E33: Prime Accounting & Tax: How to Best Set Up as an IT Contractor in Canada

In this episode, we´ve brought in our tax partners and CPAs, Nasser Khan and Ali Qamar from Prime Accounting & Tax, to give you IT professionals in Canada all the information you need to decide between setting up as a Sole Proprietor or incorporating your business.  

We explore the critical differences between T4 standard contractors, Sole Proprietors, and Incorporated contractors in Canada, helping you understand which path might be right for you. 

Whether you're just starting your IT contracting journey or looking to optimize your current setup, this episode provides valuable insights and practical tips to help you make informed decisions and maximize your financial benefits. 

Watch the episode below on YouTube:

Topics covered:

1. T4 Standard Contractor vs. Sole Proprietor vs. Incorporated Contractor:

2. Understanding the distinctions and benefits.

3. Decision Factors: What to consider when choosing your business structure.

4. Tax Implications: At what income level does incorporation become financially beneficial?

5. Provincial vs. Federal Incorporation: Differences and steps to set up your corporation.

6. Payroll vs. Dividends: Should you pay yourself a salary, dividends, or both?

7. Working with US Clients: How to navigate taxes and invoicing when dealing with US-based clients.

8. Currency Considerations: Is charging in USD while living in Canada advantageous?

9. Legal Structures: Do you need an LLC or S-Corp in the US?

10. Tax Reduction Strategies: Legal methods to minimize corporate and personal income taxes.

Transcript:

Please note, that this transcript is automated and may have errors.

Boys, taxes.

We're back.

Okay, so the reason why we're here today, and thank you, prime accounting and taxes for coming here and doing this with us. You guys are, we'll say, a partner of Montreal Associates in a sense, where you were highly referred by a friend of ours. And you've helped people or contractors in our network actually make the transition from permanent to contract, from sole prop to incorporated, from T4 to incorporated, which they appreciate. And we've gotten great reviews.

The reason why we're having this chat today is because there's a lot of questions that we get from contractors, IT contractors, right. That's what we focus on at Montreal Associates in my division, a lot of questions I can't answer. We can't answer because we're not accountants. And the purpose of this podcast is really just to start from scratch baseline. If somebody wanted to be a contractor tomorrow, what do they got to know? And just, you know, give them the tip of the iceberg that they can then reach out to you and get some more information.

To begin, I would like to start, like I said, from the foundation. What is the difference between T4, temporary employee, like a T4 temporary contractor, a sole proprietor, or an incorporated contractor in Canada?

So, in any independent contractor, there are basically three that you just explained. So T4, a temporary contractor would be like they would get a T4 slip, right? And essentially you would be paying your EI, your CPP. You would be paying, like a regular tax right now. The two that we really want to talk about, and especially a lot of IT professionals, especially the veterans they fall under, is a sole proprietor and independent contractor.

So now when you are a sole proprietor, you are basically you have your income and your taxes. You're filing it together a T1. And essentially you're taking on the full risk. So before you set yourself up, you should take legal and financial advice in terms of what your scope or your future level of income would be like, what is your risk tolerance, and what is the kind of business that you're doing? If you are going to incorporate yourself, the biggest benefit is you disassociate legal liability of that business to your personal doing. So, if you're in a business or you're in a line of work where that is somewhat necessary, it's important that you incorporate yourself. But it comes with a lot of responsibility as well, such as annual tax filing, which you will be required to do as a corporation, and a separate tax filing for personal taxes. So a lot of individuals might be like, nah, I just want to keep it simple and I'm just going to be doing this, you know, a 9 to 5 just under a sole proprietor. And that's fine with me. And you may think it's fine and it might be fine. So it all depends on what your scope is and how you're going to be functioning and what, you know, things you're going to be doing. At the end of the day, there is liability to your personal doing on your business. If you incorporate yourself, your liabilities are detached in terms of your personal belongings and your corporation. So that's the biggest benefit. But it comes with the added work that you're doing, annual filing, and separate tax filing and some other bylaws that you need to follow.

So that goes into my next question a bit, but I want to kind of unpack this a little bit from the perspective of an IT contractor. And we say an IT contractor. This could be some kind of software architect, software engineer, business analyst, project manager. The list is basically endless working in technology. But when we look at what should be considered when deciding what route is best. You've said a couple of things where we want to look at how simple do you want your taxes to be? Clearly, the most simple would be someone who's a T4, temporary, effectively a standard temporary employee of a business. Right. And then we look at the most complex, perhaps, which is the incorporated contractor route, where you have an actual registered business. In the middle is sole proprietor. I have that correct.

