You don’t have to be a professional number-cruncher to save big on tax dollars. Whether you prefer hands-on work under the hoist or the entrepreneurial side of your business, a four-point inspection could save tax dollars and help you plan for greater prosperity.
As you consider each of the four points you may also want to ask: What are my best choices longer-term? How will choices related to business, employee-related, and personal taxation as a whole influence my ability to build wealth? What factors other than tax do I need to consider as I plan for greater prosperity?
1. Minimize taxes by maximizing all reasonable business-related expenses.
“Ensure the expenses are accounted for and deducted,” says tax partner Karen Wilkinson from Deloitte & Touche. “You want to pay the least tax so you’re retaining those dollars to grow your business and personal wealth.”
Routine maintenance tip: keep all receipts throughout your business year, with a description of each purchase. This will simplify tax time, and can help prove your case to the Canada Customs and Revenue Agency (formerly Revenue Canada) if necessary. Remember to retain all records for a minimum of six years.
Consider placing funds in a Registered Retirement Savings Plan. All contributions up to your personal limit are 100% tax-deductible, and are tax-sheltered as long as the money stays in the plan. Even borrowing to reach your maximum RRSP contribution generally has long-term benefits outweighing loan interest, according to the Investors Group guide, Small Business: Financial Planning For The Owner Of The Business. A spousal RRSP contribution can reduce your tax burden even further.
You may also want to hire your spouse or children if they can provide legitimate service to your shop. “There are considerable benefits to hiring a family member,” says Lorne Dubros, associate regional director at Investors Group. “More money can stay in the family and you can use the labour cost as a deduction.”
This ‘income-splitting’ technique allows for greatest tax savings when the family member’s income is less than your own and they can take advantage of the lowest personal income tax rate. But remember that even a family member must be paid fair market-value wages according to income tax rules, says chartered accountant David Gray.
“When a family member is not providing services and you want to split income, it has to be done by dividend (owning shares). Yet to transfer shares to them, you have to be careful about attribution rules, which are being tightened up.”
Do you maintain a home office space strictly for earning business income and do you meet with customers in this space? You may be eligible to deduct home office-related expenses, says Stephen Thompson in Beat The Taxman! These may include a portion of mortgage interest, home insurance, heat, electricity, water, property taxes, maintenance and repair plus other house expenses.
If your personal vehicle is used for business, you may be eligible to deduct the business portion of “gas, oil, license and registration fees, insurance, maintenance and repairs, leasing cost or depreciation (Capital Cost Allowance) and interest costs if you borrowed to buy the vehicle.” Be sure to keep all receipts, and a logbook of business kilometres or odometer reading from the start and finish of your business year, advises Thompson.
There are other expenses that can be deducted such as interest on money you borrowed to lend to your shop. There are also techniques other than expenses for reducing tax. A professional advisor can assess your individual situation.
2. Pay yourself in a way that minimizes tax and that fits your needs and financial goals – choose either salary or dividend.
“A salary is probably the best choice if you’re trying to build your RRSP, allowing you to maximize your annual contribution limit,” says David Gray. The downside with a salary is that you must pay RRSP and Canada Pension Plan contributions. And because of shifts in our (aging) population, the CPP may not have enough money to pay you by the time you retire.
“Corporate tax rates are [lower than personal rates and] falling, so dividend is the favoured option. But it’s best to check with your advisor,” says Gray. An active small business with income below $200,000 will pay just under 20% for 2001 and about 17% by 2005. Compare this to personal income tax rates which now vary from 21.9% up to 46.4%! Keep in mind however that dividend payment does not provide for a pension contribution. And not showing a salary may also affect your ability to qualify for a mortgage, personal or corporate loan.
Note that if you used personal funds to start your business, that money can also be returned to you as another payment option, tax-free.
3. Consider the long-term picture for you and your shop, and prepare a clear financial plan.
“What are the prospects of my business to maintain its current level or grow?” says Wilkinson. “What are my personal cash flow requirements? Do they jive with my company’s prospects?
“What are my retirement plans? Do I plan to sell the business to finance my retirement?
“All stages of life have an impact on how you bring a coordinated plan together – are you younger with a growing family… or thinking of retiring?”
Begin your personal plan by deciding how much money you would like to have – set a target ‘net worth’ and a timeline to earn it. Next, calculate the income level that will allow you to meet your current needs and to achieve this net worth. “Budget to spend less than you earn, save the difference and invest it wisely,” says Gray.
The business plan? Start by paying yourself first. Make sure your shop’s income is greater than all expenses including your own pay, advises Gray, adding “you will need enough cash flow to finance inventory and accounts receivable.”
The less you spend on taxes, the more value you have to grow your business and your personal wealth.
4. Finally, hire a professional advisor.
“I’m biased toward accountants because of their knowledge of tax,” which a Certified Financial Planner may or may not have, says Wilkinson.
Gray says some of the best referrals will be other service station owners. He suggests talking to three advisors, then choosing one who understands both your business and personal circumstances… and who fits your communication style. “Some consultants are clear and concise and give commands, while others are soft and mushy, give guidance and let you decide. Which style do you need to be successful?”
Jeff Hutton helps businesses market their products and services in print and on-line. He can be reached at (519) 763-7262 or by e-mail: firstname.lastname@example.org.