For many years, some corporations have considered hiring independent contractors instead of employees. This strategy eliminates the tax liabilities for employers regarding employment insurance (EI) and Canada Pension Plan (CPP). Hiring contractors also enables companies to increase business flexibility, restructure quickly during periods of economic downturn and attract skilled contractors through attractive compensation packages.
Contractors benefit from potential tax advantages as well. Because of lack of payroll deductions and allowable business expenses, a contractor may enjoy a higher after-tax income when compared with an employee. The tax benefit is further increased when the contractor uses a corporation to contract his/her services. If the contractor’s corporation is eligible for the small business deduction, there is a significant tax deferral on income taxed inside the contractor’s corporation. The top personal income tax rate in Alberta is 48%, whereas the tax rate for income eligible for the small business deduction is 12.5%. Therefore there is a tax deferral of 35.5% each year for income retained and taxed inside the contractor’s corporation. If the contractor has a low-income earning spouse, including the spouse as a shareholder of the contractor’s corporation would result in further tax savings in addition to the deferral opportunity.