Small business owners are often worried or confused about making business decisions that affect their financial wellbeing, including how much tax they pay and how they can maximize the value of their business. At Cusimano Professional Corporation, we stay current on all the rules and regulations so that we can best serve our clients. In this post, we have answered the seven most common questions business owners ask us.
1. Should I incorporate my business?
There are two main advantages to incorporating your business.
Protect your personal assets
An incorporated company is a distinct legal entity. That means if anything goes wrong in your business dealings and someone decides to sue you, they can only go after your business — and not your house or other personal assets. Companies can also purchase various types of insurance for further protection. If you have given personal guarantees, you lose the protection of your personal assets. Of course, nobody wants to think their business will fail, but this is one way to give you peace of mind in case the worst happens.
Pay less tax
Corporate tax rates are much lower than individual marginal tax rates. In Ontario, for example, once your taxable income exceeds $200,000 you can pay over 54%. On the other hand, on corporate profits of up to $500,000 you will pay just 15.5%, and 26% after that.
These tax savings can allow you to finance the purchase of capital assets and working capital, which in turn will help grow your business. When you leave funds in your company, you can significantly defer personal taxes, which can eventually be used for your retirement.
A Qualifying Small Business Corporation (QSBC) is essentially a corporation that carries on business mainly in Canada. The Canadian government encourages the creation of QSBCs by giving enhanced tax-free capital gains on the eventual sale of the company shares. For 2018, this amount is $848,252, and it is indexed for inflation each year.
The impetus behind these incentives is that QSBCs typically either create jobs in Canada or lead to significant exports, both of which are beneficial to the Canadian economy.
To combine income tax and credit protection benefits, you can set up a holding company. Once your operation company makes profits, you can transfer them to the holding company for protection from potential creditors. These are powerful reasons to consider incorporating your business.
2. What expenses can I write off in my business?
You can write off any expense as long as it was incurred for the purpose of earning income, is a reasonable amount and is supported by proper documentation. A receipt from the supplier showing its name, address and phone number as well as a detailed description of the product or service purchased is adequate documentation, but credit card statements by themselves are not.
If charging Harmonized Sales Tax (HST), the supplier must provide their HST number as registered with the CRA. The CRA maintains an HST registry where you can verify that the HST number is legitimate.
There must be a correlation between the incurring of the expense and the potential for earning income, although that income does not necessarily have to occur immediately. Promotion expenses are an example of this.
The CRA also restricts certain expenses. For example, you can claim only 50% of business meals and entertainment, and if you are using your passenger car for business you can claim only for capital cost allowance and lease up to $30,000 plus HST, or the equivalent of the lease amount.
3. What happens if I don’t file a tax return?
If you owe taxes after eligible write-offs and tax credits, you will be charged with a penalty of 5% plus a percentage each month your return is late. If you are a repeat offender, this penalty automatically increases to 10%.
Even if your income is below the threshold, such as if you are a student, you should still file a personal tax return to allow an accumulation of earned income for Canada Pension Plan and Registered Retirement Savings Plan (RRSP) contributions.
If your incorporated business owes income taxes and does not file a tax return on time, penalties and interest will apply on the unpaid taxes. If the company does not file a return after numerous requests from incorporating jurisdiction (i.e., either provincial or federal), its charter will be canceled, and the government will seize all its assets.
There are specific CRA Voluntary Disclosure guidelines (severely tightened in 2018) where a taxpayer can obtain some relief from penalties and interest. There are also specific procedures that can be followed to “revive” companies that have been dissolved by the government authorities. Cusimano Professional Corporation has assisted numerous clients in this situation.
4. Should I pay salary or dividends to myself if I am incorporated?
If your company has the cash flow, I would typically suggest paying sufficient salary to maximize the CPP limits (up to $55,900), and then pay dividends, which are the distribution of after-tax profits.
The next threshold payment level for salary would be if you wanted to maximize your RRSP contribution limits ($147,222 salary in 2018 will maximize the RRSP contribution limit of $26,500 in 2019).
