A Sole Proprietorship (an “SP”) is a business owned and run by a person. There are no partners and there are no shareholders. And it does not have to be registered with the government in order to do business (although it can have a name registered with the government – i.e. Bob’s Auto Shop) It can simply operate under the owner’s name: eg. Bob Smith. Bob can fix my car and issue an invoice from Bob Smith.
A Sole proprietorship is different from an incorporation, which is its own legal entity. Instead, while a sole proprietorship can have a registered business name like Bob’s Auto Repair there is no actual legal distinction between Bob and Bob’s Auto Repair. If Bob were to incorporate Bob’s Auto Repair Inc., this company would be separate from Bob. But that’s not the case with the sole prop.
Either way, registered or not, the business and Bob Smith are one and the same. If something goes wrong and the business is sued, it is Bob Smith who is getting sued. At the end of the year the business does not have a tax return to file since it is not a separate entity. Rather Bob Smith declares the business income in his personal T1.
This type of business is the easiest to start and operate. There are no corporate (T2) tax returns to file each year, and there are a number of factors which make it a less expensive business to maintain. But the structure has its limitations.
Since there is no legal distinction between an individual and their sole proprietorship, all the income generated by the business is personal income of the owner. So, if $128,000 were earned from one’s sole proprietorship and there were $28,000 in business expenses, one would be personally taxed on $100,000 (your profit), and that amount would appear as taxable income on the T1 return.
And if a sole proprietorship generated $100,000 profit in Ontario in 2019, they would pay $27,563 in tax, leaving $72,437. And if the owner only required $50,000 after-tax dollars per year to pay bills, they only have to have to earn $66,000 pre-tax to pay to get $50,000 after-tax.
This means that by operating a sole proprietorship and earning $34,000 more than they needed, the taxpayer was forced to immediately declare and pay tax on the extra $34,000 that they didn’t need yet. With a corporation the taxpayer could have kept that $34,000 in the corporation and not paid it out. More on that below.
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