 20% to over 50% depending on your income and province.

• You’re personally liable for any business debt, legal issues, or CRA issues.

Recommended for:

• New Freelancers

• Tradespeople testing the waters

• Side hustlers and solo service providers

Incorporation:

Your business is registered as a separate legal company (a corporation)

• the business files its tax return under T2 every year

• Option to pay yourself a salary or dividends:

  • Salary (deductible to the corporation, requires source deductions on payroll)

  • Dividends (no payroll registration required, but affects CPP contributions, which could also lead to personal liability under Income Tax Section 160)

• You get limited liability protection, meaning your personal assets are “safer”

• You may qualify for the small business tax rate (12-13%, depending on the province)

Incorporate or Stay as a Sole Proprietor?

Consider incorporation if:

• You’re consistently making $80,000+ per year

• You don’t need to take out all your profit as personal income

• You want to build business credit or take on bigger contracts (especially with governments and corporations)

• You need more legal protection for your personal assets

• You plan to sell the business in the future

Consider sole prop if:

• You’re just starting out or still a part-time

• You need to use all your income to cover living expenses

• You want to keep things simple and low cost

Conclusion

Incorporating can lower your tax rate only if you leave money in the business.

If you’re taking every dollar out anyway, save yourself the expensive admin work and stay as a sole proprietor.

Advanced Tip:
If you incorporate, be aware of the "personal services business" (PSB) rules under Income Tax Act s. 125(7).

If CRA classifies you as a PSB, a corporation that is really just you working for one client, you could lose access to the small business tax rate and suffer from penalties.

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Until next time,

- Theo from TheTaxDean
Helping real Canadians stay tax-smart