78 – Self Employed Individuals and Income Tax Implications

Wayne Kay 00:04
Welcome to the Debt Matters podcast where we help Canadians find solutions to their debt with Licensed Insolvency Trustees from across Canada. 

I’m Wayne Kay and in today’s show we’re going to talk about self employed individuals and income tax implications. Is it better for you to operate a business as a sole proprietorship or should you incorporate into a company? 

If you incorporate into a company and become the sole director of the corporation, what are your responsibilities if you set up a corporation and later you find out things aren’t working out the way you planned and you decide, well, maybe it’s time to shut down the business? Do you personally have to pay all the debts of that corporation or this happens as well? What if you get sued by an angry client and judgment results? What happens then? 

To walk us through this and a lot more, my guest today, Glenn Steiner from Allan Marshall & Associates Licensed Insolvency Trustee with offices in Alberta, New Brunswick, Nova Scotia and Prince Edward Island. Glenn, thanks for being on the show.

Glenn Steiner 01:10
Thank you for having me, Wayne.

Wayne Kay 01:12
This is going to be a heck of a show because to be talking about self employed people and income tax. We’ve got a lot of information to go over. So small business definitely makes the world go round. You probably have noticed it in Edmonton. The number of people starting businesses is just phenomenal.

It’s just been absolutely wonderful. But I think when it comes down to actually running these businesses, there’s a lot of questions they still have. So let’s just dive in. Sole proprietor versus an incorporated company. Can you explain the difference?

Glenn Steiner 01:51
Absolutely. A sole proprietor is someone who essentially sets up a business. It’s a small business. A good example might be a guy who sets up a landscaping business. You don’t really need a corporation because you’re young, you’re starting out, you’re cutting lawns and doing landscaping and essentially – I want my lawn cut.

You set up a trade name as the sole proprietor landscaper. So it might be Glenn’s lawn cutting service. And you see my ad in the paper, you call me up and say, how much do you charge for your service? I look at your lot and I say, well, it’s going to cost you $150 a month for me to cut your lawn for the month. So a sole proprietorship is somebody where you don’t necessarily have employees. You’re doing it on your own. 

And the key to remember though, is that when you’re making money, let’s suppose you have many customers and as a sole proprietor you’re bringing in $4,000 a month. Well, as a sole proprietor, you are entitled to keep your expenses separate. You’re a business and you want to make sure that you’re acting like a businessman, keeping copies of all your receipts for your business expenses. Because as we all know, CRA will not allow you a business deduction if you don’t have the receipt to prove your expense.

So in a sole proprietorship you want to keep good books and records. But you also have to remember about income tax. You need to set aside income tax as you go along because I don’t know how many times in my career I’ve heard Wayne where somebody says – oh this is wonderful. I made like $50,000 and then come springtime when they file their income tax suddenly they owe $10,000 and they’re going oh my God where am I going to get that from? So you always want to make sure that you’re setting aside money for the tax man. 

Now in regards to a corporation, a corporation is obviously a limited company. A person wants to set up a corporation. Usually it’s fairly large. Usually you have employees. And one of the things that’s good about a corporation is you cannot pierce through the corporate veil. 

So for example I set up Glenn’s Enterprises Inc. And I hire a few people to go into renovations and projects. And the reason why I want to set up a corporation it’s because it’s easier to get WCB. A lot of organizations will not even let you on to the property if you don’t have WCB. So you have employees and as a corporation you have WCB protection and in a corporation you have better tax benefits. 

In a corporation corporate tax is less than in a sole proprietorship whereas in a sole proprietorship you’re paying income tax at the general individual rates like anybody else would.

But there are a lot of advantages to corporations. But one of the strong points that I want to make Wayne to the listeners is that if you’re thinking about going out there and starting up a business do your research. Make sure you understand what the differences are between a sole proprietorship and a corporation. I’ve had people come to me and I’ll ask them what do you operate as a sole proprietor or as a corporation? And they looked at me and said I don’t know.

If you don’t know you shouldn’t really be in business until you know. Those answers are very, very important.

Wayne Kay 05:51
I think a lot of people, what they do is they start out and all of a sudden business can take off very quickly for a lot of different businesses. So then all of a sudden they are starting to talk to people and soon enough they get some employees. 

