Tax time can be confusing for the average wage earner, but adding on the complication of owning a small business means there’s a whole different set of things to think about.
Beyond just the added bookkeeping burden, there are benefits you can miss and pitfalls you can stumble into if you don’t know what you’re doing.
With the April 30 tax deadline getting ever closer, here are some tips for navigating taxes if you’re a small business owner:
To incorporate or not incorporate?
Many small businesses operate as sole proprietors, which means business income is simply measured as personal income. But if you incorporate, the company becomes a separate entity with its own taxes.
You may think that companies that do this are typically major players in glass towers, but it’s not unusual for a small shop or service business to incorporate, says Bruce Ball, a tax partner at BDO Canada LLP and incoming Vice President at the Chartered Professional Accountants of Canada.
“(The threshold) is not that high … I would say the majority of our smaller retail clients would be incorporated these days,” he says.
Doing so means a higher burden of paperwork and slightly higher costs, but it may be worth it, particularly if you see yourself reinvesting income to expand the business.
“A lot of other businesses want to deal with incorporated businesses as well, especially with services, so that’s something to think about,” says Ball.
Another advantage of incorporating is that it can insulate the owner from liability. If an employee were injuring on the job and decided to sue, they would likely sue the company, rather than the individual.
“That’s one of the big factors in using a corporate structure, it can protect your personal assets,” says Ball.
Leave a paper trail
Small businesses have the advantage of writing off certain expenses, but you have to know what you’re doing. For certain furniture and equipment purchases, you can claim depreciation, which allows you to claim amounts as the equipment ages.
Vehicles used for the business can be claimed, and there are meals and entertainment that can be partially written off if it’s for business purposes.
Just make sure you keep track of your receipts and account for who was at the lunches, says Ball.
“The rule for any deduction is you have to prove there’s a link between incurring the expense and earning income,” he says.
Make it a family affair
Bringing on a family member as an employee can lower your overall tax burden, provided the family member doesn’t have another job that pushes his or her income above yours.
Paying a portion of the profits to a family member effectively splits the income, which might bring you into a lower tax bracket.
But again, remember that the Canada Revenue Agency will want to see evidence that the employee is more than just a way to limit taxes.
“You have to be able to demonstrate that you paid the family member what you would pay a third party,” says Ball. You have to prove that you needed them.”
Figure out how to pay yourself
If you’re a sole proprietor, paying yourself is just as simple as pocketing the profits and claiming it as income. But if you’ve incorporated your business, you have the option of either paying yourself a salary or taking a dividend, which is a payment made directly from the company’s after-tax profits.
Taking a dividend often doesn’t occur to business owners, says Ball, but it can be a way to lower your tax rate, as dividends are taxed less than income. The catch is that they aren’t eligible for government pension plans and don’t count towards RRSP contributions.
Ball says one of the biggest mistakes he sees small corporate owners make is simply taking money from the company as income, without properly accounting for it as salary or a dividend.
“If you just take it from the company, you’re taxed on it as income and it’s taxed as profit, so it gets double taxed,” he says.
And of course, avoid the temptation to be too aggressive in seeking deductions, as you could end up in a disagreement with the CRA. The easiest way to avoid this, says Ball, is to make sure you get legal and accounting help, particularly with an incorporated business.