That's correct.

Okay. And then you mentioned level of risk, right. When you say level of risk, can we define that a little bit further with respect to, let's say, a developer, right. Someone who's going to be programming through an agency like Montreal Associates at another client, say a big insurance company, right. What kind of risks should they be thinking about in perhaps a job like that? When you're contrasting, say, sole proprietor or incorporated?

Yeah. No, for sure. It's a good question. And there's many examples that do come to mind where this does become relevant. A lot of times in startups it is a little bit more relevant where the actual startups themselves don't have really, you know, defined roles or defined scope of roles. A lot of their contracts with the end clients are, you know, not fully all the I's aren't fully dotted, all the T's aren't fully crossed. So there's a little bit of ambiguity. And in that case, you know, it's always beneficial to our clients to be incorporated because if there is some sort of issue that can come up from lack of performance, if the contract isn't fully met to the terms of the end client, it's not really going to come back on them as an individual. Their corporation might have to be part of a settlement or some of that legal nuisance that can come about. But for the most part, you know, as an individual, they are shielded from that risk if they incorporate. So, you know, that can come into play. I don't know if you can think of other examples where.

That's primarily, especially in the industry that we're talking about. It would be more focused towards it. A legal liability can come from various different actions. Right. It's not just who you're working for, what you're doing, and the consequences of that work. Especially, you know, it could be different dynamics. Like you talked about contracts between organizations, but at the same time, you know, your scope of work also can define different levels of risks that may be exposed.

Okay. So from what you're saying, then being incorporated removes the person slightly from perhaps legal risks that if something on the job were to go wrong, they may not be personally liable, but their business could be liable. So it protects the person. Now, again, you can probably confirm this, but in an incorporation where there's only one person, which are, I would say, the vast majority of the contractors that we work with, is that separation actually valid in the court of law? Because I've heard this way too, where, yeah, you know, you have a business and it separates you if there's a hack, for example, and it could have perhaps been your fault personally, but because you have your business. It's like, oh, it could protect you as an example. Not even talking about business insurance yet because you're the only person who works for that corporation. Would it not be a little bit more difficult to because there's not a lot of process in your business where something could have gone wrong, where you can claim negligence? Is that valid?

There are layers to that. You know, I'll still say a corporation structure does shield you from some of that directly. Fair. And you mentioned the business insurance. It is there for that purpose. So it is important to get that. Then business insurance is one of the first things we recommend even for IT contractors who don't have a lot of physical risk and some of that traditional risk that a normal corporation would have. But a lot of the times you're still entering into contracts. If you're a project manager, you might be outsourcing different roles. Anytime you're signing contracts. We do recommend get business insurance. It's fairly affordable, economical for our IT contractors. So it's not a burden. And it does provide another layer of protection in case things do go awry. Another thing too is you did. It's true that a lot of your clients would be kind of one-person corporations, right? But a lot of times, you know, there are spouses or partners that are involved. There could be some other family members that people kind of bring along for various reasons. And that kind of does spread out that risk a little bit too and provide another layer of potential risk.

Yeah, for sure.

And yeah, you would need a little bit of unpacking with the legal advice on that one too. But you know just what Nasser said. But in terms of other elements, I guess, you know, there is that element where some IT contractors can be making a lot of money. And there are deferral strategies more obvious in the incorporated structure, where you can choose to pay yourself a salary or a dividend. We can break it down. Essentially, you are able to defer a lot of your taxes if you don't need to utilize all of your income.

So from a tax perspective, is there a level of income required if you did want to go the incorporated route as opposed to the other two?

There's not a hard rule per se. Generally, when clients come to us and ask us that question, we kind of look at a holistic picture in terms of what is their family income, how many kids do they have? What does their spouse do? What other tax liabilities might be out there that might impact their overall tax bill? So we do have to look at it from a holistic perspective to give them that right answer. Generally, the more you make, the more you can save from an incorporation. Once you get past that 80,000 mark, it generally starts to make more mathematical sense to incorporate. And again, the cost to incorporation, the annual filing isn't that burdensome for the simple IT contractors. That kind of salary level should impact your decision. In general, it just does make sense to incorporate.

Sure.

And the other thing I was going to ask too is with so what I take from that is, let's say someone was a permanent employee and they were thinking of going contract. They definitely could still sort out their incorporation situation beforehand and then get the contract later that they can run it through as much as it probably will cost them a little bit of money. We can talk about that later. They don't have to have a contract in hand to set up an incorporation, correct? Like they don't have to have a job in hand.

