Sole Proprietorship

You are the business

A sole proprietorship has no separate legal existence. There is no company to create, no shares to issue and no corporate paperwork: the day you start selling your work, you are in business. If you operate under your own name, in most provinces you can simply begin. If you use a trade name, most provinces and territories expect you to register it, a quick and inexpensive step whose exact rules depend on where you live.

That simplicity is the structure's whole appeal. Setup costs are minimal, you answer to no one but yourself, and winding down is as easy as stopping. The trade-offs, covered below, are that the business's tax bill and its debts are inseparable from you.

How the income is taxed: form T2125

A sole proprietorship does not file its own tax return. Instead, you report the business on your personal T1 return using form T2125, the Statement of Business or Professional Activities. The form captures your revenue, your deductible expenses, and, where the conditions are met, a reasonable business portion of costs like a home office or a vehicle used partly for work.

The net profit that comes out of T2125 is added to your other income and becomes part of your taxable income, taxed at your personal marginal tax rate. That cuts both ways: a profitable year can push you into higher brackets, while a losing year can generally offset your other income, such as employment income, which softens the early years of a new venture.

The trade-off: unlimited liability

Because you and the business are the same person, business debts are your debts. If the business cannot pay a supplier, defaults on a loan or loses a lawsuit, creditors can pursue your personal assets: your savings, your investments, potentially your home. There is no legal wall between what the business owes and what you own.

For a freelancer with low-risk clients and no debt, this may be a theoretical concern. For anyone signing leases, carrying inventory, hiring help or working in a field where mistakes are costly, it is the structure's central weakness. The practical mitigation is insurance: commercial general liability and, for professionals, errors and omissions coverage handle much of the everyday risk far more cheaply than incorporating would.

CPP, EI and tax instalments

Self-employment changes your payroll deductions too. You contribute to the CPP on your self-employment earnings, but you pay both halves, the employee share and the employer share, since you are both. You do not pay Employment Insurance premiums and are not covered by regular EI benefits, though the self-employed can opt in to EI special benefits such as maternity, parental and sickness benefits. And because no employer withholds tax from your revenue, once the amount you owe at filing time is large enough, the CRA will ask you to pay quarterly tax instalments through the year rather than one lump sum in April.

The $30,000 GST/HST threshold

You start out as a small supplier, exempt from collecting sales tax. Once your revenues pass $30,000 over four consecutive calendar quarters, you must register for GST/HST, charge it on your sales and remit it to the government. Many sole proprietors register voluntarily before hitting the threshold, because registration lets you recover the GST/HST you pay on your own business purchases through input tax credits.

When to consider incorporating

A sole proprietorship stops being the obvious choice in three situations. First, when the business earns well beyond what you need to live on: a corporation lets profit stay inside at low corporate rates instead of being taxed entirely at your personal rate each year. Second, when liability becomes a real worry that insurance cannot fully cover. Third, when clients or lenders take an incorporated business more seriously, which happens in some industries. Until one of those applies, the honest advice is that incorporation adds cost and paperwork without adding much benefit, and most Canadian businesses rightly start as sole proprietorships.