Weighing the pros and cons of being a sole proprietor versus incorporation
As an IT contractor, you may be wondering if it’s worth the expense and extra paper work to get yourself incorporated. IT all depends on your personal situation and where you are at in your career.
Many IT workers prefer to work in contracts rather than taking on full-time permanent jobs because they love the freedom of moving from contract to contract. That’s not the only benefit of contract work – often the money is better than you can get in a permanent role, or as a sole proprietor.
The freedom of being an independent contractor brings risk because you need to line up a new contract when the current one ends. But if you have a hot skill set and related experience, headhunters like Stafflink will line up new contracts for you.
Getting incorporated might be be a good idea. Or maybe not. Let’s explore the pros and cons.
Pros and Cons of Sole Proprietor versus Incorporation
It can cost $1000 or more to incorporate yourself as a business and it brings some extra work for you to manage your taxes. Is it worth the extra trouble and expense?
The two most common types of personal businesses that we see with the IT contractors that work for Stafflink are Sole Proprietorship and Incorporated.
Tip: You can change the legal structure of your business as it grows. Many small businesses start out as a sole proprietors or partnerships and become incorporated as the business grows.
Here are some things to consider when you are choosing what’s right for you:
Cost
One of the biggest advantages of working as a sole proprietor versus incorporation is that setting up and administering the business is comparatively easy and inexpensive. If you want to get incorporated, it costs $1000 or more depending on who you hire to assist you with the process.
Liability
One of the main advantages of incorporation is limited liability. A sole proprietor assumes all of the liability for their company. As a sole proprietor your personal assets, such as your house and car can be seized. As an incorporated contractor, you a shareholder in a corporation and you are not responsible for the debts of the corporation unless you have given a personal guarantee.
Corporations Carry On
Unlike a sole proprietorship, a corporation has an unlimited life span. The corporation will continue to exist even if the shareholders die or leave the business.
Tax Credits
Lack of flexibility with income taxes is one of the disavantages of sole proprietorship versus incorporation. Income tax rates are lower for corporations than for the personal income received by sole proprietors. Using tax planning, the tax burden can be reduced by earning income through your corporation as an incorporated contractors, due to the lower corporate tax rates.
Income Control and Tax Deferral
If you are an incorporated contractor, you have options to determine when you personally receive income from your corporation. Being incorporated allows you to report your income at a time when you will pay less tax. You may be able to realize tax savings if you receive your income at a time when you are in a lower tax bracket or if taxes have fallen.
Income Splitting
With a corporation, there exists the opportunity to pay shareholders salary, dividends or a combination of the two. Your spouse and/or children could be shareholders in your corporation giving you the opportunity to redistribute corporate income to family members with the lower incomes taxed at a lower rate.
Perception
Some people perceive corporations as being more stable than sole proprietorships. Having Ltd., Inc., or Corp. as part of your company’s name may help you attract more contracts.
- Incorporation is great but the paperwork sucks
Paperwork
Less paperwork is one of the big advantages of sole proprientorshop versurs incorporation. Having a corporation brings with it extra accounting and paperwork. Corporations must maintain minute books and corporate bylaws. Other required corporate documents are register of directors, the share register and the transfer register.
Non-Calendar Year Ends
Corporations have the ability to choose their year end and not be restricted to a calendar year-end as you are with a Sole Proprietorship. This opens up the possibility of bonus deferrals. Choosing a year-end may be better for year-end paperwork filing should your business be busy at the end of the calendar year. By incorporating you can choose to have your year-end fall during a slow period.
Bottom Line
You just read some of the advantages and disadvantages of incorporation versus sole proprietorship but what’s the bottom line? Is getting incorporated worth it or not? Before you decide, make sure to discuss your personal situation with your accountant and lawyer.
I think the feel of insecurity after a contract is ended is the main concern of an individual. But sometimes you can get more loads of work even you can handle. As usual, slow and steady wins the race. You can hire some helping hand for yourself to take extra responsibilities.
Delwar, It’s so great that you’ve figured out a way to deal with the stress of closing contracts. I think incorporation is best for people like you who feel confident that there are lots of contracts available for the works they do.
But how do you know when you are ready to take the risk of getting incorporated and running your career like a small business? Maybe it’s when you start getting calls from recruiters. Or maybe it’s when you have companies waiting for you to finish your current contract so you can come work for them.
It’s awesome that you are at the point that you have more work than your can handle. You say “slow and steady wins the race.” Sounds like you built your career through steady hard work.
Do you have any other tips that have helped you build your reputation with employers so you always have enough work?
Great post. Really applies to all sorts of entrepreneurs, not only IT contractors. I’ve seen many people simply figure they need to incorporate without really thinking it through. I’m curious about what the rules are for foreigners who want to do business in Canada. I had an acquaintance who assumed incorporation was mandatory in that case, but I’m fairly sure you can just register the business in the province(s) you’re planning to operate in if the company is small enough and there aren’t liability concerns.
Thanks Brian!
I do not specialize in helping foreign companies set up in Canada so I cannot offer you specific advice in that area. I do want to stress that foreigners who want to do business in Canada need to discuss their individual tax situation with an accountant specialized in foreign taxes.
If I start as my IT consultancy business as a Sole Proprietorship under my own name and later I decide in the middle of a contract to incorporate, what happens to the current contracts I may have? Do they get immediately “transferred” to the corporation? Or do I have to terminate all my current contracts and pursue new contracts with all my current customers?
Hi Ian,
I consulted with Joanne Hyatt (our accountant) and she says this is really a “contract” question, more than an accounting question.
The answer to your question all depends on who your contract is with and what their policies are with regards to sole proprietors and incorporated contractors.
Switching from Sole P to Incorporated is fine from an accounting perspective, but the accounting is different. When you switch, your original contract may become null, and you will need to ensure that the contract will still be enforceable under the new incorporated name. A corporation is a stand alone entity, and should have a new contract drawn up. Also, deposits/payments will need to be re-directed to the incorporated name, and not the sole proprietor name.
The bottom line is that it all depends on the policies of the company that you have the contract with. You need to consult with their HR to find out if you can change your contract in the middle of the engagement. I don’t know your personal situation, but it might be best to wait until the contract renews, and switch then.
Laura
Hello,
I am planning to open sole proprietorship for website development .Currently I am working full time.
Now my question is will I be paying more taxes from my salary if I open sole proprietorship?
Thanks,
Joy
Hello Joy,
Thanks for your question.
Every situation is different so unfortunately there is no guarantee that you will pay less taxes if you open a sole proprietorship compared to the taxes you will pay in a full-time permanent position. It all depends on your personal situation, the write-offs and deductions you take and whether you pay your tax installments on time. In order to answer this question, you need to talk to an accountant.
Laura