Published: 12 July 2006

A self-employed individual can operate via one of three operating entities: a proprietorship, a partnership, or through a corporation. The deductibility of expenses claimed through these entities are all identical, a corporation can not deduct an additional expense that a proprietor can not and visa versa.

If you are operating as a proprietor or under a partnership, the first thing to keep in mind is that you will be taxed on the profits you make and not what you put into your pocket. Many times I am faced with the question “but I had no money left in the bank at the end of the year so how can I owe taxes?” The reason this situation happens varies but is mainly due to one of the following:

• The business used current year income to purchase capital assets (assets with a life of more than 1 year and costing more than $200) such as a computer. The computer may have cost you $3,000 but your deduction for tax purposes is only $450 in the first year.
• Another reason is a build up of accounts receivable – you may have earned the income but you have not been paid. For tax purposes you are taxed on the amount you earned not what you receive.

Due to the above situations, many self-employed individuals find it more beneficial to incorporate so that the individual is only taxed on what they receive and the corporation pays tax on the excess. This situation is very beneficial due to the tax rate paid by a corporation being about 17% of the first $200,000 of profit versus an individual who can pay anywhere from 17% to 50%!

Using the example of earnings of $150,000, expenses of $50,000 and a person who needs $60,000 per annum of gross income to live on, the tax savings of operating through a corporation would be about $9,800!

The “catch” with operating through a corporation is that you need to ensure that CCRA will not classify you as a personal service corporation. This is achieved in part by ensuring you have several sources of income and employees that are unrelated to you.

In addition to the above catch, a lawyer will charge you a fee for setting up the corporation and ensuring all forms are filed with the regulatory authorities. These costs can be upwards of $1,000 for the first year and $300 per year afterwards. Accounting fees are also higher with a corporation so these costs must be weighed against tax savings achieved.

Another consideration is the double taxation issues that can be associated with a corporation. Too many times I have seen a corporation deduct an expense that CCRA later deems to be entirely personal resulting in the expense being disallowed to the company AND being added to the shareholder’s income resulting in taxes being due on the same income twice. This situation can be avoided with proper bookkeeping and accounting practices but is then another cost to be considered.

As every situation is unique and some other issues may apply to your particular situation, please ensure you consult your tax professional.

About the Author

This article was written by Gabrielle Loren -- a partner with Loren & Company, CGA's located in North Vancouver, BC and can be reached at gabrielle@loren.bc.ca, at 604-904-3807 or check out their website at www.loren.bc.ca

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