At Catalyst, we recognize that businesses in construction face a different set of obstacles and practices. As part of our commitment to the industry we are working beyond the numbers to assist by publishing articles, hosting roundtables, and more.
It is not uncommon for those in the construction industry to branch out and start a business of their own. Recently, we learned that a number of our clients were curious about the different business structures that are out there, and how to choose the right one for them. In this article we will explore three types of business structures – Sole Proprietorship, Partnership, and Incorporation – as well as the benefits of each.
Sole Proprietorship: This option is the most simplistic and a common choice for new business owners. From both a legal and tax perspective the business as well as the operator are viewed as the same. As all responsibilities fall on the Proprietor, so do all the business profits. For tax purposes, revenues and expenses are listed in a separate schedule (T2125) of the personal income tax return. All the after tax profits of the business are for the Proprietor to keep, and no other additional income taxes apply. The downside however is that claims can be made against personal as well as business assets if the business were to fail. If business losses occur they can be applied against other forms of income of the individual which is a significant advantage compared to incorporation. Another advantage of the Proprietorship structure is that it involves simple and cost effective registration as well as lower annual compliance costs compared to the other structures.
Partnership: This is very similar to the sole proprietorship; however, there is more than one owner. Partners generally work out an agreement that allocates responsibilities, duties, and the shares of before tax profits. Although not technically a legal structure, it can be beneficial to involve a lawyer when writing up such an arrangement. When it comes time for taxes, partners will include their portion of the before tax profit or loss on their personal tax return. Similar to the Proprietorship losses can be applied against other forms of income. This option is also advantageous as it is relatively easy to form a partnership and start-up costs and responsibilities are shared.
Incorporation: Incorporating a business makes it a separate legal entity. Generally this suggests that you will not be held liable for debts in the case of business failure. However, if financing is required most financial institutions require security or personal guarantees that could put personal assets in jeopardy. The major tax advantage of incorporation is that it allows the business to defer a meaningful percentage of tax on business profits therefore permitting a business to reinvest more of the profits into the business. Profits pulled from the company in the form of dividends do not however have this preferential treatment and will be subject to personal income tax. Moreover, corporations have the ability to split profits among shareholders who in many cases are family members. Those who meet specific criteria are able to benefit from other family members graduated tax rates.
The downsides of incorporation includes a higher level of regular accounting, tax, and legal compliance which generally involves the regular use of an accountant and lawyer. We advise you to contact your accountant and lawyer prior to incorporating your business.
As always, if you have any questions please feel free to contact your trusted Catalyst advisors at (403) 296-0082.