Tax Question as asked by Sarah A.
I am an IT professional. I just received an offer from my employer. My employer wants me to incorporate and they have agreed to offer a better hourly rate. I am confused should I set up a corporation or become an employee?
Disclaimer: This is not tax advice. The answer below is for general purposes. Please exercise caution while making any decision based on this post or any other post on this website. This question may have been rephrased to correct some of the technical terms. The rephrased questions are often more helpful to a wider range of readers.
Thank you very much for asking us this question.
I must say that we receive five to ten inquiries on the same topic. Many IT professionals approach us to know whether it is better to be incorporated or simply become an employee.
The nature of the relationship is key!
For starters, you must determine the relationship between you and your employer/client. If the relationship is of employee-employer nature, you should not unless this is an absolute requirement from the employer. If you are acting as an independent contractor, yes, you can incorporate.
Please keep in mind just because the contract says you are not an employee does not make you an independent contractor. Please review the five factors used to determine the employment status by CRA.
If you decide to incorporate but your relationship with your employer is of being an employee, you are an incorporated employee. Your corporation has a specific classification as per Income Tax Act, i.e. Personal Services Business a.k.a. PSB. There are restrictive rules applicable to PSB’s income as compared to other Corporations in Canada.
Our post on Personal Services Business will let you have a deeper look into this.
Independent Contractor Relationship
If you determine that your relationship with your employer/client is of an independent contract nature, PSB rules are not applicable to you. Relief! If you are an independent contractor, your corporation is a CCPC (or OPC) like any other corporation in Canada.
The decision to incorporate depends on multiple factors that your income tax accountant can help with after analyzing your personal tax situation. However, there are a few misconceptions you come across online. The top 3 are below:
- Your tax rate (corporate) is lower than individual marginal tax rates. Yes, however, this is only until you withdraw dividends or salary from the same corporation. It’s more of a tax deferral advantage rather than savings. Many keep on accumulating earnings in corporations and then pay higher individual taxes in case of a bigger withdrawal in future years.
- You can write off lot more expenses under a corporation. Not true, you cannot write off as much as you want. For an IT contractor, deductions are going to be almost similar to a sole proprietor. Automobile expenses, home office expenses, meals and entertainments, “gifts and promotions”, and many other expenses have set rules for them to qualify as deductions!
- I can take loans from corporations whenever I want without taking dividends. Yes, and No, shareholder loans are subject to strict rules. In short, a loan to a shareholder cannot be on the books for more than one balance sheet date. Also, a shareholder-employee loan as an employee is different that then shareholder loan. In the case of a single (and only) employee of a corporation, that shareholder-employee loan is very difficult.
Nothing can replace a formal consultation with a professional corporate tax accountant.