We often hear about individuals who decide to incorporate while working as an employee for a business. But is it really beneficial to do so?
Let’s look at an example. Joe works as an employee and earns employment income (a T4 slip) in Alberta. On July 1, he incorporates. Although he has incorporated, he continues to work for the same business in the same role.
This situation is known as a “personal service business”. PSB’s can be identified by the following characteristics:
- An incorporated employee
- Provide services
- Have fewer than five full time employees
- Own 10% or more shares in the incorporated company
- Works for only one customer, where they are regarded as an employee or officer
One of the biggest disadvantages if the CRA considers you to be a PSB is that your corporate tax rate would be significantly more, 37% compared to 12% for an Alberta small business. You recapture some of the extra tax cost through lower personal dividend rates, but it will end up costing about 13% on all income that was deemed to be PSB income.
Let’s assume that Joe’s corporation earns $ 500,000 per year. A calculation comparing the two types of corporations is shown below:
Income 200,000 200,000
Corporate Tax 28,000 76,000
Net Income 172,000 124,000
Without the small business deduction or general rate reduction, you can see that the amount of taxes payable significantly increases, leaving less income to grow and invest in your business.
The deductibility of expenses for a PSB is also limited. Joe would only be able to claim the cost of salaries and benefits, and a few other allowable expenses.
If you think that there is a possibility that you might be a PSB please give us a call to discuss it. Finding out that the CRA has surprisingly reassessed you as a PSB would be a very costly event.
For more detailed information please call KWB at 780-466-6204 or email us by clicking here.
Thanks to Stephanie Kwan of KWB Chartered Accountants for providing this content.