So that’s kind of – you’d think you did a great explanation of when it’s time to get into an incorporated company but oftentimes that person who started that business still may want to be like the sole director of the corporation.

So what happens then? What are your responsibilities within that incorporated company?

Glenn Steiner 06:22
Well essentially as a director of a corporation you are the CEO and executive director of the corporation. You called the shots. It’s your responsibility as a director to run the corporation as you see fit.

Now obviously you’re going to have a bunch of employees below you and they’re going to be doing some of your duties. But at the end of the day, as a director you’re ultimately responsible for the activities of the corporation. 

If you have employees, anyone who is a director of a corporation knows if you have employees, there’s a term called source deductions. Very important that you understand what that means and what it all entails. So you and I, we work for a company, we get a paycheque.

When you look at your paycheck Wayne, you see income tax deducted, CPP, EI, and what that employer is doing is they’re deducting that money off your and my paycheque. And that is like trust money to the CRA. It is the corporation and directors responsibility that gets to CRA and everything gets put into their corporate account. However, what often happens in corporations is they get this money and they just have a little bit of a tight month. So they’ve deducted money off our income tax, our CPP and our EI off our paycheques.

But they don’t send that money right today because we’re a little short on something else. So they use that money to fund something else and it doesn’t get paid. And then next thing you know you have a large source deduction issue. The other thing is GST. When we talked a little bit earlier about sole proprietorship versus corporation, you don’t have to have a GST if you’re under $30,000 and if you’re just a sole proprietor cutting lawn, you don’t even need a GST.

But in a corporation as a director, you do have to charge GST. And again, those are like trust monies. And if you collect a bunch of GST money, you better be sending that money to CRA cause you’re the director. That money has been given to you in trust to pay back CRA for those monies that you collected.

Wayne Kay 08:47
So as you’re talking, I’m instantly thinking having a good bookkeeper would be critical.

Glenn Steiner 08:53
Oh, it is huge, very huge. It’s very important that you have impeccable records because if you ever get audited, you want to make sure that your books and records are very good, right?

Wayne Kay 09:06
But because of the nature of this show, let’s continue on with that person who started that corporation. And all those things you were talking about, they’re a little bit short. So they didn’t have the money to send in that GST money or the tax money.

And they go a couple of years, things start going sideways and they decide OK, things aren’t working out properly, time to maybe shut down the business. Do they personally have to pay the debts of the corporation or how does that work being that it’s kind of an individual on its own?

Glenn Steiner 09:36
Well, that’s a great question. So a corporation again, it’s two separate entities. So if I set up a corporation Glenn’s Restoration, Inc.

I set up that corporation and it’s a limited company and those debts of the corporation belong to the corporation. Unless I personally guarantee the debt of the corporation, I’m not responsible for the corporate debt. That’s why a lot of people will set up a corporation. 

Another big difference between a sole proprietorship and a corporation is if your corporation does a job and it gets sued and it gets sued for $150,000 and a judgment happens, well that judgment is against the corporation. It’s not against Glenn personally.

And I might have a half a million dollar house and creditors cannot touch my house. My assets are protected. And that’s why people will sometimes set up a corporation to preserve your personal assets. 

If I run as a sole proprietorship and I set my business up as Glenn’s Landscaping and I get sued as the sole proprietorship, my personal assets are at risk. And creditors, if they got a judgment against Glenn, then they could come after my personal assets. So that’s another difference between sole proprietorship and corporation.

Wayne Kay 11:11
And that’s a pretty big one because you’ve got the landscaping business and all of a sudden you wipe out the prized petunia that is worth $25,000. For some reason they come after you personally for that.

Glenn Steiner 11:24
Yup yikes. Exactly right.

Wayne Kay 11:27
The other way at least you get a little protection. They’re going after the company. Very good to know. If the corporation fails there’s no asset to the corporation. How does that work? Does the liability still go against you personally or is it only if you guarantee personal guarantee for the company?

Glenn Steiner 11:48
Right. So what happens in a situation where a company is winding down? At the end of the day, we all know that you can’t get blood from a stone. If the corporation is winding down, it’s no longer a viable business and you decide to shut it down.

