Independent consultants in Canada will often incorporate their practice in order to offer some liability protection not otherwise achieved through a sole-proprietorship structure. From a Canadian income tax perspective, the incorporated consultant will often make the choice between compensating himself by way of salary or receiving dividends from the corporation. In addition, many year-end corporate accounting and reporting decisions are made relying on Canada Revenue Agency administrative positions.
The moment the consulting activity enters the United States (or any other foreign country for that matter), one should carefully consider a number of issues before embarking on the project, including:
- The type of “structure” one chooses can dictate the amount of US income tax returns required to be prepared. The level of overall US tax may vary greatly depending on the choice of structure.
- The method of compensating the employee / shareholder may not be an easy decision as an individual’s normal method chosen may create a higher US tax liability.
- The length of the employee’s physical presence in the US can impact the taxation not only of the corporate employer but also the employee. In a worst case scenario, extensive time in the US by the employee can trigger US personal residency and create extensive US personal tax reporting requirements.
Certain changes to the Canada-US Income Tax Convention which took effect in 2010 were designed to make it harder for consultants to avoid US federal taxation. The impact to consultants working across the border has been significant by triggering US federal taxation which may have been previously avoidable.
State and local tax authorities often have much lower filing thresholds, triggering the need to file US state and local income tax returns. However, such obligations can accidentally be overlooked if it is thought that no US federal tax liability exists.
With corporate tax rates in the US significantly higher than in Canada, the decision to retain US profits inside the corporation could trigger US tax payable at rates approaching close to twice the amount in Canada once US state and local income taxes are considered. This incremental US tax can represent an additional cost which may not be recoverable.
If a decision is made to pay the consultant-employee a salary, it is important to understand that such salary is subject to US wage reporting rules and US personal tax reporting. While this may create additional personal and corporate tax compliance, it may result is in a more balanced Canada-US income tax situation.
At the end of the day, one should not mind paying US personal or corporate income tax as long as one receives a full credit back for such US taxes in Canada. Where the US personal or corporate tax exceeds the amount otherwise payable in Canada, then the additional US tax will represent an incremental cost to the project.
One of the most important tasks to undertake during the project is to monitor and track the days of presence in the US both related to the business/consulting days as well as personal vacation days. As an individual tracks those US days, he/she must be sure to count any part of a weekend or travel day in which they are physically present in the US. One needs to be mindful as one approaches 183 days in the US in any 12-month period beginning or ending in the year. Extensive US activities in 2013 may actually impact the 2012 tax year as well, just when one might have thought the limited 2012 US activities had no implications.
Lastly, in addition to income tax issues, an individual should also consider social security taxes and whether the Canada-US Social Security Agreement may apply. We recently posted a blog entry on this subject titled Canada-United States Social Security Agreement.
While the US may offer plenty of consulting opportunities, it is important that the various cross-border federal, state and local income tax issues be considered before an individual undertakes such work physically in the US. A little upfront tax planning work will go a long way to making the US project a smoother, more profitable and hopefully headache-free experience.
Written by Daren Raoux, CA, CPA