Business name very similar to another business name. What's the rule of thumb?

There is a saying in writing and filmmaking etc. which has several expressions, like "kill your babies" or "kill your darlings". It means getting rid of things that you have fallen in love with, because they no longer serve the purpose of the work. Very often the things that stand out to us as particularly clever actually detract from the overall work, so the paradox is that a piece of writing is often improved by deleting the sentence you are most proud of. Bummer, eh?

I don't know how big you are thinking of going with this business, but the cost of a name change now is going to be miniscule compared to what you could be faced with later. Losing sunk costs suck, but one of the predictable irrationalities of human economic reasoning is our desire not to abandon choices when we have already sunk costs into them, even though less overall loss and more overall gain is to be had by letting the prior option go. So be vigilent against that trap too.

Rethink if the name will work given the new info. I also have a domain name that is a homonym with 1 letter difference in spelling from another one, but the project I have in mind for that domain name is an arts & business blog focused on a particular region of Canada, and the other domain name holder is a German machine parts fabricator. I'm sticking with the name I've chosen because there is essentially no way you can confuse these two businesses. If I were in your shoes, with the two similarly-named businesses seeming so similar, I'd kill that baby.

Does the other business have a trademark on the name or have they been running the business a long time? If they do, you could have a problem and might want to consider renaming.

Customer confusion is the bedrock of all trademark claims. In the same vein, customer confusion can be deadly to a business.

If you already have invested a lot of time/effort into branding you might want to stick with it (does not appear you have, but I could be wrong). If it's just a minor cost, I'd seriously think about renaming.

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Steve Blank had a good summary of the different kinds of intellectual property -- trademarks, patents etc. In this there is a link to a short overview of US trademark regulations. And lastly you can search for existing US trademarks online.

If you discover that they have trademarked their name in the same business niche as you might want to be in, then I'd say change your name now.

If not, then it's a more difficult judgment call. But as Jesse points out, if real customers regularly will confuse your two companies, then there will likely be trouble later on.