Once all the corporate assets have been liquidated, there’s no corporate bank account, all the money has been drained out. If your corporation owes $30,000 in debt, there’s not much that a creditor can do because as I said, you can’t get blood from a stone.

So at the end of the day you will essentially wind your corporation down, letting the creditors know that you can no longer make the payments as they generally become due. And often what happens if there were some personal guarantees from the corporation – what an individual who was a director of a corporation will often do is file either a Bankruptcy or a personal Consumer Proposal with me.

Wayne Kay 12:57
So you obviously are there to walk them through. If they have questions, they have a situation. Always best to reach out sooner rather than later. And your area was really hit hard and you did see a lot of people who started businesses when everything went sideways.

Glenn Steiner 13:14
Right. And let’s face it, there were so many people that were affected when the pandemic hit these small businesses and hairdressing. You could even go get a haircut through the pandemic and all those people that were involved in that industry and the gym industry. 

I don’t know how many calls I’ve had recently where people were affected and at the end of the day, they just couldn’t make a go of things because there was no business. The economy was taking a huge hit for those types of people. The oil patch slowed down. It was a really crazy time, to say the least.

Wayne Kay 13:54
When we look at it, it was like two major whammies in a row that happened for many people in Alberta. What would be your advice? Because you mentioned that there were a lot of bailouts that were kind of happening or they were trying to help Canadians. And still a couple of years later, maybe they still have a huge debt behind them, so they come see you. What are you saying to them at that point?

Glenn Steiner 14:22
Well, again, we go over all of their assets and all of their liabilities. If they’re looking at it from the perspective of a corporation, one of the first questions that I’ll ask the director of the corporation is this just a temporary lull? Is this something that the business is just a slow time and it’s a really harsh year this year? Is your business viable? Do you have the cash flow to survive the low periods of time?

We all know that businesses have peaks and valleys and if you’re down in the valley, can you crawl up the hill when the business comes back? A lot of businesses are seasonal and you keep a skeleton staff maybe on to keep the tire shop open, for example. But at the end of the day, that’s the big thing, is that you have to ask yourself, is the company viable?

Wayne Kay 15:20
It’s probably an uncomfortable conversation. Yes, just to say the least. Any final words of advice here regarding self employed, individuals and income tax implications?

Glenn Steiner 15:33
Well, I do want to talk a little bit about directors’ liability. So if you’re a director of a corporation, Revenue Canada is the government agency that wants to make sure that you are playing by the rules. You remember when we chatted about when income tax, CPP and EI deducted off a paycheque?

Well, that is source deductions, that’s trust money. And in a corporation, because you are the director, you’re ultimately responsible for sending that money to CRA if you do not have a successful business and your business closes down. And remember we talked earlier about well, what do you do if the business closes down?

You cannot be held responsible for the corporate debts unless there’s a personal guarantee. Well, Revenue Canada has the right to raise what they call a director’s liability against directors who did not pay GST and who did not pay all of their source deductions for all of their employee deductions. 

So if you’re a director, make darn sure that your bookkeeper shows you that you’re setting aside money and sending their remittances to CRA, because if they do not, CRA can assess you personally for that amount of money.  

I’m currently dealing with a gentleman right now who has a $30,000 personal liability for source deductions, and he thought that he was scot free, and I said, no, unfortunately, you’re not scot free, because they can raise this director’s liability. 

So I just encourage listeners again, get legal advice, talk to business owners, do your research, because it’s very important that you understand what you’re signing yourself up for.

Wayne Kay 17:30
I really appreciate it, and I think our listeners, too. What a great big topic. Glenn, thank you very much for being on the show today.

Glenn Steiner 17:38
All right, thank you for having us.

Wayne Kay 17:40
Well, thanks again to my guest, Glenn Steiner. And if you want to learn more or schedule a free consultation with Allan Marshall & Associates Licensed Insolvency Trustee, you can go to www.wecanhelp.ca. 

And that’s it for today’s Debt Matters podcast. Make sure you subscribe wherever you get your favorite podcast from. And of course, if you want more information, you can always check out debtmatters.ca
Thanks for listening.