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Sole Proprietorship or Partnership:

By Lloyd Lindsay |

Norm asked:

I am starting a home-based printing business and I need to register. I am leaning towards sole proprietorship. My wife currently provides admin support from home and was thinking of adding that work into the printing/admin business. I am wondering what is better sole proprietorship or partnership. I do not want the hassle of employee deductions, etc, but want to split the income 50/50 so that we are both the same tax brackets. Does it matter if its sole proprietorship or partnership? Is one better than the other for tax time?

Lloyd Lindsay answered:

Liability Issues
Proprietorships and General Partnerships are unincorporated entities. Because of this, their owners may be personally liable for the unpaid debts of their business. Many new businesses don’t survive the first few years, and unincorporated owners may have to use their own personal funds to pay off their unpaid business debts.

If a husband and wife form a Partnership, then all of their family assets may be at risk for the unpaid debts of the business. For this reason, some people will run their business as a Proprietorship, and the owner will transfer his/her personal assets to the non-owner spouse to protect their family assets. As a rule, the Income Tax Act provides a tax-free rollover of assets to a spouse. But after the transfer, income earned or capital gains realized from the transferred property would be taxed in the hands of the proprietor unless certain steps are taken.

Income Tax Issues
A partnership allocates its taxable income to each of its partners. But, is a 50-50 split between spouses reasonable for tax purposes? Well, arm’s length partners determine the allocation based on their capital contributed and services rendered to the partnership. However, spousal partners are not dealing at arm’s length. So a 50-50 split may not be acceptable to Canada Revenue Agency (CRA) if one spouse provides no capital and no services to the partnership. In this situation, CRA might reallocate the partnership’s income to the spouse who contributed all the capital and services.

Paying a Spouse a Salary
Yes, there is the hassle of dealing with employee deductions and benefits if a proprietor pays his/her spouse a salary. However, there are advantages:

  1. The proprietorship receives an income deduction for the salary as long as it meets the following criteria:
    • a. It’s reasonable in the circumstances
    • b. It’s spent to earn taxable income, and
    • c. It’s not personal or capital in nature;
  2. The spouse and the proprietorship are contributing to the spouse’s Canada Pension Plan—even if the Proprietorship has a loss; and
  3. The spouse’s personal assets are not at risk as they would be if the spouse were a partner.

Before deciding on whether your business should be a Proprietorship or a Partnership of spouses, you should discuss your personal circumstances with a lawyer and a professional accountant before making your decision.

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