There is a concept called “integration” which essentially says that if you are not incorporated (i.e. a sole proprietor) the total amount of income tax you pay should be the same as an individual whose company pays him or her a salary and then the rest of the profits are drawn by way of dividends.
Technically, when you receive dividends, you get a dividend tax credit corresponding to the implied corporate taxes the company paid. As corporate taxes drop, the dividend tax credit rates do not change. In prior years, there was an advantage to earning dividends, but CRA has recently changed rates, and now this integration is such that there is not much difference.
5. If my spouse and adult children are shareholders in my company, can I pay them dividends as well?
CRA has dramatically changed the taxation of dividends received by spouses and children. These restrictions used to only apply to minors receiving dividends, and were referred to as the “kiddie tax.” Effective January 1, 2018, the tax has been greatly expanded and is now referred to as “tax on split income” or TOSI.
If these rules apply, the recipient will be hit with the top marginal tax rates with little or no deductions. As a result, the payment of dividends to spouses and other related individuals will be subject to reasonableness and other tests.
6. Should I contribute to an RRSP or a TFSA?
This typically depends on your income level. Both of these are considered registered plans by CRA and are credit protected.
Normally, you would contribute to an RRSP when your marginal tax rate is high, and you hope to withdraw it when your marginal tax rate is low, such as when you retire or take sabbatical or maternity leave.
You can also make a spousal RRSP contribution, but in this case the spouse must keep the funds in the account for at least three years before withdrawal, at which time they will be taxed in the hands of the spouse.
The RRSP route is also beneficial for a lower income individual, as the Canadian government allows an individual to withdraw $25,000 to purchase a principal residence in Canada ($50,000 if husband and wife). Any funds withdrawn have to be repaid over fifteen years, or a minimum amount is included in income each year.
Contribution to an RRSP can be made up to sixty days past the end of the prior calendar year.
A TFSA contribution should be made by high-income individuals who have no registered investments, as income within a TFSA grows tax-free. There is an annual maximum contribution limit to a TFSA (for 2018 it is $5,500) as well as a lifetime limit (which was $57,500 in 2018).
You must be at least eighteen years of age to purchase a TFSA. If you have never contributed to a TFSA, your maximum is determined by the number of years past age eighteen and the limit amount per annum, to a maximum of $57,500 for 2018. TFSAs must be purchased within the calendar year.
7. Should I have life insurance?
Anyone who is married, especially with children, should have some form of life insurance.
Typically “term” insurance is purchased by younger individuals. The premiums are for a period of ten years and are renewed after that for the same term at a higher rate. This is similar to renting a house, in that if you stop paying the premium, you have no more coverage. Term insurance is a better alternative than “mortgage insurance”, typically sold by mortgage companies, whose payout goes down as the mortgage is paid off.
An alternative form of insurance is called “whole life”, whereby you pay a higher premium for a predetermined period and then you own the policy for the rest of your life. There are many varieties of whole life insurance to suit everyone’s needs. Once a cash surrender value is built up, some insurance companies will allow you to borrow against your life insurance policy. Depending on the size of the policy, the borrowings could be quite significant.
There are different ways of treating the interest on the life insurance loan. If it is for the purposes of earning income, then the interest on the policy loan can be written off as an investment expense. These are referred to as “insurance financing arrangements” or IFA’s in the insurance industry. Taking advantage of low corporate marginal tax rates (see above question) will allow you to purchase more insurance with company funds than if you tried to buy it with personal money. (The implications of corporate owned policies are beyond the scope of this post.)
I hope I have answered some tax and business questions you may have. If you have other such questions, feel free to reach out to Cusimano Professional Corporation. As chartered professional accountants in Toronto, we have many years of experience offering a range of accounting and tax services for individuals and businesses across the Greater Toronto Area. To learn more about our services, please click here. If you want to know how we can help you, contact us by clicking here.