Why Contractors Should Get Incorporated
Stephen Nesbitt | IT Recruiter
Why Should You Get Incorporated?
A common thing heard from contractors in the IT industry is that getting incorporated is more hassle than it’s worth; there’s too much paperwork. While yes, there is some paperwork, the benefits to the consultant of getting incorporated far outweigh any inconvenience. This blog will run through some of the benefits of getting incorporated so you will then be in a better position to decide if it’s right for you as a contractor.
Types of Organisation:
There are three forms of organisation available to independent contractors in Canada – Sole Proprietorships, Partnerships and Incorporations.
Immediately it’s extremely important to point out partnerships are not something you want to do. The reason is because any partner can legally bind the other. This means they can put you at risk! A partner acts as an agent of the firm and his acts bind the firm and other partners. A dishonest or incompetent partner may lead the firm in difficulties because the other partners shall have to pay for the dishonesty or inefficiency.
If you would like to enter a partnership the best advice is to do so via incorporation so that a shareholders’ agreement can be put in place to protect the individual.
The Sole Proprietor is fairly inexpensive to set up, but that is the only advantage! Everything you earn will be taxed on you as an individual. There is no way to separate income streams! Personal tax rates can go as high as 46% compared to the 15.5% charged to independent entities. With sole prop you must use December 31st as year end, however if you are incorporated you can use any date of your choice as a year end.
Another facet of Sole Prop is the fact that you will need to pay EI, even though most good contractors will not need to make a claim AND the amount put in is nowhere near what you can take out! Another drawback is that most major banks, Insurance companies or Staffing Agencies will not touch sole prop’s because there is always risk!
One benefit to you as a sole prop is that you can submit expenses to take down your taxable income level.
Incorporation – Non-Financial Benefits:
There are many advantages to getting incorporated, both financial and non-financial. Two of the main advantages are asset protection and increased marketability.
As mentioned above, most major banks, insurance companies and staffing agencies will not touch sole props. Therefore, you immediately increase your marketability by getting incorporated! This is arguably the most important benefit! Quite simply the fact that you are incorporated means that you have a limited liability. Therefore the risk associated for financial institutions, insurance companies or even staffing firms is greatly reduced! Staffing firms do not need to pay EI or CPP for you which makes you as an incorporated entity a lot more attractive to work with over Sole Props.
Incorporations – Financial Benefits:
The tax law for incorporated entities states that any income up to $500,000 is taxed at 15.5%.
One of the main benefits of getting incorporated is the fact you can take money out of the incorporation tax free! This is known as a tax free loan. There are a number of reasons to do this – Dividends, write offs for a mortgage/car or debt repayment.
The advantage of this is that you are decreasing your net income over a period of time. So instead of taking $50K out to finance your mortgage interest you can take $2K out for the next 25 years, thus consistently lowering your taxable income through deductions.
The ideal income you want to be around as an incorporation is $40,000 as this will keep you in the lowest tax bracket.
Another financial advantage is the ability to draw dividends from your incorporation. You can withdraw up to $40K in dividends tax free. This money is taxed at 15.5% under your incorporation so you can then write this off against your personal tax return.
The long-term goal is to leave your money in the incorporation. Any money taking out should be as a salary as that is eligible for CPP. When you retire you no longer have to pay CPP and you can now begin to take money out of the incorporation as a dividend! Pretty sweet eh?!
As the tax system in Canada is marginal – the more you earn the more tax you pay – a big advantage to incorporated entities is the ability to smooth out income over a period of time. The longer you can do this the better off you will be! It is better to earn $50K two years running than to earn $100K one year and nothing the next.
The categories for deductible expenses are wider for incorporated entities than sole prop or Partnership.
But I don’t like paperwork or data entry:
One of the main concerns heard when speaking with contractors is that while there may be benefits associated with getting incorporated there is just too much paperwork or data entry when completing your year end taxes.
Well, now there are many tools available to help you! Generally independent contractors have relatively simple tax returns, the main complication being finding an entering all your receipts into your books. A Toronto Startup called Wave Accounting can take this hassle out for you. They provide web-based applications that can link to your bank account to gather all the data needed to file your taxes. All you have to do is ensure you use debit or credit for your business transactions! This reduces your workload significantly so you can easily separate deductible and nondeductible expenses.
If you want to get incorporated and like what you have read here feel free to contact the experts on this topic – Wall & Associates.
Contractor? Incorporated? What do you think?
Can you think of any more benefits? What are your opinions on Incorporation? Comment below and follow me on Twitter and LinkedIn for contractor advice!
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