No, they don't. They can prepare everything so they're ready. And then when that right opportunity comes up, they can then decide to start working as a contractor through their incorporation.

Absolutely. And in some level of IT contracting, we've seen people hold more than one role. There are part-time roles. There are elements of that.

I was going to ask you about that.

And that makes it more easier for you to manage from an incorporated perspective. It goes back to the answer Nasser just gave in terms of income threshold, if you are holding two separate roles, you are likely going to be in that 80 or over $1,000 per annum. And then it makes sense not to be withdrawing all that income if you're not utilizing it. So deferral tax strategies definitely kick in much stronger at that level for sure.

And I mean hey, as an IT contractor, not knocking anyone who's making 80 K or below. But if you're working as a contractor, you're going to want to be per year even on one contract, well above this. And if you're not, you can talk to me. But that's a good question, though, because I've also heard from other people who are looking to be contractors. Do I need to have multiple contracts in order to be a contractor compliantly? Is that true or is that not true?

It definitely does help. We've seen the CRA definitely do a crackdown lately on those individuals who only have one contract. So the guys at the bank who do three years, 40 hours a week, and then they switch banks back and forth as a contractor. They're cracking down on some of those guys here in Toronto. It's very common, as you're probably well aware, to have those bank contracts.

Or government.

Or government. It had been going on for a while. We have seen recently the CRA is starting to send a lot more notices, a lot more pressure on them to really prove that this is actually in cooperation with the ability to handle other tasks than just the one 9 to 5 that they have. So there has been a greater spotlight placed by the CRA. So our advice to our clients has been very clear is that definitely try to diversify, mix it up. If you got a life partner, I'll bring that point up again, just try to get them going somehow as best you can. We get pretty creative with some of those things as best as we can within the limits of the CRA regulations.

That's what it comes down to is the CRA kind of changes its spotlight every few years. First it was the real estate crackdown. Right now it's the IT contractors. In a few years, hopefully the spotlight moves elsewhere. But we're definitely seeing that right now.

Interesting spotlight. So it's not a hard rule to have multiple contracts, but it definitely could avoid some hassle from the CRA. If you do have some diversity in where your revenue comes from.

The verbiage in the contract is being looked at a lot more by the CRA these days. So that is something we would advise. When you're getting that contract, get it reviewed by a lawyer or we can help in that too. Hopefully your HR is flexible enough to change a few words around to really give it that flexibility that gives the appearance that this is a legitimate contract between a corporation and the bank or the government.

Then there are certain contracts that even though it is a B2B transaction, the contract very much appears like an employment contract.

That's the problem. That's where we've seen the issues. It shouldn't appear like it. It should not, of course. It really has to appear like a business to business contract. If we look at an example, I like to use the banks and the government contracts, in this case, because that's where you may see things like that. But someone who, for example, perhaps was working three years as a contractor in the same business with the right contract, where it really does make sense, where this business has a specific ability to deliver very niche technological whatever. That's something that, even in the eyes of the CRA should fly. No, that should be fine. Because it's a B2B contract. Nothing in there has anything to do with employment or doesn't allude to a type of direct employment where if somebody were to read it, it's like, okay, no, this is clearly they’re going to effectively a consulting company to deliver a piece of work, even though it happens to be one guy.

Exactly.

Or am I wrong?

No, no. That on its own might not be enough. That's what we're seeing. There are other factors at play here. The CRA might ask, were you on-site in that same office, 40 hours a week, 50 weeks of the year, basically an employee of that company? Or did you have your own office where you worked out of and those kinds of things?

I completely understand. I have a story there. I've done contract staffing in Germany, actually, and I think the UK has a similar law now. It's called like IR35. I don't even know, not sure if that's a thing anymore, but we used to have to fill out a questionnaire that would basically deem the person a true independent contractor or not. I haven't seen this in Canada where we have to provide that with Canadian businesses. I've seen a little bit in the States with certain companies, but you're right. If this person, for example, has all the exact same permissions as permanent employees doing a very similar type of work, where people are doing that as perm, that's where it's like, okay, this is looking a little bit funny and that's where you can get into some trouble.

Okay. Very good. Now the difference between a federal Canadian incorporation and a provincial incorporation. What is the difference? Is one better than the other? Do you need to use one or the other? What's the deal with this?

