Pitfalls of Incorporating a Personal Services Business [Feb 25, 2018]

It has become common practice over the last several years for large companies to hire contractors, rather than employees, for many positions. There are definite advantages to working as an independent contractor, primarily the ability to deduct all business expenses allowed under the income tax act. Incorporating can add two further advantages:

  1. Creating access to the small business tax rate, and
  2. Facilitating income splitting. Using multiple shareholders creates tax planning opportunities for incorporated small business owners.

Before you rush to incorporate, however, be aware that if yours is a personal services business (PSB), these particular advantages do not apply. The deductions are limited to the incorporated employee’s salary, which eliminates the income-splitting potential, and the small business tax rate is not applicable, which will result in a substantially higher tax rate than would be paid as an employee.

The determination of whether a person is carrying on business as an independent contractor, or has a personal services business, requires a careful examination of a number of factors. Essentially, if there is an employer/employee relationship, ie the person providing the service is completely reliant upon that particular company for their income, with little or no control/risk and no major investment in tools or equipment, there is a very good chance that they will be classed as a PSB. If reassessed as such, they will be subject to arrears interest and penalties on any additional taxes that may result.

Incorporating definitely has its advantages, but the PSB classification is a hidden pitfall to watch out for.

Kevin Cox, CPA, CGA can be reached at kevincox [at] coxandcompany {dot} ca