Presentation: IT Consultants – Tax Issues

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Tax Consequences of Providing IT Consulting Services 

Canadian IT Contractors Can Work:
  • As employees;
  • As sole proprietors (or independent contractors);
  • Through a corporation.
Pros & Cons of Being an Employee

Benefits of Employment:

  • Taxes withheld at source;
  • Health, disability, life insurance plans;
  • Pension plans;
  • Unemployment insurance.
  • Employee rights (ie. Wrongful dismissal) are available.

Disadvantages of Employment

  • All income is taxable with few deductions;
  • Cannot have an assistant (ie spouse) on payroll;
  • Cannot deduct mortgage interest or any other item which self employed persons are able to deduct.
Pros & Cons of Being Self Employed

Benefits of Self Employment:

  • May pay salary to assistant;
  • May deduct normal business expenses;
  • Can be exempt from U.S. taxation by Treaty;
  • Lowest administrative cost of all organization alternatives.

Disadvantages of Self Employment

  • May be considered an employee by taxing authorities anyway;
  • Very little tax planning –income earned in year appears on tax return;
  • Must pay quarterly installments of tax;
  • Must collect and remit GST if working in Canada.
  • Must buy own insurance 
    • Health
    • Professional liability
What is a Corporation?
  • Separate legal entity –distinct from owners.
  • Must maintain separate books & financial statements.
  • Must file annual tax returns where it operates
  • Can vote, be sued, & act like a separate person.

Why Incorporate?

  • Reduce chances of being considered an employee.
  • Tax advantages available.
  • Other advantages
Being Considered an Employee
  • Many sole proprietors are considered employees even with proper contract;
  • CCRA wants to consider all persons employees;
  • Difficult to distance self from “customer”;
  • Consider nature of relationship.
Tax Advantages
  • Lower rates of tax on first $200K per year;
  • Must leave net income in corporation
  • Must be active business carried on in Canada
  • Choice of compensation –dividends vssalary
  • $500K capital gains exemption
  • Tax deferral and pay of family members possible.
Other Advantages of Incorporation
  • Access to capital –can sell shares vs borrowing;
  • Perpetual existence –corporation remains if owner dies;
  • Limited liability –can only lose what you put in unless guaranteed.
  • Anonymity –of owners.
  • Ease in transfer of ownership;
  • Decreased audit potential;
  • Choice of fiscal year;
  • Name protected;
  • Estate planning –family trust ownership.
Incorporation Feasibility Checklist
  • Conducting an active business? > If not –tax rates too high.
  • Not incorporating a job? > Personal service corp.
  • Gross revenue test. > Generally over $100K
  • Plan to leave some net income in corporation? > If not, many tax advantages negated.
  • Prepared to handle extra administration? > Improper handling increases costs and creates a nightmare.
Pros & Cons of Working Through Your Own Corporation

Benefits of Incorporation:

  • Benefits outweigh disadvantages
  • Independent of customer;
  • Limited liability to contractor;
  • Highest degree of tax planning available;
    • Income splitting
    • Salary vs. dividends
    • Spanning calendar years through fiscal year planning.

Disadvantages of Incorporation

  • Higher set up cost;
  • Higher annual administrative costs;
  • More administrative work:
    • Must maintain books;
    • Must have a payroll;
    • Must file annual financial statements and tax returns;
Classic Canadian Corporate Tax Planning Model
  • Corporation earns money carrying on an active business in Canada;
  • Pays salary to shareholder (and others)-on payroll;
  • Retains up to $200K each year at 23% “small business”tax rate.
  • Retained earnings form “pension plan”-taxed as dividends when withdrawn;
  • Personal & corporate taxes are minimized.

Some Basic Rules

  • Family members must provide value to corp.;
  • Only things required for earning income are deductible;
  • Owner and spouse must be on payroll –with monthly remittances;
  • “Small Business Deduction”only available for:
    • Active business
    • Earned in Canada

Basis of Taxation

United States
  • The U.S. Taxes citizens and residents.
  • U.S. tax residents are subject to U.S. Tax law regardless of where they live.
  • U.S. residents must file tax returns each year if they meet minimum income thresholds.
  • Non residents with U.S. source income must file returns –but only declare the U.S. income.
Canada
  • Canada bases taxation on residence.
  • Canadian citizens cease to be taxable in Canada when they leave.
  • Expatriate Canadian’s need only file returns for Canadian income, rentals and RRSP’s (elective).
  • It is possible to be considered resident in both countries.