Well for federal and you can be registered as federal or provincial. It completely depends on the work you're doing, the geography of where your business was going to function. It also depends on the IT worker. Do you want to be available in a province, or is your scope more of a national level? But the main difference becomes from a registration perspective it's not too different. There are a few additional, you know, you're governed by provincial laws where when you're registered federally, you're governed by CBC. Your jurisdiction is national. But at the same time, there's a bit of a different set of laws. So if you're going to be only operating in Ontario, there's very little reason for you to be federally incorporated. Keep it simple for the business. If you have any level of scope. Let's say you're doing cybersecurity for TD Bank. They’re across national. And if there is any reason for you to be geographically available or your company is going to get contracted in New Brunswick and Ontario at the same time, then, okay, maybe there's a different scope of work and a different need. But most IT contractors, I would think they're geographically localized. So it would make sense. We haven't really come into a situation where we had to tell someone, you need to be federally incorporated versus provincially incorporated. Just like I'm talking IT specific. Just because they don't have any functions outside of the province. So keep it simple. You function within that province, the provincial laws, and you don't need to be exposed to federally governed laws.

The only reason I ask is because there's a lot of contractors that want to take contracts where the head office of their client is outside of Ontario. We're in Ontario now, by the way, for those of you who don't know, Toronto. For those contractors who are trying to work with clients outside of Ontario or perhaps even the United States, does that automatically mean they should have a Canadian federal incorporation as opposed to provincial?

No, no. For IT contractors? No. The majority of our clients are provincially registered. We have a lot of clients in Alberta, BC, and Ontario. It's fine. And they can trade with clients anywhere in Canada still. And the states.

That's correct.

Okay. Cool. Yeah. There are a few steps to that. We can dive into the states. The states are a little bit different than Canada. But for the most part when it comes to providing any sort of IT service, it's fine. A lot of our clients are federally registered because they went through a lawyer. So the lawyers tend to do federal registrations. A lot of them.

Do you know why? Do they make more money that way?

I think probably a little more complicated. That's why.

And complicated for lawyers means better money.

One more billable hour.

Exactly right.

One more billable hour. No doubt. So we get a lot of those. But, to Ali's point, for your listeners, there's really probably not much reason to ever really do a federal incorporation. If they have grand plans, grand visions, grow this thing out, definitely might be something to look at.

Perhaps if they wanted to have employees eventually that are in different provinces and not their own, is that where maybe a federal could make sense?

Not even. Any corporation can have a payroll account set up with the CRA, so that is the main thing from a CRA perspective. However, employees in different provinces might prefer that for some reason. But to be frank, there's not much.

So you can get by with a local provincial one. And regardless whether it's provincial or federal, you did recommend that they should get business insurance as a corporation, right? That's a good idea. Now, I've heard someone say this. And again, I didn't really have a rebuttal. One of my contractors maybe. No, I'm kidding. I didn't really have a rebuttal for this because I didn't fully understand. But they were saying, oh, you know, when the agency asked me to provide business insurance, I never do that because that means liability gets pushed down to me. And I'm thinking it's because the agency. So Montreal Associates obviously has business insurance, but if the person who's ahead of you in the chain before the client has business insurance, does it automatically stop there? Or if you made the mess, can the buck still come down to you without insurance?

Another podcast with a lawyer on it.

We should have had one, but that's okay. If that's too much on the lawyer side, we can do that in another session.

There might be one walking down Yonge right now.

You can probably run out. All good. We can move on from that one. I'll keep that one in the bank. What are the steps to setting up an incorporation? Can I do this myself? Do I need an accountant?

You could use an accountant for professional advice and help you go through the process. But in terms of setting it up, it's pretty simple. Depending on the structure. If you do it thoroughly, you’re choosing a name, you're registering it. If you register as a provincial corporation, your name is not protected in other provinces. So someone can take your name. If, for example, I open Ali's Cafe in Ontario, tomorrow, I want to open it up in Manitoba, somebody else could have already opened up Ali's Cafe. And I don't have the rights to it. So choosing the name, in terms of setting up a corporation, you choose your name, establish your articles, select and appoint your directors, and then you file those articles. Once you file those articles, you set up bylaws, you make sure you convene a meeting and follow the bylaws. Those are the simple steps in a nutshell. It's not that difficult. And in between, you get your business number.

The HST number.

Depending on where you’re operating, we'll call it your tax number and your business number. It takes about 5 to 6 days. Then you convene your meeting. Setting up an incorporation, getting the right tax advisors and legal advisers is essential. From there on, it's pretty simple. Steps are very simple. Canada and Ontario made it very simple to create businesses, to operate businesses. But you just need to understand and get the right advisors and experts in the room to make sure you're doing it correctly and within the correct scope of work.

I believe there would be a provincial government website where you would go and do that or have an accountant do it for you. And there's a Canadian federal website where you either do it yourself, like you actually click incorporate, or have an accountant help you walk you through the process.

