Many Canadian small business owners spend a fair bit of time in tax season combing over their tax returns looking for potential income tax deductions. But strangely, many small business owners neglect the best income tax deduction - the Registered Retirement Savings Plan (RRSP).
If you run a sole proprietorship or partnership in Canada, your business income is all or part of your personal income, and you file your income taxes using the T1 form.
The Registered Retirement Savings Plan or RRSP is the best income tax deduction for unincorporated businesses because:
1) An RRSP shelters your income from tax. Whatever you put into your RRSP will not be taxed as income until you take it out - and that goes for whatever interest you make on the investments you hold within your RRSP.
2) Your RRSP contribution is deducted directly from your income. It comes off the top, so to speak - meaning that it reduces your taxable income. And if the amount of your RRSP deduction drops you down a tax bracket, it can provide you with considerable tax savings.
3) You can carry forward your contribution room. This is perhaps the best thing about the RRSP tax deduction for Canadian taxpayers running small businesses because it gives you some control over how much income tax you pay. Many small businesses have up and down years, income-wise, and being able to make a larger RRSP contribution in a year when your income is high can really be beneficial.
To do this, of course, you have to have contribution room. You can find out what your personal maximum RRSP deduction limit is by calling the Canada Revenue Agency (CRA) TIPS service at 1-800-267-6999, by going directly to your CRA account (their My Account service) or by looking at last year's Notice of Assessment statement the CRA sent you.
For the 2013 tax year, the maximum allowable RRSP contribution is $23,820. (This amount will increase to $24,270 in 2014.)
But suppose that you only took out a $5,000 RRSP last year (tax year 2012) when the maximum deduction limit was $22,970. That would give you an additional $17,970 in RRSP contribution room, for a total of $41,790 in 2013!
Now it's not quite that simple, of course. Not everyone qualifies for the maximum deduction limit. The maximum RRSP contribution that you personally can make in any given year is tied to your earned income; you may contribute up to 18 percent of your earned income in any given tax year (or the maximum annual RRSP contribution limit for that tax year, whichever is lower).
But still, if you can forecast your probable income for a year partway through, you can manipulate the RRSP contribution you make in any given year to provide real tax savings.
If you don't have the funds to maximize your RRSP contribution and take full advantage of this income tax deduction, you should consider borrowing. While the interest expense is not deductible, the benefits of maximizing your RRSP income tax deduction may outweigh the costs involved.
You Don't Have to Wait
Judging by the yearly February and March rush, another thing that many people don't realize about this valuable income tax deduction is that you don't have to wait until "RRSP season" to make an RRSP contribution. The earlier in the year you make your RRSP contribution for any given year, the better off you'll be. Compound interest means that you'll end up with a lot more money in your RRSP if you contribute early.
If you have sufficient earned income to allow you to make an RRSP contribution, you definitely should. The deadline for RRSP contributions for the 2013 tax year is March 3, 2014 (as March 1 falls on a Monday this year).
For more information on Registered Retirement Savings Plans, you may wish to visit the RRSP section of the Canada Revenue Agency website - or talk to your financial advisor or accountant.