How Sole Proprietors are Taxed
By Nizam Shajani, CPA, CA, MBA, Partner
The type of business structure you choose has a significant effect on the way you report your income. On a legal standpoint, a sole proprietor is indistinguishable from its owner. It is an unincorporated business that is owned by one person and that person is personally liable for that businesses debts and obligations.
For tax purposes, the owner of a sole proprietorship receives all the profits and claims all losses. As such, sole proprietors are taxed on the individual owner’s personal tax return. There is no separate tax return such as a corporate return – however there are varying schedules within a personal return to be completed that include a set of financial statements or a prescribed form.
In considering the staggered tax brackets for individuals and the lower corporate tax rates in comparison to personal tax rates – where corporations can have advantages for more mature and profitable enterprises, sole proprietors can be advantageous for start-ups that incur expenses in the early stages of its business life.
Business endeavors often go through a process of losses in the first years of operations – where those entities are set up as sole proprietors, losses can offset other income of the individual and become a tax deduction. This tax planning tool is often overlooked in the haste to incorporate. Tax savings are higher where the individual has other income that puts them in a higher tax bracket.
The ideal timing of moving from a proprietor to a corporation is therefore not necessarily at the onset of commencing operations. Both legal risk as well as anticipated profitability should be considered through appropriate planning. Meeting CRAs standard of a reasonable expectation of profit with evidence to support this intention is also imperative.
With the varying forms a business entity can take – the sole proprietor has significant benefits under tax legislation that should be considered before rushing to incorporate. Where loses are anticipated at the initial stages, tax benefits should be weighed against the protection provided to the shareholders of corporations.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.