Does the amount of income tax you paid last year make you shudder? You can't avoid income tax, but there are tax strategies that you may be able to use to reduce the amount of income tax you pay if you operate a small business in Canada.
Read through this list of small business tax strategies and see how many you're currently applying to reduce your income tax bill - and which ones you can start applying right now to reduce the amount of income tax you're going to owe this year. (Note that some of these small business tax strategies only apply to people who are running sole proprietorships or partnerships, who file their income tax using a T1 form.)
1) Always collect receipts for business-related activities.
I'm amazed by how some business people don't bother to get or keep receipts for "little" things. The parking fee on the way to meet a client, the "few" letters you mailed, the bag of coffee you picked up for the office - all these little things can really add up over the course of a year.
Maximize your income tax deductions by collecting the receipts for all your purchases that are or may be business-related, and recording and filing them appropriately. (See Maximize Your Business Income Tax Deductions for more information on handling receipts and specific business expenses.)
2) Manage your RRSP contribution.
The Registered Retirement Savings Plan (RRSP) is The Best Income Tax Deduction for Small Businesses. But that doesn't mean that you should necessarily just make the maximium RRSP contribution every year. Managing your RRSP contribution is a much better small business tax strategy.
Your allowable RRSP contribution will carry forward if you don't use all of it in a particular year, so estimate what your total income for the year will be and then decide how much of an RRSP contribution you should make that particular tax year, if any, to maximize your RRSP's tax bang for the buck. It doesn't make tax sense for you to make a large RRSP contribution in a low income year.
3) Maximize your non-capital losses.
Similarly, if your business has a non-capital loss (defined as when your expenses exceed your income for the business) in any year, consider when you can best use this loss to decrease your income tax bill before you use it. Non-capital losses can be used to offset other personal income in any given tax year, can be carried back three years, or carried forward for up to seven years. It may make more sense for you to carry your non-capital loss back to recover income tax you've already paid, or to carry it forward to offset a larger tax bill in the future than it does to use it in the tax year the capital loss occurred.
4) Maximize your charitable income tax credits.
Charitable donations to registered Canadian charities or other qualified donees earn you tax credits. But are you aware that charitable donations that total over $200 provide you with more of a tax credit because they're assessed at a higher rate? To maximize your charitable income tax credits, consider giving more to the registered charities of your choice this year. If you make $30,000 in income and decided to give only 5% of your income, the fortunate charities would get $1500. (Be aware that non-registered Canadian charities, American charities, and political parties don't count.)
5) Maximize your Capital Cost Allowance (CCA) income tax claim.
Most Canadian small business owners know that instead of just deducting the cost of whatever depreciable property they've acquired to use in their business in a particular year, they need to deduct the cost of the depreciable property over a period of years, through a Capital Cost Allowance claim.
But many small business owners are not aware that they don't have to claim Capital Cost Allowance in the year that it occurs - a tax strategy that you can use to reduce your income tax. The CCA is not a mandatory tax deduction so you can use as much or as little of your CCA claim in a particular tax year as you wish; you can carry any unused portion forward to help offset a larger income tax bill in the future. It doesn't make sense for you to take your full Capital Cost Allowance claim deduction in a year that you have little or no taxable income.
Another aspect of maximizing your Capital Cost Allowance claim is to buy (and sell) your assets at the right time. You want to buy new assets before the end of your fiscal year and sell old assets after the current fiscal year.
Be aware, too, of the 50% rule; in the year that you acquire an asset, you usually can only claim 50% of the Capital Cost Allowance that you would normally be able to claim (and in some cases, the "available for use" rule means that you can't claim Capital Cost Allowance until the second tax year after you acquired an asset).
6) Split your income.
The income splitting tax strategy lets you take full advantage of the marginal tax rate disparities. The higher your income, the higher your marginal tax rate. By transferring a portion of your income to a spouse or child, a person with a lower income, you can reduce the marginal tax rate on your income.
This is an especially powerful tax strategy for small business owners with children of post-secondary school age. Suppose that you employed your 19-year-old daughter in your business, paying her a salary totalling $10,000. Because of the basic personal income tax exemption, she would pay very little income tax, and would have a nice nest-egg to help pay for her education. (If you paid her an income equalling the personal income tax exemption, she would pay no tax at all!) And meanwhile, you've "lopped" $10,000 off your income for the year, decreasing the amount of income tax you personally owe. See Decrease Your Income Tax Bite With Income Splitting to learn more about this tax strategy.
7) Take full advantage of the income tax deductions available to home-based businesses.
Do you operate your business out of your home? If not, what's stopping you? While not every business is suitable for a home-based business, home-based businesses do have advantages when it comes to income tax. Besides the Business Use-Of-Home Deduction, home-based business owners can deduct a portion of many home-related expenses, such as heat, electricity, home maintenance, cleaning materials and home insurance. If you own your home, you can also deduct portions of your property tax and mortgage interest. Home Business Tax Deductions will give you more information about these potential income tax deductions.
8) Incorporate your business?
One reason many sole proprietors and partners incorporate their businesses is because of the tax advantages of incorporation. The best known of these tax advantages is the Small Business Tax Deduction, whereby the income of qualifying Canadian-held corporations is taxed at a special "reduced" rate. For Canadian-controlled private corporations claiming the the small business deduction, the corporate net tax rate is 11% as of January 1, 2008. For other types of corporations, the corporate net tax rate is 19.5% as of January 1, 2008.
However, incorporating your business as a tax strategy will only be effective if your business has grown enough for incorporation to be worthwhile. You not only have to have a significant income already to offset the costs of incorporation, but need to be prepared to leave enough of your business earnings in the corporation to benefit from corporate tax deferral.
For instance, if you operate an incorporated business and the corporation's profits in a given year are $60,000, but you take $60,000 from the corporation in salary, your $60,000 is then taxed just as your personal (T1) income would be now, making incorporation for this reason pointless. Should You Incorporate Your Small Business? gives more information about the general advantages and disadvantages of incorporation.
Start Reducing Your Income Tax Today
While not all of these tax strategies will work for every small business, hopefully this list has gotten you thinking about tax planning. The amount of income tax you pay is not an absolute written in stone. There are legal, sometimes simple things you can do to decrease your income tax bill - small business tax strategies that you can start applying today.