As a Toronto based firm working with private enterprises and entrepreneurs, we have compiled the Top 10 tax tips that majority of you will find useful. At MP Group, we see the benefits of these tips being utilized by our clients and lead to significant tax savings.
Tax Tip #1 - Salary or a Dividend
Most business owners ask whether to take a dividend or salary. A lot of the times, the answer is, it depends! If the owner does not earn any other source of income, it would be ideal to take out dividends as the first $35,000 of dividends can be taken out with no personal tax implications to the shareholder. Furthermore, if the company's taxable income is approaching greater than $500,000, it may be ideal to "bonus down" or take out a salary to ensure that the profits are taxed at the lowest tax rate for Canadian Controlled Private Corporations of 15.5% in Ontario (only up to $500,000 in taxable income is taxed at the lowest 15.5%). Also, other factors to consider is whether you value the CPP, since if you take out a salary, you will need to contribute toward CPP, and withholding taxes as a shareholder.
Tax Tip #2 - Shareholder Loan Repayments
Many times shareholders contribute funds toward business activities or incur expenses on behalf of the company. This generally creates a Loan Payable to the shareholder. As such, at the discretion of the shareholder, the company can repay the loan back tax free to the shareholder. This ensures that profits are still retained in the company.
Tax Tip #3 - Reinvestment into the Business
As noted above, the profits earned in a Canadian Corporation is taxed at the lowest rate of 15.5% on the taxable income of up to $500,000. If the company is paying dividends or salaries to the shareholder, and the shareholder does not need to take out additional funds, it may be a good idea to leave after corporate tax funds in the company to reinvest in the company. The funds can be used to acquire additional equipment, inventory, or other investments needed for the business to grow. This ensures that more funds are available after tax for use rather than taking out fund as a salary or dividend and paying taxes personally as well.
Tax Tip #4 - Income Splitting
For corporations, income splitting can be done. One way is to issue another class of shares to your spouse or to your adult children (older than 18 years). The beauty of issuing a separate class of shares to your spouse who may not have income streams, is that it provides flexibility on declaring dividends to either your spouse or to yourself as the business owner.
Tax Tip #5 - Spousal RRSPs
If your spouse is not earning any income, it may be a great idea to open up a spousal RRSP. This is a joint RRSP, and the spouse earning income can contribute toward the RRSP and receive a tax deduction that decreases their taxes. The opportunity to income split arises after 2 years from the contribution, where the spouse with no income can withdraw fund from the RRSP and not pay any tax if within the tax bracket thresholds. Also, upon retirement, both spouses can split equally to reduce taxes.
Tax Tip #6 - Loan Funds from your Business to Your Spouse
The business can loan funds to your spouse. Your spouse can now use the money to invest and generate passive income. However, the business will need charge interest to the spouse at the CRA prescribed rates. Currently the prescribed rates are low at 1% therefore, this strategy can be beneficial as obtaining a loan for cheap and earning investment income at a higher rate of return most likely greater than 1%. Also, the interest paid on the loan for the spouse if used for investment is deductible for tax purposes.
Tax Tip #7 - Tax Free Expense Reimbursements and Automobile Allowances
If you incur expenses on behalf of the business or use your motor vehicle for business purposes, you can get reimbursed by the company for the expenses you incur. Therefore, it is imperative to keep track and have support of your business expenses you paid personally so that you know how much you can get reimbursed back from your company. Also, you can claim 54 Cents on the first 5000 kilometers driven (48 Cents after that) using your personal vehicle for business purposes. Ensure you have a log book keeping track of the day, kilometers driven and purpose for travelling as support for the CRA and to charge to your company for reimbursement.
Tax Tip #8 - Sole Proprietor? Incorporate Your Business
Most business owners are not incorporated and may operate as a sole proprietorship. As such, the business profits earned are taxed personally at the hands of the owner. There is no way to defer taxes by leaving funds in the corporation (taxed at the lower rates noted above). Also, from a legal standpoint, the owner is exposed to legal liability personally.
Tax Tip #9 - Pay Salaries to your Spouse and Family Members
Another way to income split, is to pay salaries to your spouse or family members. However, ensure that the salaries are reasonable, justifiable and documented for the employment services they are providing in case CRA comes knocking on the door.
Tax Tip #10 - Creditor Proof Your Business
Another strategy is "Creditor Proof" your business for legal and tax purposes. This involves having a holding company owned solely by the shareholder and that holding company owns the operating company. The tax benefits come from the fact that the companies are connected corporations for tax purposes. Dividends can flow tax free between connected corporations. As such, funds can be issued to the holding company and the funds in the holding company can be used to invest in other business opportunities. Also, from a legal standpoint to Creditor Proof the business, the operating company can issue a dividend to the holding company and subsequently the holding company can loan funds back to the operating company. Now the operating company has a liability outstanding and due to the holding company. Creditors have first claim to business assets of the company in times of distress.