Sole Proprietor vs Corporation

Incorporation provides: (1) Tax deferral -- corporate tax rates (9-12.2% for small business income) are much lower than top personal rates (48-54%), allowing you to defer tax on income left in the corporation. (2) Limited liability -- personal assets are generally protected from business debts. (3) Income splitting -- potential to pay dividends to family members who are shareholders (subject to TOSI rules). (4) Lifetime capital gains exemption -- up to $1,016,836 (2025) on qualifying small business corporation shares. (5) Credibility -- some clients prefer working with incorporated businesses.

Initial costs include incorporation fees ($200-$1,000 depending on federal vs provincial), legal fees ($1,000-$3,000), and setup accounting ($500-$1,500). Ongoing annual costs include corporate tax return preparation ($1,500-$5,000), annual filings, and potentially separate bank accounts and bookkeeping. You may also need a minute book and annual resolutions. Total annual overhead is typically $2,500-$5,000 for a simple corporation. These costs should be weighed against the tax savings.

A corporation is a separate legal entity, so the corporation's debts and obligations are generally separate from the shareholders' personal assets. However, this protection has limits: directors can be personally liable for unpaid wages, HST/GST, and source deductions. Lenders often require personal guarantees from shareholders of small corporations. Professional liability (doctors, lawyers, engineers) may pierce the corporate veil. Sole proprietors have unlimited personal liability for all business debts and obligations.

RRSP contribution room is based on earned income from the prior year. Salary creates RRSP room (18% of salary, up to the annual maximum), but dividends do NOT create RRSP room. If you pay yourself entirely in dividends, you generate zero RRSP room. This is a significant long-term cost because RRSP contributions provide a tax deduction and tax-deferred compound growth. Many advisors recommend paying at least enough salary to maximize RRSP room.

Incorporation may not be beneficial when: (1) You need all your business income for personal expenses (no income left to defer). (2) Your income is below ~$80,000-$100,000 where the tax deferral benefit is minimal. (3) The annual compliance costs ($3,000-$5,000) exceed the tax savings. (4) You plan to wind down the business soon. (5) Your province has very low personal tax rates. A sole proprietorship is simpler, cheaper to maintain, and may be sufficient for lower-income businesses.

TOSI (sometimes called "kiddie tax") applies the top marginal tax rate to certain income received by family members from a related private corporation. This limits the ability to split income by paying dividends to low-income family members. Exceptions exist for: adults over 24 who are actively involved in the business, spouses over 64 receiving retirement income, and the capital gains exemption on qualifying shares. TOSI has significantly reduced the income-splitting benefits of incorporation since its expansion in 2018.

The transition typically involves: (1) Incorporating a new company. (2) Transferring business assets to the corporation using a Section 85 rollover (to defer capital gains). (3) Changing business registrations (HST/GST, payroll accounts). (4) Updating contracts, bank accounts, and insurance. (5) Setting up payroll for yourself as an employee. The process should be managed by a tax professional to avoid unintended tax consequences. The transfer can usually be made retroactive to the beginning of a fiscal year.