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Best Business Income Structure, USA vs Canada

Hi Nicolas,

We are returning from the USA to Canada for the school year, due to COVID, the goal is to return to Brooklyn in summer 2021 but we’ll see (we will have fun when the time comes for several years of taxes it looks like). J.’s job will provide her a new work contract, as a self-employed worker. Since her income is quite large, we would like to declare it all in a corporation (which is OK from the employer’s point of view).

We want to open a single new company in our two names and use it for each of our contracts (me for writing / consulting – and her for her consulting contract) and even for other investments? I’m going to shut down my own company so we’re just going to put everything in one place.

From a tax / legal perspective – is there any reason not to do this? (and do sole proprietorship instead?)

Thank you,

Mr. S.

Hello Mr. S.,

The answer is really complex and I can only highlight the main aspects / impacts, but to make a real decision, it will take a larger discussion because it depends on a lot of factors.

The first angle to analyze is to determine your residency status when you return to Canada. From a Canadian point of view, are you coming back to settle in Canada or are you only here temporarily (therefore potentially non-residents of Canada)? Will you have housing available in Canada, will you also have one in the US? If we calculate the “substantial presence test”, will you be considered tax residents in the USA? What does the tax treaty say based on your answers to these questions, etc. Once these questions have been answered, only then can we determine the real impacts of using a company.

If you are considered U.S. tax residents:

  • Canadian company: not recommended due to lack of integration with the American system. Withholding tax if dividends to US shareholders + US tax forms to be filed (5471).
  • USA company: generally more complex to set up and administer and more expensive in taxes than direct operation as a self-employed worker.
  • Sole proprietorship: it is more or less self-employed income. The simplest structure and the one that will probably generate the smallest tax bill.
  • LLC flow-through: makes it possible to establish itself as an independent contractor, but adds legal protection (corporate veil like a company). Tax efficient but a little more structured than self-employment (but less than a company).

If you are instead considered tax residents of Canada:

  • Canadian Company: a good option for active business income but a less good option for passive income such as investments. No tax savings on the other hand if you use all the cash generated by the company to pay your personal expenses. Legal and accounting costs related to the incorporation and maintenance of this company.
  • USA Company: not recommended due to lack of integration with the American system.
  • Sole proprietorship: it is more or less self-employed income. The simplest structure. Recommended if you will be using all the cash generated by the business.

Closing the old company: be careful, when you close a company, there are deemed dispositions of the assets that are in the company, and then there is also a dissolution dividend. All these impacts have a tax cost and significant administrative formalities that depend on your residence status.

Change of residence status: every time you change your residence status, there are significant tax impacts in relation to your business structures. What may seem like a good idea depending on a tax status quickly becomes a nightmare when changing status.

Other investments: the nature of the income (assets = business vs liabilities = investments, investments) greatly changes tax rates, administrative formalities, etc.

Given the complexity of the situation, I believe that a videoconference consultation would be necessary to recommend the right structure to you. There are so many factors to take into account that it is impossible for me to give you a clear recommendation, especially since it also depends on your tax residency status.

See you soon,

Nicolas Godbout, M. Fisc., Pl. Fin.

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