U.S. Taxation of Corporations

  • U.S. taxes corporations with a fixed base in the U.S.
  • Corporation tax rates are graduated.
  • Subchapter S corporations available to U.S. residents only.
  • Canadian corporation must file U.S. return if operating in the U.S.
  • Canadians must report operations of Canadian corporations if living in theU.S.(Form 5471)

Canadians Providing Self Employed Services in the U.S.A.

  • Canadian travels to U.S to work as subcontractor.
  • Treaty exempt regardless of amount earned or time spent in the U.S.A. unless fixed base in the U.S.;
  • Must maintain Canadian residence;
  • Presence in U.S. to work is NOT considered a fixed base or permanent establishment.
Canadians in the U.S.A.
  • U.S. personal taxability is based on PLACE services are provided.
    • Not the payer
    • Not the place payment is received
  • U.S. corporate taxability is based on fixed base or permanent establishment.
  • Canadians may work in the U.S. in one of the following ways:
    • Employee (W-2);
    • Self Employed (1099);
    • Employed through a wholly owned Canadian corporation.
Working in the US Through a Canadian Corporation –Chart

canadian-tax-based-on-residency.jpg

Canadians Providing Services Through a Canadian Corporation
  • Canadian individual performs personal services;
  • U.S. customer pays the Canadian corporation;
  • Canadian corporation pays the individual (on payroll);
  • Canadian corp. is Treaty Exempt in U.S.;
  • Canadian individual files personal taxes in U.S.;
  • Canadian individual files taxes in Canada (if resident);
  • Canadian Corp. files Canadian F/S and returns.
  • Must reduce net corporate income to zero by salary:
    • No small business deduction available in Canada;
    • Net income is Subpart F income if left in Corporation.

Canadians in the U.S.A.

  • U.S. personal taxability is based on PLACE services are provided.
    • Not the payer
    • Not the place payment is received
  • U.S. corporate taxability is based on fixed base or permanent establishment.
  • Canadians may work in the U.S. in one of the following ways:
    • Employee (W-2);
    • Self Employed (1099);
    • Through Cdn. Corp. (“corp. to corp.”)
    • Employed through a wholly owned U.S. corporation.
Working in the US Through a U.S. Wholly Owned Corporation –Chart

canadian-tax-based-on-residency-2.jpg

Canadians > Employed by Own U.S. Corporation in the U.S.A.

  • Canadian severs Cdn. residential ties;
  • Employee of U.S. corporation;
  • U.S. corporation taxed as usual in U.S.;
  • U.S. corporation cannot sponsor TN visa for shareholder.
    • But can sponsor unrelated parties.

Treaty Article XIV Independent Personal Services

  • Complete exemption from tax, regardless of amount earned or time spent in other country;
  • Cannot have “fixed base or permanent establishment”;
    • Self employed Cdn in U.S. deemed not to have fixed base;
    • Cdn corporation without U.S. office, agent, bank, etc., deemed not to have fixed base.

Treaty Article XV Dependent Personal Services

  • Exemption qualifications:
    • Earnings under $10,000;
    • Stay in U.S. < 183 days;
  • Working as an employee of a Canadian corporation where salary is not “borne by”a U.S. entity.

Subpart F Income

  • If U.S. persons control a foreign company, it is a CFC.
  • (Canadian living in the U.S. is a U.S. person).
  • Persons owning more than 10% of a CFC must file form 5471 to report Subpart F inc.
  • Subpart F income is all passive income PLUS:
  • Service Income earned by the corporation outside of its country of incorporation.
  • Failure to file: $10,000 fine.

While You Are Away

  • Per Diem Expenses;
  • Ceasing to be taxable;

Who We Are & What We Do

Who We Are:
  • Certified Public Accountants
    • Licensed for all states & federal
    • IRS Certifying Acceptance Agents –to obtain ITIN and employer identification numbers.
  • Chartered Accountants–Licensed throughout Canada
What We Do:
  • Tax returns & financial statements
  • Corporate & personal tax returns
  • Incorporation (Canada & USA)
  • Tax & financial planning.
  • Representation before IRS & CCRA.

Thank You

This presentation has been made courtesy of Mark T. Serbinski, Certified Public Accountant and Serbinski Partners PC, Chartered Accountants

Creative Solutions to Cross Border Income Tax Issues

More information online: Serbinski.com

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