Tax Planning a Year-Round Activity

By JoAnne Sommers

The June 15 deadline for self-employed Canadians to file their income tax returns is rapidly approaching but it’s not too late for entrepreneurs to consider money-saving tax strategies, says Mark Shoniker, director of commercial banking at BMO Bank of Montreal. In fact, notes Shoniker, in order to derive the greatest benefit from your tax planning efforts you should be thinking about them on a year-round basis.

“Small business owners need to take a holistic approach to tax and retirement planning in order to wind up with a lower overall tax rate and a good diversity of income when they retire,” he says.

Tax planning should be part of your overall financial plan, agrees Adam Salahudeen, senior manager of taxation advisory services at Scotiabank. Rather than filing your taxes and forgetting about them it’s wise to think about how to make the most of your tax deductions throughout the year, he says.

A variety of tax-planning opportunities are available to help small business owners boost their bottom line. Here are some to consider:

Income Splitting
Family-run businesses can take advantage of income splitting by hiring a spouse or children as employees. They earn income while you get to use their wages as a tax deduction.

“Many small business owners think it’s verboten to have family members on the payroll but provided their compensation is market-driven and they’re performing an actual service, it’s a great way to split income among several people at lower tax rates,” says Shoniker. “The keys are to ensure that their pay is reasonable, their roles in the company are clearly defined, and their performance is well documented.”

• Incorporation
Consider whether or not to incorporate your business. Sole proprietorships are advisable when you’re starting out because you may be facing losses and you’ll want to be able to deduct them against your other income, says Salahudeen. You can’t do that when you’re incorporated.

According to Adrian Mastracci there are two main reasons to incorporate: the first is to protect your personal assets from creditors; the second is to take advantage of the small business tax deduction, whereby the income of qualifying Canadian-held corporations is taxed at a special “reduced” rate. The combined corporate tax rate on the first $500,000 of active business income can be as low as 10.5 per cent, depending on the province, compared with as much as 50 per cent if you file as a sole proprietor, says Mastracci, portfolio manager with KCM Wealth Management Inc. in Vancouver.

Remuneration Options
Small business owners who have incorporated have greater flexibility in determining how they will be compensated. Their options include paying themselves a salary, dividends, or both. According to BMO, a reasonable salary can create personal RRSP room, provide a business deduction and help bring taxable income below the $500,000 threshold for the small business tax deduction. On the other hand, a dividend may be taxed at a lower rate for the owner than a salary or bonus would be, but would not be deductible for tax purposes.

“Review your personal compensation and that of other family members,” advises Mastracci. “A blend of salary and bonuses totaling $125,000 in 2011 creates the maximum RRSP room for 2012.”

• Capital Gains Exemption
When you sell your business, you are entitled to a lifetime capital gains exemption of $750,000 on qualified small business corporation shares. If your spouse, or children through a family trust, own shares in the corporation, you effectively increase the number of exemptions accordingly.

“When you set up your business make sure to create a share structure that will allow you to maximize the capital gains deduction,” says Shoniker. “The first $750,000 of capital gains accrue to you tax free and since you and your spouse are both eligible for that you can get up to $1.5 million tax free.”

Some rules apply, including a requirement that the claimant must have owned the shares for at least two years before selling, notes Mastracci.

• Work with a Professional
It’s important to work with an expert, such as a chartered accountant and/or tax advisor, to take full advantage of the deductions available to you, says Salahudeen. “This is one area where you really need professional help,” he says. “Besides, you don’t want to take time and energy away from your business to do your taxes.”

Adds Shoniker: “Smaller accounting firms can be very helpful with this. Find someone who knows how the tax rules apply to your business because there can be major financial consequences for you now and in the future.”

Note: while self-employed Canadians have until June 15 to file their tax returns, any tax owing to the government was due to the CRA by April 30.

For further information on tax-planning strategies for small business owners, visit BMO SmartSteps for Business(TM).