Personal services business: when incorporating costs more than employment

Current to September 11, 2026.

Incorporating is often the right answer. Where it goes wrong is when the corporation exists mainly to hold a relationship that would otherwise be employment.

The personal services business rules address a specific arrangement: an individual provides services through a corporation, and but for that corporation, they would reasonably be regarded as an officer or employee of the party paying. The corporation is not treated as a genuine business for these purposes.

How the rules apply

A corporation found to be a personal services business loses the small business deduction and the general rate reduction, the two provisions that bring corporate rates below the full federal rate. It also pays an additional federal tax on that income. Just as significantly, the deductions available to it are sharply restricted — broadly to salary and wages paid to the incorporated employee and a narrow set of related amounts. The ordinary business expenses a corporation would normally claim are not available.

The combined effect is that the structure adopted to save tax can cost materially more than simple employment would have, and the assessment can reach back over prior years.

Where the exceptions sit

There are carve-outs, including where the corporation employs more than five full-time employees throughout the year, and where the amounts are received from an associated corporation. Most one-person consulting corporations meet neither.

What can be done about it

The risk is a function of how the relationship actually operates, which means it can usually be changed.

That may involve restructuring the engagement, revising the services agreement so it reflects and supports genuine independence, broadening the client base, or in some situations accepting employment and pricing it properly. Which of those makes sense depends on facts that are specific to the arrangement, and the exposure is best established before an assessment rather than after one. See tax, the contractor and employee question, and whether incorporating is worth it at all.