Small business enterprises (SBEs) form the backbone of the Canadian economy. While SBEs tend to stimulate economic growth and innovation, they often struggle with controlling cash flow (managing expenses and revenues), which affects each organization’s tax obligation. While no business can avoid paying taxes, effective planning can manage and reduce how much is owed each year.
Understand Your Business
In legal terms, is your business considered an SBE? According to Statistics Canada, an SBE has 99 employees or less. Is your business structured as a sole proprietorship, a general or limited partnership, or a corporation? The most common objectives entrepreneurs focus on are simplicity of operations, flexibility, and protection from risks and liabilities. But many fail to consider how their legal set-up affects their tax obligations.
For sole proprietorships, the individual and the business are considered one and the same. Thus, the net profit is added to the amount earned during the year, which is then subject to federal and provincial tax rates depending on the total amount.
Partnerships aren’t taxed directly; instead, revenue passes through the partners. They must each declare and include their share (depending on the partnership agreement) as personal income. As such, this is taxable using the applicable tax percentage.
Corporations are deemed separate legal entities from shareholders. Revenues are retained by the business until the funds are distributed to the stockholders. The basic federal tax rate is 38% but is reduced to allow provinces and territories room to impose corporate income tax.
Carefully evaluate the structure suitable for your business. Consider incorporating if necessary, especially when the business has grown significantly. It may cost you in the short term, but it may also provide significant savings in the future.
Review with Regularity
Most entrepreneurs focus on overseeing day-to-day operations and only think about taxes when it’s time to file. They don’t realize that tax planning is an ongoing process. Regularly reviewing your income and expenses is one way to stay informed, but consulting an accountant is highly recommended. Business owners can greatly benefit from the assistance of professionals who possess financial, accounting, and taxation expertise.
Keep Accurate Records
The foundation of an effective tax strategy is good and accurate record-keeping. All amounts claimed and reported must be substantiated by receipts and invoices, regardless of value. Properly classify and itemize expenses into different categories (office supplies, bank charges, advertising, etc.). Accounting software like Microsoft Excel can help you summarize the data quickly. Generally, all related forms, reports, records, and documentation must be saved for up to seven years.
Another critical component of record-keeping is separating business and personal expenses. Open and maintain chequing and/or credit card accounts exclusively for the enterprise. This will make it easier to monitor your business finances, as well as individual transactions. You’ll have a clear picture of the company’s situation, without having to manually separate your personal transactions from the ledger after the fact.
Set Up a Registered Retirement Savings Plan
An RRSP is another way of deferring earnings and reducing tax obligations. Any contributions made will lower taxable income and allow an individual to save for retirement. Taxes aren’t paid until the funds are taken out. In the event of an audit, this will properly substantiate all data.
Claim All Deductions
To qualify as a write-off, a deduction must be directly related to the business. Every dollar spent is a possible tax deduction, provided that certain guidelines are followed. For example, meals and entertainment are allowed when meeting a client. To qualify, business must be discussed before, during or after the meal, and it must be conducted in an environment conducive to a business conference.
For home-based businesses, maximize the allowable expenses available. Owners are permitted to deduct a portion of home-related overhead, including utilities, maintenance, insurance, property tax, and mortgage interest. This allowance is calculated by determining the percentage of the work space against the total size of the home. The Canadian Revenue Agency will usually ask for a floor plan to confirm that the estimates are accurate. Furthermore, once a specific area is designated as an “office,” ensure that that section is used for business purposes only.
Personal transportation can also be claimed as a deduction. When using your personal vehicle for business purposes, a certain percentage of operating costs (such as gas, insurance, lease, and repairs) can be written off. Track the total mileage accrued while doing things like visiting customers and attending conventions. This will make it easier to determine the allowable disbursement for the fiscal year.
Defer Your Losses
It is possible that a business might not record a profit for a few consecutive years. Proprietors can use non-capital losses to decrease income tax in any given year. The accepted practice is “three years back, seven years forward,” which means that losses can be carried back as far as three years or carried forward up to seven years.
Put Everyone on the Payroll
If a friend or family member does some work for the business, consider employing them. The remuneration rate should be reasonable based on their duties and responsibilities. To corroborate this, maintain and file the required employee reports, which also include submitting payroll deductions (Canadian Pension Plan, employment insurance, and income tax).
File Taxes on Time
This will allow you to avoid penalties and interest charges. The deadline for self-employed individuals is June 15, but interest begins to accrue after April 30. Remember that every dollar you make is hard-earned. Following these tips will allow you to keep as much of your earnings as possible!
Zaida Ricafrente | Contributing Writer