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Should you Incorporate Your Small Business?

When a business is started, it can be structured as a proprietorship, partnership, or corporation.

Proprietorship

A sole proprietorship is one person operating a business, without forming a corporation.  The income of the business is then taxed in the hands of the owner (the proprietor), at personal income tax rates.  The income is considered income from self-employment, and is included on the personal income tax return of the owner.

Advantages of proprietorship:

Disadvantages of a proprietorship:

Partnership

A partnership is also an unincorporated business.  It is similar to a proprietorship, except two or more entities are partners in the business.  For partners who are individuals, the income from the partnership is taxed at personal income tax rates, and a percentage of the income is included on the personal income tax return of each owner.

Advantages of partnership:

Disadvantages of a partnership:

Corporation

A corporation is a separate legal entity, which is formed by application to either the federal government, or one of the provincial/territorial governments.  The corporation issues shares to the owners, or shareholders.  The funding of the corporation can be done through the issue of shares, or by borrowing.  Instead of investing a large amount in shares, shareholders can lend money to the corporation, and invest only a minimal amount in the shares.  This way, when the corporation has available cash, the shareholder loans can be repaid without attracting personal income tax.

Being a separate legal entity, a corporation pays corporate income tax, which is calculated completely separately from the owners' personal income tax.  If the corporation pays wages to the shareholders, income tax and Canada Pension Plan contributions, and sometimes Employment Insurance premiums, must be deducted and remitted to Canada Revenue Agency.

Advantages of incorporation:

Disadvantages of incorporation:

Generally, the higher the net income of your small business, the more advantageous it is to incorporate instead of remaining as a proprietorship.

No matter what the type of business structure, spouses and children can be employed by the business, thus effectively splitting income.  However, amounts expensed must be reasonable amounts based on services provided, and must actually be paid to the spouse and/or children.

Each type of business entity has its advantages and disadvantages.  It is wise to seek professional advice to assist in your decision-making, and in the setting up of your business structure.  It is also very important to get your accounting records set up and organized properly at the start of your business.

The Canada Business Service Centres provide information related to starting a business.  There are links to their web sites on our Links page.

Tax Tip:  It is very important to get your business set up properly - get professional advice!

TaxTips.ca Resources

Provincial Web Sites for Business Information and Services - most of these websites have information on how to incorporate.

Canada Revenue Agency (CRA) Resources

Income Tax Folio 16: Partnerships

Checklist for Small Businesses

 

Revised: October 14, 2025