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Discussion Starter #1
I have a friend who wants to help me with my contracts. We live in BC and are trying to setup a configuration that works best when it comes to taxes. What we have in front of us are the following options:

  • Each of us forms a Sole Proprietorship and get paid directly by clients
  • Each of us forms a SP, but I get paid by clients and then pay him for his work
  • We form a Partnership
  • We form a Corporation
  • Other?
I know option 4 has the lowest taxes. But the problem is the dividends which are essentially non-existent because we don't want to leave money in the corporation; we will want to put our after-tax earnings directly into our pockets. I know this registers as debt for the company and we will need to return this money within 3 months, so I'm not sure if incorporating a business is a viable option.

For the purpose of this question we can assume a total income of $120K for both of us.

If liability was not a concern which option would you recommend to save on taxes?
 

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In my view a corporation is unlikely to yield any significant tax advantage and is needlessly complicated if there are no liability issues. A partnership would make the most sense (because that's what it is). There is no particular tax advantage to any of the models you listed if your intention is to withdraw profits immediately.

Whatever method you choose, make sure you document the basis for sharing profits and how you will end the partnership when the time comes. That will save a lot of mess.
 

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If the customer will agree to option 1, then you can bill up to $30k each without collecting and remitting sales tax. It is also the easiest to administer. You will both need a business number if you bill more than $30k.
 

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Liability protection is not very good with corporations since any good lawyer will name everyone personally as well as the corporation thus breaching the corporate wall of protection.

Anyway, you said it wasn't about protection so...

As usual, there is no right answer. Each option has benefits and drawbacks depending on your circumstances at the time...for example, an SP is very useful in the beginning when you have other income and losses, since the losses can be used to lower your total income.

Corporations can be used to control income and has other tax benefits, but cost more to set up and operate.

Being individual entities has advantages if things go wrong and you want to separate.

From a client point of view, some clients prefer dealing with corporations, not the "unprofessional" sole proprietors...more an image bias than anything else.

If you plan to grow beyond $120k/ year, you'll probably want to evolve into something more complex...nothing says you can't evolve later on too. Many people start as SPs then incorporate later on when the profits start getting larger.
 

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Discussion Starter #5
Thanks everyone. There were some good pointers in each and every post. Can someone please breakdown how option 2 would look like? I am assuming I will have to pay him from my after-tax money, and in turn he gets taxed on this transaction. But if I write off his payments as cost will that make this a good option?

Also about the $30K limit; is that per client or per payment?
 

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Option 2 may be a problem..........(unless your partner has other clients)

If you are a sole proprietor and bill the client and then pay your partner, then your partner may be considered as your employee.

Your partner would have no invoices from billing the clients directly, which is a requirement by the CRA for designation as a sole proprietor

As an employer you would have the responsibilities as an employer (CPP, WSIB, EI, Vacation pay, Stat holiday pay, severance pay, overtime)

I suggest you consult the CRA website for information and clarification.
 

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The 30K threshold for collecting and submitting HST is the total business earnings per calendar year.

Also, once you obtain an HST account, you must collect and submit HST on all sales/work as you lose the $30,000 threshold.

I would think Option 1 would be the simplest method.
 

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If you are both independent, other issues can arise...such as him finding better business elsewhere, or you finding a cheaper alternative. There is no "partnership" to bind you two together as it were. Of course, if things don't work out, it's easier to split.

You also need to keep each other separate. Technically, CRA could list one of you an employee of the other (with significant tax and penalty consequences) if you have no other clients and are using equipment from only one company. Being two separate entities may require you to duplicate equipment and supply purchases which may be more expensive than combining into one company. Filing taxes also has twice the costs, you may need lawyers, etc. Of course, these expenses are probably tax deductible. You can have a single client as a company, but make sure you read cra's website to understand what you need to do to be considered a contractor not an employee.

Of course, you'd bill each other and pay with pre-tax dollars (claimed as income/expenses for each company as appropriate).

The gst/HST is a total. You need to file for a number if you pass $30k in a single year (each of you would need one, again double filing, but not double tax).
 

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One wrinkle to watch for is if youy billings are over $30k under option 2. You have to bill GST and your partner does not so you cannot claim input credits for his billings.
 

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If you are truly partners, I would eliminate option 2 from consideration.
There really aren't any tax advantages, and your partner is likely viewed as an employee in the eyes of the CRA in that case, as was mentioned.
 

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Since the OP claimed they were going to make $120k/year it's doubtful that either of them would fall below the threshold, so they may as well both get a gst/HST number and collect/file right from the beginning. I think all this talk about the 30k threshold is just confusing him. There is no savings here for them.
 

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If liability was not a concern which option would you recommend to save on taxes?
Since you want to have all the money in your pockets, presumably in the year which is was made, there is no real tax advantage to any of the set ups. The tax code was set up this way to avoid what you are trying to do. Incorporating does add drag and additional paperwork.
The benefits of a corporation are that you can keep the money in the corp (after paying corporate taxes) and reinvest and don't have to pay the personal level taxes (dividend or income) until you pull it out of the corp. So it's not a tax savings so much as tax deferral on the original earned amount.
 

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Discussion Starter #13
It seems for the assumed income option 1 is the way to go. Thanks everyone for pitching in! I learned a lot.
 

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This question really depends on your personal cash flow needs. A corporation is generally used as a vehicle to defer tax. I would get an accountant to run numbers for you.

On Active business income (consulting work) you can be looking at 15% tax on income 500k or less and if you don't have taxable capital employed of 10 mill.
as a sole proprietorship or partnership, you are still taxed at marginal rates which means at 120k per year you are going to be at the highest tax bracket per year.
 
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