Transitioning from Sole Proprietor to Corporation: Tax Steps and Pitfalls — CPA Firm Near You, Montreal

Introduction

Many entrepreneurs in Quebec begin as sole proprietors and later incorporate as their business grows. Transitioning from a sole proprietorship to a corporation can unlock tax savings, protect personal assets, and improve business credibility — but the process must be done correctly. A poorly executed transition can create unexpected tax bills, double taxation, GST/QST errors, and compliance problems. This guide explains the tax steps required when moving from sole proprietor to corporation, and how a CPA near you in Montreal can help avoid costly pitfalls.

Legal and Regulatory Framework

Under the Income Tax Act and the Quebec Taxation Act, a sole proprietor and a corporation are two separate legal and tax entities. When you incorporate, you must transfer business assets to the new corporation. This can trigger capital gains unless structured properly using an Article 85 rollover. The corporation must obtain its own Business Number (BN), GST/QST accounts, payroll accounts, and maintain its own books. The sole proprietor must file a final year of business income (T2125/TP-80), and the corporation must file a T2 and CO-17 annually. Mixing personal and corporate income after incorporation leads to reassessments.

Key Court Decisions

Courts have ruled that improperly transferring assets to a corporation without documentation can trigger immediate taxable gains. Judges confirmed that failing to close GST/QST accounts for the sole proprietorship or incorrectly transferring them to the corporation results in penalties. Several cases highlight that revenue earned after incorporation but deposited in a personal account is still corporate income, creating compliance issues. Courts emphasize the need for formal agreements, resolutions, and clear financial separation.

Why CRA and Revenu Québec Scrutinize Transitions

Transitions are frequently audited because they involve changes in ownership, asset transfers, GST/QST accounts, and revenue classification. CRA and RQ look for incorrect rollover elections, missing asset transfer values, mixed personal and corporate expenses, income reported in the wrong entity, and unreported GST/QST. New corporations often fail to maintain proper bookkeeping during the first year.

Steps to Transition from Sole Proprietor to Corporation

Step 1: Incorporate the business

Choose provincial or federal incorporation, set up share structure, and prepare a minute book.

Step 2: Transfer business assets

Transfer equipment, inventory, contracts, goodwill, and accounts receivable to the corporation.

Step 3: File an Article 85 rollover

This prevents immediate capital gains on the transfer of assets.

Step 4: Register the corporation for GST/QST

Sole proprietorship accounts cannot simply be “switched”; the corporation needs new accounts.

Step 5: Open a corporate bank account

All future revenue must flow through the corporation.

Step 6: Adjust bookkeeping

Track sole proprietor income until the incorporation date, then corporate income afterward.

Step 7: Prepare payroll or compensation structure

Choose between salary, dividends, or a mix.

Step 8: Update contracts and suppliers

Clients must pay the corporation, not the individual, after incorporation.

Step 9: File final sole proprietorship return

The last year of self-employed business income must be reported on T2125 and TP-80.

Common Pitfalls

Incorrect asset transfer

Transferring assets without documenting fair market value creates tax exposure.

Mixing business and personal accounts

Using one bank account after incorporating creates compliance issues.

GST/QST confusion

Using the sole proprietor GST/QST number for corporate transactions is prohibited.

Paying personal expenses with corporate funds

This creates shareholder loan problems and taxable benefits.

Not updating clients

Revenue belongs to the corporation after the incorporation date.

Mackisen Strategy

At Mackisen CPA Montreal, we guide business owners through the entire transition by incorporating the company, structuring the Article 85 rollover, preparing resolutions, registering GST/QST and payroll accounts, setting up bookkeeping systems, and handling year-end filings. We ensure all income is reported in the correct entity and prevent errors that lead to audits or large tax bills.

Real Client Experience

A Montreal consultant incorporated but continued using her personal GST account. CRA reversed two years of credits and assessed penalties. We corrected filings and set up proper corporate accounts. Another client transferred equipment without a rollover; we filed a late Section 85 election and prevented a large capital gain.

Common Questions

Do I need a CPA to transition?

Yes, especially for the Section 85 rollover and GST/QST setup.

Can I use the same bank account?

No. The corporation requires its own account.

Does my business name change?

Not necessarily, but legal invoices must be in the corporation’s name.

Is incorporation always tax saving?

Only when profits exceed a certain threshold or reinvestment is planned.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal ensures your transition from sole proprietor to corporation is smooth, compliant, and tax optimized. We protect you from the pitfalls that commonly trigger reassessments and penalties.