If you are an incorporated employee, you are not eligible to claim the Small Business Deduction (SBD) when filing your income tax.
An ‘incorporated employee’ is essentially an individual who conducts their affairs in the legal format of a corporation, but for all other intents and purposes would otherwise fit the description of an employee.
If you are incorporated and you only have one client, the Canada Revenue Agency (CRA) can deem you to be “an incorporated employee”. At the very least, the CRA may investigate the possibility that you are, vis-à-vis an audit, since the higher tax rates would apply.
Section 125(7) of the Income Tax Act contains a provision to deem a corporation essentially to be an “incorporated employee”.
If your services show that you are classified as an incorporated employee, then the corporation would no longer qualify for the Small Business Deduction (SBD). The corporate tax rate applicable would change from 15.5% to 39.5% on any income reports in that company.
If the Canada Revenue agency conducts an audit and determines you do not qualify for the SBD, you could be facing corporate back taxes of up to 24% of taxable for a minimum of 3 years. Additionally, some expenses previously deducted may also not qualify.
Qualifying for the SBD is not a ‘once-and-for-all’ time item. Each year an examination of the books and records will determine whether or not you qualify.
If you are not sure if you qualify for the small business deduction, schedule a time with your accountant, who is familiar with the topic, to review your books.
Author: Kristopher McEvoy, CPA, CGA