When it comes to business structures, the simplest is often a sole proprietorship or a partnership between individuals. For this reason many start-up businesses begin with these structures.
A proprietorship is an unincorporated business that is owned and operated by one individual. If you have one or more business partners, you would be considered a partnership rather than a proprietorship. Other than a business license from your local municipality, there are no registrations or legal documents required to establish a proprietorship or partnership. It is a fast and inexpensive way to get your business up and running.
In both cases, the profits or losses from the business are reported on the proprietor or partners’ personal tax return and taxed in that individual’s hands. As such, the year end of the business would be December 31, the same as your personal tax year. If you are reporting income from a proprietorship or a partnership on your personal tax return for the year, you have until June 15 (rather than April 30) to file your personal tax return. It should be noted however, any taxes owing are still due by April 30.
Whereas 100% of the profits of a proprietorship are taxable to the individual owner, the profits from a partnership are allocated to the individual partners based on the agreement made when the partnership was formed. Although a formal partnership agreement is not required, it can be a crucial document for outlining terms such as the division of profit, financial contributions, dispute resolution and responsibilities of each partner, among other things.
There are a number of factors that should be considered when determining what works best for you and your business:
- Inexpensive and simple to set up
- No additional tax filings are required for a proprietorship. In most circumstances, the same is true for a partnership.
- No annual legal filings and no requirement to maintain a minute book
- Business losses can be applied against other personal income. This can be especially beneficial in the first few years of operations when losses are likely to occur
- The business has unlimited liability which means that personal assets are not protected. If there are insufficient assets in the business to pay off its debts than creditors can go after your personal assets
- No continuation of business – the proprietor is the business, when they die, so does the business
- When the business becomes successful, the profits are subject to higher personal tax rates. The top marginal personal tax rate in B.C. for 2016 is 47.70%, which is 34.7% higher than the small business tax rate
As your business grows you may want to consider whether your proprietorship or partnership structure is still right for you. Next month we will look at the pros and cons of incorporating your business.