Option 3: Incorporated Business

A corporation is a separate legal entity, which is formed by application to either the federal government, or one of the provincial/territorial governments. No CPP, EI or Income Tax is deducted from the compensation payments to Contractors' limited companies. No T4 Supplementary form is issued with respect to such payments to Contractors' limited companies. Please consult a tax professional to determine your specific circumstances and eligible deductions.

For Income Tax purposes, the Contractor's limited company must file a separate annual income tax return, reporting all business income. Reasonable expenses can be deducted from income to arrive at net taxable income.
If the annual revenue of the Contractor's limited company exceeds $30,000, the limited company must register for a GST number, and file a GST return periodically with the CRA, as required.

Advantages of Incorporation:

One of the most significant advantages of incorporating a business is limited liability. This means that the liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation. However, many incorporated small businesses are not able to get bank loans without the personal guarantee of the shareholders, so this eliminates part of the advantage of limited liability. The personal assets of the shareholders are protected from lawsuits against the corporation. However, shareholders who are directors of the corporation can be held legally liable for some debts of the corporation (such as GST and payroll taxes) in certain circumstances.
Profitable small businesses also enjoy income tax advantages. A Canadian controlled private corporation, or CCPC, pays a much lower rate of federal tax (small business rate) on the first $400,000 (in 2007) of active business income than would be paid by an unincorporated business, due to the small business deduction. Active business income generally does not include investment income or rental income. The combined federal + provincial small business tax rate varies from approximately 16% to 22%, depending on the province. The threshold amount subject to the lower rate also varies between provinces. Keep in mind that this tax advantage is mainly a deferral of taxes until the profits are paid out to the shareholder. If all the profits are paid out to the shareholder as they are earned, leaving the corporation with little or no taxable income, then they will be taxed entirely as income of the shareholder, at personal income tax rates.
Another tax advantage of incorporation is the $750,000 capital gains deduction on the sale of shares of a qualifying small business corporation. One of the qualifications is that the corporation must be a CCPC with active business income.
Private Health Service Plans can be used to provide tax-free benefits to employees. This deduction is also available to sole proprietors and partners, but the treatment for corporations is more favorable than that for unincorporated businesses. As an incorporated business owner you may deduct any amount of premium cost. However, as a “sole proprietor” you may only deduct $1,500 for your self; plus $1,500 for your spouse; and $750 per eligible child per year from your business income.
An Incorporated Contractor's deductible expenses are not restricted to those allowed to Employees. A Contractor can deduct most expenses incurred to earn income including interest, depreciation, etc. There may also be opportunities for income splitting with family members to reduce overall tax. Again, we recommend you consult a tax professional to determine your specific circumstances.

Disadvantages of Incorporation:

Incorporation is the business structure with the highest setup and administrative costs.
Incorporation is the most complicated business structure. It is very important to take extreme care in setting up classes of shares, deciding who will be shareholders (spouses, children) and how much control they will have (control is determined by % of voting shares owned). Professional advice can avoid serious problems.
Business losses cannot be written off against other income of the owners (shareholders).
More administrative work is required for a corporation. This includes annual reports filed with the corporate registry, and corporate tax returns which are filed separately from the owners' personal tax returns.

Generally, the higher the net income of your small business, the more advantageous it is to incorporate instead of remaining as a sole-proprietor.

No matter what the type of business structure, spouses and children can be employed by the business, thus effectively splitting income. However, amounts expensed must be reasonable amounts based on services provided, and must actually be paid to the spouse and/or children.

An Independent Contractor must normally be registered for GST purposes, collect GST, and file periodic returns. If the contract is terminated, the Contractor is not eligible for EI benefits. As noted above, we recommend you consult a tax professional to determine your specific circumstances.

Liability and E&O issues

Each type of business entity has its advantages and disadvantages. It is wise to seek professional advice to assist in your decision-making, and in the setting up of your business structure. It is also very important to get your accounting records set up and organized properly at the start of your business.
The Canada Business Service Centers provide information related to starting a business.