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 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


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


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 Professional 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 Professional Accountants

Creative Solutions to Cross Border Income Tax Issues

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