Just to add on, where a CPA or a lawyer could help with this process is there's a lot of legal jargon through those forms. That's where a lot of IT contractors come to us. It's quicker, it doesn't cost too much. We're able to do that holistic analysis for them to help them set up the corporation with potentially family members, potentially other people to help reduce that tax bill once they start making that money.

I can't wait to get to that part. Should I, let's say I open up incorporation, got a contract ready, I'm working, billing, and my corporation is making revenue. How should I pay myself? Should I payroll myself? Should I issue dividends? Is there another way to pay myself, some kind of combination? Let's say this person is making well over 100,000, or their revenue is well over 150,000 per year. What's the best strategy?

There's no one size fits all like you just said. You could pay yourself a combination. You can pay yourself only salary, only dividend, or a combination. Having a payroll has its complexities but has a lot of benefits too. A payroll makes you liable for CPP, but you also get the benefit when the time comes. When you pay into CPP and EI, you're contributing and your long-term strategy makes sense. What the dividend allows you to do is that you don't need to withdraw the entire income. Dividend can sometimes be tax advantageous.

I have one client outside of the IT industry. There was a grant available for that specific industry, but the grant was only available if someone was on a payroll. But these two brothers, they have a nice business, but they were only paying themselves dividends. They can't access the grant, which is a couple hundred thousand dollars accessible to that industry. All their colleagues are doing it, but they can't because they didn't realize how big they were going to become. They went from 100,000 to $2 million revenue in six years. Now they're resetting up correctly. Getting the right industry expertise and advice is crucial because not one size fits all. They should have had both payroll and dividend setup.

For a lot of newcomers to Canada, the first question we get is how to save taxes. But the question we go back to them with is, what are your financial goals? Do you want to qualify for your first house or get a car? If that's the case, having that regular T4 and contributing to banks like that makes sense.

If you got the house, the car, and your life is set up, you may want to lean more towards dividends.

Can we talk about the tax rates actually? You have to pay or charge HST on your services, pay HST, pay corporate tax, and eventually income tax if you payroll yourself. Can you walk me through those percentages for each of those situations?

Sure. In Ontario, when you invoice, it's going to be 13%. For IT contractors, there aren't as many HST deductions available as there are for goods and services businesses with more inventory. So, a lot of times every quarter, our clients do have to pay most of that HST back to the government. But that's kind of an in and out. So it's not really a real tax for most of our contractors. The two main taxes that we should talk about are the corporate income tax, which is the profit that the corporation makes, the roughly 12.5% tax that the corporation has to incur, no matter how much revenue they make or up to a certain amount.

For corporate taxes, it's pretty much a flat rate for the most part. So if I my revenue is 2 million. So under okay. Yeah. I'm talking more for IT contractors which would be. Surprised my friend. True. Yeah. Um but let's see. So I think he's trying to recruit us. Huh. Is it up to 500 grand? No. Given that almost all of your clients would still qualify as a CCPC, a Canadian controlled private corporation, assuming they are Canadian residents, that corporate tax rate would be around that 12.5% for Ontario corporations.

That rate doesn't differ too much by province. You know, the provincial portion isn't too different. So even if you're in Quebec, Alberta, that corporate tax rate in Canada is pretty low and pretty consistent across provinces. Where it hurts most is on the personal side. And whether you get a dividend or a salary, you do have to pay personal taxes. As you're probably aware, the more you make, the higher the rate goes.

Probably for most of your clients, they are getting to that 45% tax bracket, which does hurt. And that is where initially we mentioned for the most part dividends. The net math on that does help. It's just a lower tax bracket. So if you're in a higher tax bracket, the income tax that you have to pay on a dividend wouldn't most likely be lower than what you have to pay on a straight salary.

Okay. So if we look at the straight up payroll, if someone payrolls themselves effectively, they get taxed just like they do as a permanent employee because that's how they're running it. You're a permanent employee of your own corporation. You are going to pay taxes like any permanent employee would up to you say 40. It feels like 50. But they're going to pay tax within the respective bandings with dividends.

Can we just get a bit more detailed on what that tax actually looks like and perhaps percentages for sure. For the T4. One thing to also keep in mind is the corporation. Your corporation has to pay the employer portion of CPP and EI, right? So if you're an employee at a normal corporation, you're only incurring that one side of it. At a corporation, you got to pay both sides of it. There is that additional hit that which is deductible, though, from payroll.

What you what you. So that's the advantage, right? Is that the corporation gets a deduction. What I mean. Exactly. Now the reason again mos...