Tax advantages are one of the primary reasons individuals incorporate their business, but if the CRA classifies your business as a “Personal Service Corporation” it may set you back. In a previous article, we outlined the benefits and drawbacks of incorporating your small business. Incorporating your business not only saves money during tax season but also protects your personal assets and reduces your liability. However, as a one-person company, the ramifications of incorporating are huge.
A Personal Service Corporation tax declaration will cause you to lose your tax deductions and you may even be required to pay up for tax deductions from previous years.
What is a Personal Service Corporation?
Corporations are treated as a separate entity from the business owner. If you declare your business as a Personal Services Corporation, you will not be considered self-employed, but rather an incorporated employee (an individual working on behalf of a corporation). The relationship between the company and the incorporated employee needs to be distinctly an independent contractor in order to not apply.
Personal Service Corporations provide personal services to individuals and groups. An incorporated business that provides services that an employee of the company would usually perform is considered a Personal Service Corporation and the individual, an “incorporated employee”.
How does a Personal Service Corporation Work?
With boundaries and changing work practices, freelancers and independent contractors run the risk of resembling an employer-employee. If your business is incorporated and you operate as an independent contractor, the business you are hired by doesn’t need to pay employee tax.
Am I an employee or an independent contractor?
To determine if you are an employee or an independent contract, the Canada Revenue Agency considers the following factors:
- Do you control your hours and schedule?
- Do you control the work?
- Do you own the tools used for your job?
- Are you responsible for any financial risk in your contract?
For small businesses with no big plans to expand, a sole proprietorship may be a better option, despite fewer tax benefits and protection.
How to Avoid Being Declared a Personal Service Corporation
In good faith, we cannot provide a pros and cons list because there is significantly more disadvantages to being classified as a Personal Service Corporation by the CRA. Fewer deductions, more tax, and tax penalties are the main disadvantages. Here is how to avoid being classified as a Personal Service Corporation:
- Hire more than five full-time employees throughout the year. This option isn’t always the most feasible, especially for small business owners.
- Provide services to associate corporation
Do I still receive deductions?
Unlike other corporations, personal service businesses do not receive small business deductions and generate rate reductions. They are fully taxed federally and provincially on all their taxable income. In addition, there is another 5% tax on their taxable income.
A personal service business cannot write off as many expenses either. Some items they cannot deduct include:
- Travel expenses
- Phone bills
- Office supplies
They can only deduct:
- A salary/wage/benefit that is paid to the incorporated employee(s)
- Legal expenses for collecting amounts owing
How are Personal Service Corporations Taxed?
A personal service corporation pays tax at the full corporate. They are taxed by multiplying taxable income by 21%. In British Columbia, the total tax rate for a corporate business is over 30%. For high-earning professionals with a C-Corp or Personal Service Corporation, the structure allows employees to leave some of their income in the corporation to be taxed at a lower corporate rate. Even though a Personal Service Corporation has less relief with deductions due to the classification, employees and business owners can still make use of tax-free fringe benefits such as health and dental insurance, medical expenses reimbursement, and education assistance.
Need help with taxes?
If your business is a Personal Service Corporation, you still need to manage your finances and pay taxes. To ensure, you do not get in trouble with the Canada Revenue Agency (CRA), it is important that you take extra care to track where your money goes.
At Soleimani Accounting, we specialize in providing professional financial services for small businesses and corporations. From bookkeeping and accounting to tax, we are here to help your business thrive through sound financial advice and assistance. Get in touch to book a free 30-minute consultation.