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“Tax Talk” Or How to Minimize Taxes for The Self-Employed By Leslie Slater, CA, MBA Topics to Be Covered Similarities and Differences between incorporated businesses, and unincorporated Income taxes Ownership structures Paying yourself Paying family members Taxation of profits

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Tax talk or how to minimize taxes for the self employed l.jpg

“Tax Talk” Or How to Minimize Taxes for The Self-Employed

By Leslie Slater, CA, MBA

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Topics to Be Covered

  • Similarities and Differences between incorporated businesses, and unincorporated

    • Income taxes

    • Ownership structures

    • Paying yourself

    • Paying family members

    • Taxation of profits

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More Topics

  • Expenses of car, home office, meals and entertainment, travel, etc.

  • Health Spending accounts

  • IPP’s


  • SRED and other government programs

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Final Topics

  • Salary/Dividend Decision

  • New Dividend Tax Credits

  • Should you incorporate?

  • Your employees – how can you help them and yourself

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Incorporated Companies

  • Separation between you and your company

  • Ownership can be you, other business partners, your spouse, adult kids, a family trust, other corporations

  • Corporation pay its own federal and provincial taxes separate from you

  • You are paid salary/bonuses & dividends

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How are you really paid?

  • If draws due to inconsistent cash-flow, then need to either show self-employment income or dividends

  • Don’t want it to be a series of loans and repayments

  • Company then doesn’t pay employer CPP

  • Shareholder loans/draws need to be zero at end of your fiscal year

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Important Tax Rates

  • CCPC are charged 18.6% in Ontario on first $300k of active business income – then pay dividends after corp tax

  • Increasing to $400k January 1, 2007

  • Ontario lowered rates on $400k so there is a another tax bracket – 26.3%

  • Over $400k, pay 36.1%-40.8% on ABI

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New Dividend Tax Credit

  • For dividends paid out of earnings not subject to federal small business rates or investment income (after Jan 1, 2006)

  • So not relevant to the salary/dividend decision below $300k (moving to $400k)

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Salary versus Dividends

  • At all levels of corporate income, there is deferral of taxes for income left in the company and invested since corp rates are less than personal rates

  • But will pay high taxes on the investment income unless pay it out to shareholders

  • Ultimately about 3% less taxes by paying dividends versus salary

  • And salary attracts CPP, EHT

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So how do I make the decision?

  • Generally bonus down to SBD until 2010 when rate changes may make you neutral

  • Below SBD, pay dividends unless you are already below SBD before start

  • If below $300k when you start, do you pay dividends or salary?

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Salary, dividends or leave it in?

  • Salary is

    • earned income for RRSP,

    • subject to CPP,

    • part of EHT calculation on total payroll

    • Considered for debt servicing levels

    • So generally pay tax until reach levels for desired RRSP and debt servicing

    • Max 2006 $106k x 18% = 19,000 if desired

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Leave it In?

  • Tax deferral –i.e. no personal taxes yet

  • But need to watch how big your investment assets get – 50% of assets for 2 year, 90%

  • Income on investments taxed at high rates if not needed during business cycle

  • Refundable taxes if pay out dividends ($1:$3 ratio)

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So The Decision

  • Leave cash in the business if

    • don’t plan to sell within 2 years,

    • below the $300k (soon 400k) and

    • you are at your desired earned income levels

    • but watch you don’t build up too much

    • Have income split to lower tax brackets with family members

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Income Splitting with Family

  • Can pay high reasonable amount for work done

  • Have to actually pay them; and get invoices if they are contractors

  • Spouses can be partners or shareholders

  • Family Trusts can be partners or shareholders

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Income Splitting Cont’d

  • Sole proprietorship – pay for work done

  • Partners – + allocate partnership profits

  • Shareholders – dividends (but not to minor children), duplicate capital gains exemption if sell shares (but need to pay them)

  • Many considering everyone in a family trust for maximum discretion on allocations

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Similarities between Corp & Other

  • Paying family members for work done

  • Home office as principal place of business

  • Meals and entertainment

  • Travel

  • GST, PST

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  • Car

  • Paying family owners

  • Health spending accounts vs group medical

  • CPP

  • SRED and other government programs

  • IPP’s

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Home Office

  • Principal place of business; all costs (except mtg princ) x sqft/sqft or #rooms

  • Consider market rates to charge incorp co

  • Rental income on your personal tax return

  • Lease with company

  • If not princ. place, then regularly and continuously meet clients there and exclusive business use (court cases)

