The distinction between a personal services business vs professional corporation lies primarily in their definitions, tax treatment, legal obligations, and business operations.
Personal Services Business (PSB)
A PSB is generally created when an individual provides services to a client through a corporation, but the relationship is akin to that of an employee-employer relationship. It’s sometimes referred to as an incorporated employee.
Characteristics:
- The individual providing services through the corporation might otherwise be considered an employee if not for the corporation.
- The corporation has few employees (other than the principal shareholder).
Tax Implications:
- Higher tax rates: Income from a PSB is taxed at a significantly higher rate than active business income. PSBs cannot claim the small business deduction in many jurisdictions (e.g., Canada).
- Limited deductions: PSBs can only deduct expenses that would be allowed to employees (e.g., travel or supplies), restricting tax planning flexibility.
- Personal liability risks: The principal individual can face personal liability depending on the nature of the services and contracts.
Personal Services Business Benefits
- Sometimes used for contractual flexibility, but overall it’s not tax-efficient.
Key Considerations:
To avoid being classified as a PSB, ensure:
- There is no direct control by the client (you have autonomy over your work).
- The business has multiple clients.
- You provide tools, equipment, and resources for your work.
Professional Corporation (PC)
A Professional Corporation is a legal structure available to specific regulated professions (e.g., doctors, lawyers, accountants, engineers, etc.), often dictated by the regulatory body of the profession.
Characteristics:
- The corporation is owned and operated by members of the same profession.
- It must comply with specific rules set by the professional body (e.g., naming conventions, ownership, and practice restrictions).
Tax Implications:
- Access to lower tax rates: PCs often qualify for small business tax rates, making them more tax-efficient.
- Income splitting opportunities: PCs may allow income to be shared with family members (where permitted).
- Tax deferral: Earnings can be retained in the corporation for investments, deferring personal taxes.
Professional Corporation Benefits
- Limited liability protection: While liability for professional negligence remains, PCs offer protection for general business liabilities.
- Enhanced tax planning: PCs provide opportunities to manage income and retirement savings (e.g., through dividends or pensions).
Key Considerations:
- Ensure the profession permits incorporation and adheres to rules regarding ownership and practice.
- Keep in mind that income earned through a PC is still subject to the same professional standards as if earned individually.
Comparison Chart
| Feature | Personal Services Business (PSB) | Professional Corporation (PC) |
|---|---|---|
| Tax Rate | Higher | Lower (access to small business deduction) |
| Expense Deductions | Limited to employee-like expenses | Broad business deductions |
| Control Over Work | Limited (client often has control) | Full autonomy over operations |
| Liability Protection | Limited | Limited liability for business operations |
| Suitability | For incorporated employees | For professionals in regulated industries |
Professional Corporation Tax Rate Ontario
In Ontario, Professional Corporations (PCs), like other Canadian-controlled private corporations (CCPCs), benefit from the small business deduction (SBD), which applies to the first $500,000 of active business income. This income is taxed at a combined federal and provincial rate of approximately 12.2%. Income exceeding this threshold is subject to the general corporate tax rate of 26.5%. It’s important to note that the SBD is gradually reduced for corporations with taxable capital between $10 million and $50 million, and is eliminated for those exceeding $50 million. Additionally, certain passive income levels can affect eligibility for the SBD. Professional Corporations should consult with tax professionals to understand how these rules apply to their specific circumstances.
What are The Disadvantages of Setting up a Professional Corporation
Limited liability while PCs protect against general business liabilities, they do not shield against professional negligence or malpractice. Regulatory restrictions PCs must comply with strict rules set by professional regulatory bodies, which may limit ownership, services offered, and naming conventions. Costs incorporating and maintaining a PC involves setup fees, annual filing requirements, and accounting/legal costs. Tax complexity while PCs provide tax advantages, managing these benefits requires careful planning and compliance with tax laws. Restrictions on Losses business losses cannot be used to offset personal income, unlike in sole proprietorships. Distribution restrictions PCs may have limits on income splitting or dividends based on regulatory and tax rules.
Frequently Asked Questions For Personal Services Business VS Professional Corporation
Is a professional corporation a personal services business?
No, a Professional Corporation (PC) is not classified as a Personal Services Business (PSB), as PCs typically provide services through regulated professionals and are not treated as incorporated employees.
What is the difference between a corporation and a personal business?
A corporation is a separate legal entity offering liability protection, distinct taxation, and ownership through shareholders, while a personal business (e.g., sole proprietorship) is owned and operated by an individual, with no legal separation between the owner and the business.
How do you avoid being classified as a PSB?
To avoid being classified as a Personal Services Business (PSB):
- Work with multiple clients.
- Maintain control over your work (no client supervision).
- Provide your own tools and equipment.
- Avoid relationships resembling employee-employer setups.
- Hire employees or subcontract work.
What is the difference between business and professional CRA?
- Business Income: Earnings from commercial activities, like selling goods or general services.
- Professional Income: Earnings from regulated professions (e.g., doctors, lawyers) requiring specific qualifications and adherence to professional standards.
What are the disadvantages of setting up a professional corporation?
- Regulatory Restrictions: Must comply with professional body rules.
- Complexity: Involves higher setup and ongoing maintenance costs.
- Limited Liability Protection: Does not protect against professional negligence.
- Tax Rules: May require complex tax planning.
- Income Splitting Limits: Restrictions on how income can be distributed.
