What’s the difference between a partnership and a corporation?

By: Updated: April 28, 2022

Topics:

When you start a business in Canada, one of the most important decisions that you must make is what kind of legal structure it will have. There are three main options: sole proprietorship, partnership or corporation.

In this article, we will primarily be discussing the differences between partnerships and corporations. We’ll look at the pros and cons of each.

 

What is a sole proprietorship?

First, let’s look at a sole proprietorship. With this type of structure, you are the sole owner of the business. You simply report any business income directly on your personal income tax return.

 

What is a partnership?

A partnership is similar. The partners include their earnings on their personal tax return. Let’s say that you have one partner and you have a 50-50 partnership. In this case, you report half the partnership income on your tax return and your partner does the same.

 

What is a corporation?

A corporation is a separate legal entity and offers a different business structure from a sole proprietorship or partnership.

Corporations are run by the shareholders and directors. If you are setting up a business by yourself, you may be the only shareholders. If you have one or more partners, each person can be a shareholder. You can vary the number of shares each partner holds, depending on their investment of money or time.

One of the most important aspects of a corporation is limited liability. With a sole proprietorship or partnership, the business owners face unlimited liability. This means that if the business gets into debt or is sued, their personal assets – such as a house or savings – can be seized to pay those obligations.

On the other hand, the shareholders of a corporation do not face this risk. If a company cannot pay its debts, its assets can be seized but not those of the shareholders. (However, directors of the company are responsible for paying out salaries and wages.)

A corporation continues to operate even if its shareholders die. It keeps going until it is dissolved by the owners.

 

Tax as a partnership vs a corporation

One of the key differences between a partnership and a corporation is the way they are taxed. Corporations offer much more flexibility in dealing with taxation.

As we mentioned, those participating in a partnership must declare their income on their personal income tax return. If your partnership reports a loss, you may be able to deduct these losses from other income when you file your return.

On the other hand, corporations offer a wide range of tax options:

  • Paying salaries to the owners and having them include these payments on their personal tax returns.
  • Paying dividends to the shareholders from the profits of the corporation.
  • Holding the funds in the corporation and investing the profits.

Corporations pay income tax just like individuals. While there is no escaping taxes, corporations offer more flexibility and may help you to reduce the amount of tax you pay. It’s a good idea to check with you accountant or tax lawyer to see which approaches would work best for you and your partners.

 

Partnership vs corporation pros and cons

Partnerships Pros:

  • Simple to set up: Partnerships can be established at no cost. You simply need a partnership agreement – while you can do this yourself it is wise to have a lawyer draft it.
  • Low cost to maintain: As we indicated, the partners simply report their earnings on their personal income tax return. You don’t necessarily need an accountant.

Partnership Cons:

  • Liability risk: If the partnership gets into debt, or is sued for damages, the partners are personally liable.
  • Ending the partnership: If one party wants out of the business, it can be more difficult to exit a partnership than a corporation. With a company, you can simply sell your shares (assuming that you can find a buyer).

Corporation Pros:

  • Limited liability: Company assets can be seized to pay debts or for damages from a lawsuit. However, the personal assets of shareholders and officers cannot be targeted.
  • Tax benefits: There are different options to make payments to shareholders or to hold funds inside the corporation. These can reduce taxes owing.

Corporation Cons:

  • Set up costs: You will need to pay an incorporation fee to your province. For example, in Ontario this costs $300. You will also likely need help from a lawyer in preparing the articles of incorporation and share structures. These costs could add up to $2,000 or more.
  • Ongoing professional expenses: You will need an accountant to prepare and file your corporate income tax each year. A lawyer can help you to update your corporate records.

 

Here’s a chart summarizing the key differences between a partnership and a corporation:

 

Partnership

Corporation

Ownership

Partners are the owners

Shareholders are the owners; there can be any number of shareholders

Profit/Loss

Income is directly reported on personal income tax returns

Directors decide whether to distribute profits via salaries or dividends. Or hold profits in the company

Liability

Partners are personally liable

The corporation is liable. Shareholders are not directly liable, except for unpaid wages

Decision-making

Partners make decisions about operations and investments in the partnership

The directors of the corporation make decisions

Taxation

Partners report their income directly on their personal tax return and must pay taxes on this

The corporation must file a corporate income tax return and pay taxes accordingly

 

 

Partnership vs Corporation

The structure of your business can have a big impact on the taxes you pay, the liability risk you assume and whether it’s easy to exit. Before you start your business, carefully consider whether a partnership or corporation (or a sole proprietorship if you are the only person in the business) best suits your needs.

 

Write off 100% of your medical expenses

Are you an incorporated business owner with no employees? Learn how to use a Health Spending Account to pay for your medical expenses through your corporation: 

Download the HSA Guide for Incorporated Individuals

Do you own a corporation with employees? Discover a tax deductible health and dental plan that has no premiums:

Download the HSA Guide for a Business with Staff

What's in this article


Subscribe to thge small buisness outlook

Subscribe to the blog