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Meals and Entertainment

  • 50% deductible by company or self-employed

  • 50% for GST Input tax credits

  • Keep track of who you entertained on the receipt to show business purpose

  • Don’t want to be shareholder appropriations if incorp; double taxation

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  • Need to register where >30k last 4 quarters

  • Start usually as annual filer and remitter

  • Move to quarterly remitter or filer based on first year

  • If have a refund always (e.g. US sales and Cdn costs), then want frequent filing

  • CRA doesn’t like sending big refunds

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GST cont’d

  • Value added tax – difference between amount charged and amount paid

  • Have to keep track to both unless use other method

  • Quick method – $200k limit

  • 6% as of July 1, 2006 changed rates for calculations

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GST over the Internet

  • If US resident – zero-rated but you have to have declaration from them

  • What are you selling – an intangible or a service (software can be either)

  • If wholly outside Cda, not required on service

  • If intangible with right to use in Cda - GST

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  • Sales tax, not value added tax

  • Consider all items that go into your product

    • E.g. software companies might provide owners with CD’s, paper manuals, use development computers and can buy these without PST

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PST over Internet

  • How and where delivered

  • If delivered electronically, servers outside Ontario and can’t download in Ontario, then no PST

  • If can download in Ontario, then PST

  • If delivered in other provinces, may have HST (BC based on if you do direct advertising)

  • Complicated so check it out

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  • If self-employed, write-off the business proportion of all your auto costs (s/t max $800/mo, 30k cost)

  • If corporation, then difference if company owned or leased (taxable benefit) versus personally owned or leased

  • If personally owned or leased, can charge company .50/km first 5,000 and $.44/km over and no taxable benefit or chg allowance (taxable income)

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Health Spending Accounts

  • Health Spending Accounts only available to corporations

  • You make a contract with your company to cover list of medical expenses and put a set monthly amount in separate bank account each month until employee submits the medical expenses and gets reimbursed

  • Account is not considered part of company books

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Health Spending (cont’d)

  • No maximum, but should do set monthly amount

  • Unlike group premiums for self-employed where get to deduct $1,500 for self, $1,500 for spouse and $750 each dependent child from business income (not incl life, ltd)

  • Need to establish for all employees

  • Monthly amounts are deductible to co; not taxable benefit to employee

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  • If incorporated, then company pays employer portion of CPP

  • Self-employed pay both sides when file their personal tax returns – 9.9% of 42,100, max $3,821 in 2006

  • If within 15 years of retirement, want to ensure that you are maximizing your CPP contributions

  • Can receive as early as 60 (reduced); normal 65

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  • SRED is Scientific Research and Experimental Development

  • Only available to corporations

  • Important cash incentive to software companies & manufacturers in Cda where contribute to tech advancement and where there was tech uncertainty

  • Pays $ even if don’t pay any income tax

  • Approved SRED can be collateral for bank loan

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Other Government Programs

  • Mainly focused on corporations

  • Some provide cash even if no taxes, some match funds (e.g. IRAP) and some provide income tax credits against taxes payable

  • Ontario has some focused on media

  • Also, there are government funds looking to encourage innovation

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IPP (Individual Pension Plan)

  • Can define a smaller group (you, your partners, but not general employees) to be covered

  • Corporation - need employee relationship

  • IPP’s useful to accumulate larger amts than RRSP’s, get company deduction, if around 50, steady corp. cash-flow, and have been running the corp. for a number of years

  • Companies will calculate benefit and consult for free; set up costs coming down

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So Should You Incorporate?

  • If you make more money than you need or want to live on – yes, tax deferral at least

  • If there is liability risk – yes, corporate veil

  • If there are contracts which are not assignable

  • If you have income splitting opportunities with spouse and/or children

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Incorporation Advantages

  • If you think you qualify for SRED or other government programs

  • If you think you’ll be in business for a while and ultimately sell – capital gains exemption

  • If you might want do retirement planning (IPP’s) or health spending accounts

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But what about your employees?

  • How can you help them to minimize their taxes?

  • Specify in employment contract that they need home office (e.g. technology workers) with internet connection, cellphone, and personal computer; car also

  • Give them a T2200 to write off these against their employment income

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Other Ideas for Your Employees?

  • If they negotiate contracts, pay some of remuneration as commission and specify as such on T4 slip

  • Commissioned employees have more write-offs than salaried – even their fees for income tax preparation

  • If they pay part of their benefits, specify it covers the life and long term disability part

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To Conclude

  • When you start a business, you may not incorporate, so you can write-off losses against your personal income…but if the business is going to continue, it usually makes sense to incorporate

  • There are more opportunities for tax deferral, income splitting, estate planning, health care deductions, retirement planning, etc.

  • So make sure you are getting all the possible advantages