The proper business structure can be the major difference between a failed and a successful business. This all-important factor also impacts your personal tax and estate planning considerations. Your choice of business structure should depend on a few factors – the type of business, location, size, taxation considerations, financial needs, and possible exposure to liabilities.
Let’s take a look at some of the common business structures.
Common Business Structures
1. Sole Proprietorship
A sole proprietorship is suitable for small enterprises because of its simplicity and cost-effectiveness. You own the business completely, so you make decisions and receive all the profits. However, you are also responsible for the debts and obligations arising from the enterprise, which puts your business and personal assets at the risk of claims by creditors.
Regarding taxation, the sole proprietorship business structure requires you to file a personal tax return detailing your business income. Your personal tax return will also include your business income and losses. The tax-planning options here are limited because your net business income is taxed as personal income.
2. Partnership
A partnership is also easy to set up with low start-up costs. The primary benefit of having partners is that they serve as additional sources of investment capital while extending the management base.
The only challenge here is finding suitable partners to work with and the division of authority that comes with multiple people owning a business. That is why experts recommend signing a written partnership agreement that sets out the terms of the business and how to share the business profits. This also helps to minimize potential conflict by protecting the interests of each partner.
Depending on the partnership type, the personal liability for the business and your partners’ actions can be different. Your partners’ decisions are legally binding on you. That is why you must discuss every part of your decision, including tax and legal implications, with your Ottawa CFP beforehand.
Taxation in partnership is such that the income/loss of the partnership flows through to the individual partners. Then each partner will share their net income/loss from the partnership through their personal tax returns.
3. Corporation
Corporations are becoming increasingly popular in the business world. A corporation is an entirely separate legal entity from its shareholders. However, it maintains all the legal features of an individual. A corporation may conduct business, own properties, incur legal liability, borrow, and lend.
Running a corporation offers a few major advantages over other business structures. It offers a more extensive business community with the possibility of buying and selling shares while keeping the company running. Raising investment capital and attracting specialized management expertise is also easier with incorporated business.
In addition, the liability of a shareholder in a corporation company is limited to their shareholding. Personal assets are protected from the creditors, except you offered personal guarantees for loans to the corporation.
Tax planning for corporations comes with a few positive opportunities. First, the small business deduction offers possible tax-deferral opportunities and lower corporate tax. But this only applies to the first $400,00 of active business income. Second, small business corporations can protect all or a part of the profits from sales of shares from personal taxation through the $750,000 capital gains exemption. Incorporating also allows you to split income and reduce taxes by allowing adult family shareholders to earn dividends. Finally, with a family trust, you can add other family members as shareholders and transfer future tax liability on the company’s growth to the lower-income members.
Finally…
If you are still unsure of the right business structure for you, we recommend speaking to an Ottawa Certified Professional. These experts offer professional guidance on taxation and legal issues associated with choosing the proper structure for your business.
