Many IT consultants and independent contractors are operating as sole-proprietors without considering the benefits of incorporation, according to an informal survey by Accountants for IT Consultants. Not only are they paying higher taxes, they are also exposing their personal assets to potential legal liabilities. This article will cover the key reasons why it is beneficial for IT consultants and independent contractors to incorporate.
Pay Taxes at a Much Lower Rate
Income earned by IT consultants and independent contractors for the services they provide is classified as active business income (ABI). ABI is subject to a low corporate tax rate of 15.5% up to $500,000, after which the tax rate increases to approximately 28%. On the other hand, the personal tax rate increases with the level of taxable income earned, with the highest marginal tax rate being 46%.
After incorporation, the taxpayer can pay personal taxes at a low rate of tax by only withdrawing money from the corporation that is required for his/her living expenses. The remaining funds kept inside the corporation are sheltered from personal income taxes.
Thus, by incorporating their business as advised by Accountants for IT consultants, self-employed individuals can save a considerable amount taxes!
Take Dividends Instead of Salary
If you are a shareholder of a Canadian Controlled Private Corporation, then you can receive up to $40,000 in dividends each year from your corporation, without paying any personal income tax whatsoever. As well, by taking a dividend instead of a salary, CPP premiums will be eliminated. CPP premiums must be paid if you receive a salary – see http://www.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/clcltng/cpp-rpc/slf-eng.html .
Dividends may not be appropriate for you if you have a lot of child care expenses. Child care expenses are only deductible against salary.
Also, dividends are not recommended should you wish to increase your RRSP contribution room. Only salary is considered to be ‘earned income’ for the purposes of calculating your RRSP contribution limit. To learn more about whether to take salary or a dividend, please visit http://madanca.com/blog/should-i-pay-myself-salary-or-dividends-from-my-corporation-as-a-business-owner/ .
Income Split with Family Members
By incorporating, you can add additional shareholders to your corporation such as your spouse or other family members. The key is to pay the individual who is in a lower tax bracket more money from the corporation versus yourself, until you both reach the same marginal tax bracket.
You can learn more about income splitting methods at http://www.cbc.ca/news/business/taxes/6-ways-income-splitting-could-cut-your-tax-bill-1.1218592.
Creditor Proof your Personal Assets
Many self-employed individuals enter into contracts with companies without considering the legal liabilities that could arise. In the event such a liability should occur, operating as a sole-proprietor would expose your personally owned assets such as your house, rental properties, vehicle, etc.
By incorporating, if your company should ever face a lawsuit, your personal assets will not be at risk. IT consultants and independent contractors in particular are prone to lawsuits, because of the inherent risky nature of their services. Putting the tax benefits aside, limited liability alone is a very important reason for considering an incorporation.
To learn about important incorporation tips by an Accountant for independent contractors, please visit http://madanca.com/blog/tips-for-incorporation-canada/ .
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.