Operating your own business has tax-saving benefits and helps to keep extra money in your pocket. These advantages as a self-employed business owner also come with tax rules that you must play by to ensure you can have the most benefits for your position.
Today we are going to talk about one of these tax rules is called the Personal Services Business.
- What is a personal services business?
- What types of personal services come under such a definition?
- what happens if you are classified as personal services business?
- How does the personal service business operate?
- What can you do to not fall into the trap of a personal services business?
Let us Dive Deeper into the Personal Service Business
The Definition of Personal Service Business
PSB is defined as:
“… a business that a corporation carries on providing services to another entity (such as a person or a partnership) that an officer or employee of that entity would usually perform” (T4012 –T2 Corporation Income Tax Guide, Chapter 4, Canada Revenue Agency).
Yah, very complex. To break it down this is essentially what it means.
A personal service business is
- business that is registered as self-employed as a proprietorship or incorporated;
- has only a single shareholder or employee working within that business that is provided services to…
- a business that is its only customer; and
- has a contract that stretches over a long period of time with no end date.
Why would this happen? Because it is easier for the hiring company to bypass all the expenses of an employee such as payroll taxes, health benefits and not have to provide the contractor with office space, equipment, and so on.
It is also important at this time to reflect when you do get these types of contracts if you are indeed a contractor and not an employee. Refer back to the link (put a link here for the blog employee vs contractor)
What types of Personal Services come under this type of definition?
Personal service activity can be any startup or entrepreneurship that provides services like a field of engineering, and trade services, long-haul truck driver, IT technician who contracts to a single customer.
Another way to look at this is can the business that is providing the service have anyone else take over the contract to do the work and is the only client you have that is generating income for your business? Then you are more than likely a personal service business.
This is a common problem especially for those who are in the long-haul trucking business or in the trades industry. Most entrepreneurs do not even know they are a personal services business till they are told by their accountant.
What happens if you are classified as Personal Services Business?
IF you do fall under the classification of this, it is not the end of the world. (You can breathe a little bit easier) The disadvantage of being classified as this is the loss in the reductions of tax rate which other small businesses would be allowed to have. Meaning are being taxed at a higher tax rate on your earnings of the business.
Currently there are two benefit tax rates that will be lost.
- The small business rate (SBR) will decrease the overall tax rate by 13.5 percent, applicable to the active business income of $500,000 or less.
- The general business rate (GBR) will decrease the overall tax rate by an additional 26.5 percent.
Income from a PSB is not eligible for the small business deduction or for the general corporate rate reduction. With these tax rate deductions, income is usually taxed at 14.6%, but will now increase to the possibility of 44.5% depending on what province or territory you live in for Canada.
The other catch is the restrictions in the company of never being able to claim a loss.
How does the personal service business operate?
Canada’s tax regulations label you like a personal service corporation if you sell your services in an employer-employee scenario but as an independent contractor. It enables the business or the employer who hired you to evade tax payments they would be obliged to pay if you are tagged as an employee.
Depending on certain conditions. The Canadian Revenue Agency may label you as an employee or independent contractor. These include:
- whether you have control over the work schedule, work hours, and work output
- whether you have the ownership of the job tools
- whether you bear any financial risk for the business arrangement
if you are working under the client’s directions, the CRA will tag you as functioning as personal services corporation. The government labels an employee as an employee regardless of the label you put on.
There are two main factors via which the Canadian Revenue Agency identifies a personal service corporation.
- If the main shareholder, owning 10% or more of shares, is considered an employee in the absence of corporate structure
- The number of employees a corporation has; five or less
To ensure your self-employed status, you need
- to be in charge of your work hours
- to invest in work tools to execute your job
- to have distinctly defined contracts with each client
What can you do to not fall into the trap of a personal services business?
To sum it up, being a personal services corporation may draw business and clients, but it can cut back on your revenues if identified. To avoid it all, you must:
- set your own working schedule with your client
- try working with different clients at one time
- work on two or more gigs if working full-time with a single client and draw separate invoices for each gig, make the payments on record and official
- pay yourself via wages instead of dividends
- pay for your work tools, including your own transport, computer, cell phone, office space or work-desk, courses, meetings, and other dues
- get a clear contract written with precise details identifying you as an independent contractor, enlisting the business’s risks, and any charging fee owed by either working party. Know personal services contract definition
- work with associated businesses.
Learning about how the CRA defines employees and independent contractors helps in the long run. Timely information will help you make informed decisions and also aid in protecting your corporate status.
Personal Service and Taxes
This service is taxed by multiple taxable incomes. It is taxed by 21%. In personal service, the tax rates are pretty high. That is why personal service businesses do not qualify in the small business deduction that most Canadian businesses are privy to. With organizing, some tax benefits come as a C Corporation, due to that many high earning professionals use the structure?
Such as C Corporation permit their employees to leave some of their earnings in the corporation. It will get a lower corporate rate than the marginal tax rate. Many of the professionals take advantage of this tax-free fringe, limited liability, benefits and might receive some favorable business deductions.
Don’t confuse personal service corporations with professional corporations. These are business entities that are made up of a certain type of profession under the state of law.
In the type of expenses, there is a big limitation. For tax purposes, the corporation deducts the expenses. According to S. (18) (p) of the income tax act, restricts the deduction of expenses of personal service business of a corporation. Following are the allowable deductions:
- The salary wages paid to the incorporated employee or other remuneration paid in the year by the employee to the corporation.
- The cost of any benefits or allowance provided by the incorporated employee. This can be applied if the corporation provided medical benefits as a part of the employee agreement.
- Any cost relating to negotiating any contact by the corporation or selling a property, as long as the amount is deductible. If it had been expended by the incorporated employee under a contract of employment that required the employee to pay the amount.
- 5 full-time employees cannot be hired by the corporation throughout the year.
- The associated corporation is not given the services.
In simpler words, you can be a personal service business if your corporation has one employee or client that is less than six full-time people.
Be aware that you should’ve been filing as a CRA and PSB, later determining that you might meet the criteria. You could be subject to penalties and interest for filing incorrectly and even paying the wrong tax rate. Reach out if you are unsure and avoid this.
Minimizing the tax in the personal service business
The tax rate is much higher in PSB and the deductions are limited. The smart way to minimize the deduction is to pay all the earnings in the corporation as wages to the incorporated employee. This can result in no taxable income inside the corporation and even allow the incorporated employee to pay tax at a marginal personal tax rate.
PSB employee pays BC employees and amount of $100,000 results in taxed of $25,400. If you somehow find out that your company is might be considered as a PSB, reach out immediately. Follow all PSB income out as wages to avoid any negative tax consequences. To identify early so you can register for a payroll account and start taking wages