Strategy and planning are always a key focus area for any small business. From an accounting perspective, there are a number of simple, but effective ways in which small business owners can optimize their tax planning approach.
1. Income Splitting
In Canada, taxpayers are subject to a system of income tax brackets. For each dollar earned, a different tax rate may apply depending on which tax bracket the additional income falls into. In other words, higher income earners will have to pay higher rates of tax on a portion of their income.
To help combat the tax implications of earning more, business owners that can employ a spouse or their children should consider splitting their income with members of the family. This will help utilize any lower tax bracket room that might be available through other family members and reduce the overall personal tax bill for the year.
It should be noted that family members on payroll should not be overcompensated. Good policy is to pay family members fair compensation for work performed.
By Dividend Sprinkling:
This strategy can also be achieved by restructuring the company shares. To achieve this goal, allocate different classes of non-voting shares to family members with the intention of paying dividends to the members with the lowest tax bracket. The result is that the corporation income will be taxed at the lowest possible tax rate.
2. Optimize the Timing of Significant Capital Asset Purchases
Under Canadian tax law, capital assets are depreciated based on the rules specified for a number of predetermined asset classes. While each class differs, the majority of classes are subject to what is known as the half-year rule. When the half-year rule applies, a business can only claim one half of the annual depreciation in the year of acquisition.
With this in mind, businesses planning to purchase significant assets near the year end date should do so before the fiscal year is over. Under this approach, the business will be able to utilize the full write-off much sooner. If the purchase of an asset is delayed until the coming year, the business will have to wait a full fiscal year before the maximum depreciation rate can be used.
3. Compensation Split – Dividends vs. Salary
Over the past few years, a number of changes have been made to the tax system, reducing the difference from a tax perspective in receiving dividend or salary compensation. Currently, the after-tax cash received at the individual level is largely the same for both wages and dividends in most cases.
That being said, those that earn salary are still subject to paying into the Canada Pension Plan. For many business owners, this means paying the maximum amount for both the personal and company portion of CPP. For 2015, the maximum contribution amount is almost $5,000 dollars.
Historically, those on payroll never receive dollar for dollar value for their contributions. Benefits received during retirement are typically only a fraction of the amounts contributed. As such, business owners currently on salary should consider taking dividends instead of wages. Under a dividend compensation approach, there is no requirement to pay into CPP. The dividend recipient is then free to take those proceeds and invest for retirement on their own terms.
One caveat to this approach is that dividends do not create RRSP contribution room the same way that salaries do. Individuals seeking additional RRSP contribution room should consider a hybrid or strictly wage approach to compensation. Discuss with your financial advisor to determine which approach is best for you to achieve your financial goals.
4. Home Office Expenses
If you work from your home, you may be able to deduct a portion of your home office expenses, such as utilities, insurance, rent or property taxes. However, there are rules to follow:
- Workspace must be the principal place of the business of the individual, meaning more than 50% of the time
- Workplace must be used exclusively to earn business income and used on a regular and continuous basis for meeting clients, customers or patients of the individual in respect to the business
Home office expenses can only be deducted from the business carried on in the home, and cannot be used to create a business loss. The portion of the otherwise deductible expenses related to a work space that cannot be deducted in a taxation year can be carried forward as long as the two conditions above are met on a continuous basis.
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