It’s never too early to start tax planning, especially if you’re a small business owner. Tax planning is all about flexibility and control, and a small business owner has much more of each than an employee who has few tools beyond charitable donations or RRSPs to keep their tax bill in check.
As a small business owner, you have an extra ‘person’ for tax purposes: the corporation, That corporation has several attributes you can use to your advantage, and the earlier you start planning, the more opportunities you have to minimize the tax you pay.
But it’s not too late to make some tax-smart moves to close out the year. Here are some tax strategies you should consider that will benefit you this tax year and next:
If your business is profitable as you approach your fiscal year end (and for the purpose of this article we are assuming a December year-end, but the concepts apply to any year-end), then you want to incorporate as many expenses and deductions as you can into the current year and push off as much income as you can to the next year. For example, you may want to consider giving yourself a bonus or increase your salary and claim that deduction. The same applies to family members who worked in the business. Make your charitable donations before December 31 and let your company make your RRSP contribution for 2011 on your behalf directly to your RRSP. You don’t have to withhold any tax. Deduct, deduct, deduct.
If you know you are planning to purchase equipment or other assets in the near future, you may as well buy them now before year end. Thanks to the tax depreciation rules, you can deduct six months’ depreciation on the asset – regardless of when in the year you buy it.
Are there any receivables you don’t feel you’ll be able to collect? If so, you may want to take a provision against them and claim it as an expense now to bring down your net income instead of waiting until it actually happens. Is there any inventory that is over-valued? You may want to write that down sooner rather than later.
If the business is losing money, the opposite applies: you’ll want to push expenses into next year and bring income into the current tax year. As well, if you’ve paid corporate taxes in the last three years, you have the ability to carry this year’s loss back up to three years so the CRA pays you.
During the year you’ve likely been drawing a salary. If you’ve lost money and don’t need the deduction, it may be better to take dividends instead. You’ll be taxed at a lower rate. In fact, January is the perfect time to develop a compensation strategy for yourself that can serve as a tax-saving tool for the coming year. You’ll need two pieces of information: how much money the business is going to make and how much you need to support your lifestyle.
Our tax system is set up to encourage small business owners to reinvest in their business because that’s what drives the economy. If you don’t need the money to live, you pay less tax by leaving that money in the corporation, which then gives you the opportunity to either reinvest it to grow the business or to pay debts in the business or to invest in real estate or securities to grow your wealth.
An effective compensation strategy should tie into your corporate structure. Is your structure such that you have the ability to split income with your spouse, your children, your parents? For example, depending on the province you live in, you can pay someone who has no other income about $30,000 in dividends without them having to pay tax on it. By paying your adult child who doesn’t work in the business that money in the form of dividends, you can fund their education in a way that’s tax advantageous to the whole family.
What’s your long-term view on the business? Are you going to grow it and sell it? Do you want to pass it on to your children? Asking and answering these questions will dictate how you want to structure your shareholders. For example, a $750,000 capital gains exemption is available to every Canadian shareholder. If you sell your business for $3-million and you are the only direct shareholder, then only $750,000 will be tax exempt. If, on the other hand, your spouse and two children are also shareholders, then each of you can claim a $750,000 capital gains exemption, bringing your tax on the sale to little or nothing.
That’s why planning and planning early with an eye to the future is so important. What assets are you going to buy? What expenses are you going to write off? Will you take a salary or dividends? It becomes much easier to make decisions when you plan – and an effective tax plan can lead to significant savings and put you in control.
Jason Safar is a tax partner with PricewaterhouseCoopers