Tax Tips for Business Owners
James Schofield - May 24, 2023
Unfortunately we can't eliminate taxes, but we can mitigate or defer them through wise business practices. Here's a few.
As an entrepreneur, dealing with the day to day operation of your business and planning for the future, consumes a lot of your time. Though you may put taxes in the perpetual “I’ll get to it later bin” the reality is that they are probably more important than many of the day to day tasks you work on. Effective entrepreneurs are the ones who are able to bypass the urgent, not important tasks in favour of the important, but not urgent items like taxes
As you review the strategies below, consider how you may be able to apply them to you and your business.
Employ your spouse and children.
Whether you carry on your business personally or through a corporation, you should consider paying a salary to your spouse and/or children.
Canada’s progressive tax system, which assesses high income earners with higher tax rates, provides an incentive to split income with family members in a lower tax bracket. Paying a salary to a spouse and/or child who pays tax at a lower rate than you can create net tax savings. But you must ensure that the salary is reasonable for the services they perform for the business.
Incorporate your business
If your business produces more profit than you require to satisfy your personal cash flow needs, then incorporation could produce a sizeable tax deferral by accessing the lower small business tax rate for active income. This deferral benefit, however, is only available if the profits are left in the company. The longer the profits are left in the company, the larger the tax advantage. It is important to note that investment income and rental income do not receive this lower tax rate as these are considered passive income sources.
If you eventually sell shares (not assets) of the business and are eligible for the lifetime capital gains exemption (LTCGE) the tax deferral can become permanent. You can multiply the LTCGE by including family members as shareholders. There are other ways of splitting corporate income with family members, including paying out dividends to family members who are taxed at a lower rate and receive creditor proofing from the limited liability. We can help determine which strategies work with your situation.
Invest excess cash
Leaving profits in the corporation will give you the biggest bang for your buck when it comes to taxes, but then the question becomes what to do with those profits. If repaying debt or reinvesting in the business operations are not options, then a smart investment plan is your best alternative. When choosing investments for the excess cash inside the corporation, you should abide by the principles of sound asset allocation, and diversification, the same way as you would with personal investments.
Plan for your retirement
To make the maximum allowable Registered Retirement Savings Plan (RRSP) contribution next year, you will need to create the contribution room this year by maximizing reported earned income. If incorporated, you will want to review the best dividend/salary mix for your situation. As part of your overall plan, you may also want to contribute to your TFSA. Talk to us about achieving balance in your personal investment plan given all the variables and how it will fit with this year’s maximum contribution limits for business owners
Do not forget to think about RRSP contribution room when setting and reporting remuneration for services provided by family members who also work in the business.
We also recommend that incorporated business owners explore an individual pension plan (IPP). An IPP is ideally suited to business owners in their mid-forties or older who have a history of earning employment income from their company more than $150,000 per year. An IPP will allow you to shelter even more earnings from tax than your RRSP while still offering some protection from creditors.
Prepare for the sale of your business
It is never too early to plan your business exit strategy. If you are planning on selling all or part of your business at some point, confirm with your Accountant that you are eligible for the small business lifetime capital gain exemption. Because it may be necessary to undertake a reorganization of the corporate structure, you should discuss the structure well in advance of the expected sale.
Make use of R&D expenses
Expenses related to research and development activities incurred to develop and enhance your products and production processes, may qualify for valuable tax incentives in the form of refundable and non-refund- able tax credits. While the guidelines governing program eligibility can be complicated, a wealth of information is available at the Canada Revenue Agency to help you assess your eligibility for the program.
Unfortunately, we cannot eliminate taxes. But we can use wise business practices to minimize or defer income taxes that would otherwise be payable. These are only a few of the tax-planning opportunities applicable to business owners. Talk to us about a complete tax check-up to help identify all the tax planning strategies available to you.
The tactics you employ today will help you reap rewards at tax time next year.