HOW TO CHOOSE THE RIGHT BUSINESS STRUCTURE FOR YOUR BUSINESS
one of the most important decisions you’ll make. This choice can have significant implications for how you manage your business, your taxes, and your personal assets.
In this article, we’ll explore two main types of business ownership: Sole Proprietorship and Corporation.
A sole proprietorship is the default business structure when you start working for yourself. In this setup, your business and personal finances are intertwined. Essentially, you and your business are one and the same.
All the net income, which is your income minus expenses, is reported on your personal tax return and taxed accordingly.
Pros of Sole Proprietorship:
Firstly, setting up a sole proprietorship is relatively easy and quick. You can start your business without much bureaucracy and paperwork. Secondly, it’s cost-effective. In terms of accounting, legal requirements. Furthermore, you’ll generally spend less compared to other business structures.
Cons of Sole Proprietorship:
However, there are some drawbacks.
Sole proprietors have fewer strategies available to reduce taxes compared to corporations. Additionally, all the profit made by your business is subject to taxation on your personal tax return.
Perhaps the most significant concern is unlimited liability. In the event of you running into some serious legal dispute, your personal assets, such as your personal car and house, are exposed.
Lastly, securing business loans can be more challenging as a sole proprietor.
On the other hand, when you incorporate your business, it becomes it own separate legal entity. A corporation has its own cash, assets, and liabilities.
More importantly, it pays its own taxes, and the net income earned by the corporation is taxed separately from your personal income.
When you decide to pay yourself from the corporation, either as an employee through wages or as a shareholder through dividends, you will pay personal income taxes on that income.
Now, let’s explore the advantages and disadvantages of incorporating your business.
Pros of Corporations:
One of the significant advantages is tax planning and deferral opportunities. With a corporation, you can choose to retain some profits within the company, taking advantage of lower corporate tax rates.
Limited liability is another key benefit, protecting your personal assets in the case of legal disputes.
Corporations also have the advantage of an unlimited life, AKA continuance, meaning the business can continue to exist even after the owner’s death.
Financing is generally easier, as borrowing money becomes simpler, and you can benefit from the Lifetime Capital Gains Exemption when selling shares of your company, this means you can sell your business for almost a million dollars, TAX FREE!
Cons of Corporations:
However, there are associated costs. If you were the only shareholder, it’s relatively simple, but if you have a group of people, you may have to get a lawyer involved.
There’s also ongoing accounting fees each year. The accounting is more complex than a sole proprietorship.
Incorporation vs Sole Proprietorship. Which Is The Right One?
With these insights into the pros and cons of both sole proprietorship and incorporation, you might wonder how to make the right choice for your business. Let’s look at a few examples.
Choose Sole Proprietorship
An example of sole proprietorship could be like setting up a lemonade stand. If you’re a young entrepreneur starting a small venture, like selling lemonade on your street corner, a sole proprietorship could be fitting. It’s simple to operate and doesn’t involve complex paperwork or high costs. You report all the money you make on your personal tax return, just like you’d count your lemonade earnings.
Now, imagine you’re planning to open a big laundromat. Incorporating your business would be like building a fortress around your laundromat. It gives you a separate legal identity, and shields you from your personal assets. Plus, you can have more financial tools to manage a big operation. But, it comes with more paperwork and more effort to maintain your dirty laundry empire.
If you know your business is going to grow and generate substantial profits, incorporation may become advantageous.
Secondly, if you intend to seek external investors or secure significant loans to fuel growth, incorporation offers a more appealing structure to investors and lenders.
Additionally, if your business operates in an industry with higher liability risks, such as construction or healthcare, incorporation can protect your personal assets from potential lawsuits or debts incurred by the business.
Lastly, if you plan to transfer ownership or bring in partners, incorporation simplifies the process, allowing for the sale or transfer of shares.
Everyone’s situations are very unique to each person. Setting up a business entity is not black and white.
It’s always a good idea to seek and consult with an accountant before you choose a business structure. Most accountants will offer a free consultation.
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