If you are a small business and need guidance about dealing with your small business taxes, apart from your corporate tax accountant, this blog might be able to help.
RRSP and TFSA
The first level of tax planning is quite common, but still excellent and relatively underutilized. Business owners can use an RRSP and/or TFSA to save money for the future. They are low-cost and low risk and every business owner should look at them first if he wants to reduce the amount of taxes he pays. RRSPs and TFSAs are ingrained in our tax system, so they’re unlikely to go anywhere any time soon.
RRSP v. TFSA
RRSPs are registered retirement savings plans and TFSAs are tax-free savings accounts. Both are great savings vehicles but have different tax implications when filing a t2 tax return.
How RRSPs work
With an RRSP, you get a tax break when you contribute. This means you will pay fewer taxes this year. Money inside an RRSP grows tax-free until you retire it. When you withdraw money, you pay tax on the withdrawal amount at your marginal tax rate for that year.
How TFSAs work
With a TFSA, you don’t get a tax break when you contribute. This means that you will not save any taxes in the current year. Instead, money within the TFSA grows tax-free until you withdraw it. When you withdraw funds from your TFSA, you don’t have to pay withdrawal fees as you do with an RRSP. Both TFSAs and RRSPs are excellent savings vehicles, but which one is better depends on your specific situation.
When to use an RRSP vs TFSA
This is an oversimplified way of looking at things, but it’s generally a good way to look at them.
RRSP – If you think you’ll be in a lower tax bracket in retirement than you are now, an RRSP is probably a better option.
TFSA – If you think you will be in a higher tax bracket in retirement than you are now, a TFSA is probably a better option.
Both – If you are not sure, you can always use both!
There are other factors that go into this decision, like how much room you have for contributions and how long you expect to save the money before you need it. If you’re not sure what to do, it’s worth talking to a corporate tax accountant for your small business taxes.
Start Your Own Business
Incorporating your business gives you access to low corporate tax rates for small businesses, allowing you to reinvest funds into your business and build your wealth. The chances of the government removing the benefits of incorporation are pretty slim; however, the government has reduced some of the income-sharing benefits in recent years. However, incorporation is a safe and effective tax planning strategy as it aligns well with the government’s goals of growing the economy through business and job growth.
The main disadvantage of incorporation is the additional administrative costs and burdens:
- Constitution costs
- formation expenses,
- Annual t2 tax return of legal entities and legal filing
- More compliance (company documents, minute’s book, etc.)
After all, you are bringing a new entity into the world. Plus, if you ever want to turn it off, you’ll have a cost there as well. However, for many business owners, the benefits can outweigh these additional costs.
Benefits of incorporating in Canada
Limited Liability – Enables business growth without personal liability.
Lower Tax Rates – A business can claim the small business deduction, which gives them a lower tax rate on the first $500,000 of business income.
Income Splitting – A business can split income with family members who own shares in the company if they are involved in the business. This can lead to significant tax savings. However, the government has been restricting it in recent years.
Accumulate wealth – A business can accumulate more wealth in it than an unincorporated business before facing higher tax rates, although the government has put restrictions on this as well.
When to start your business
If you are unsure about incorporating, you can start by reviewing our article on when it makes sense to incorporate your business. The next step would then be to contact your accountant and discuss whether incorporation makes sense.
How to incorporate your business
If you’re ready to incorporate, refer to an online platform for incorporating and managing business documents. This article provides information on the different ways to incorporate your business and some tips on when each method might make sense for you.
Company structuring
The next level of tax planning we will discuss is corporate structuring or the use of holding companies. Creating a holding company can be a great tax planning strategy to protect and build wealth in certain circumstances. As with incorporation, this is a relatively low-risk strategy overall. However, as it is more complex, you will face more administrative costs and burdens. There are several important advantages to using a holding company.
Property protection
Operating companies are exposed to risk in their day-to-day business activities. Transferring some of the assets of an operating company to a holding company can provide a layer of protection in case creditors come after those assets.
We can help you get a lifetime capital gains exemption
The Lifetime Capital Gains Exemption (LCGE) provides owners of Canadian-regulated private corporations (most small businesses in Canada) with tax-free capital gains of up to $913,630.
Some operating companies may not be eligible for LCGE because they must demonstrate that the majority of their assets are used in an active business. If the operating company also holds a lot of investments, this requirement may not be met.
A holding company can help with this by having the operating company transfer funds to the holding company through tax-free corporate dividends. The funds can then be invested in the holding company instead of the operating company. This helps the operating company meet the requirement that most of its assets be used for business.
Tax deferral from the holding company
A holding company can provide some flexibility regarding the timing of income (and therefore taxation). This creates some tax deferral opportunities for business owners. If you want to learn more about holding companies, start with our guide to holding companies linked here. Once you understand how they work, it’s a good idea to reach out to a tax professional to help you structure things properly.
Using Insurance
Insurance can be a useful tax planning tool. However, we are getting there in terms of complexity and risk. The government has hinted lightly that they may focus on health benefits for taxation in the future, but nothing has yet been brought forward. Life insurance policies already have limitations on the deductibility of premiums. In addition, there is always the risk that the government could target them for taxation in the future.
Health insurance
Health insurance can be a handy tax planning tool at this time. Health insurance plans make it easy to deduct medical expenses for owners and employees. This is a good way to provide benefits to your company employees (including owners) and also to ensure that healthcare expenses are tax deductible within the company, thus this helps you with the t2 tax return as well.
Life insurance
Another tax planning and wealth-building tool can be life insurance. This is especially important when it comes to estate planning.
Tax Havens and Loopholes
We are now getting to the expert+ level in tax planning and the lines can start to blur toward tax evasion, which is definitely not legal. Tax loopholes can actually be a blessing when filing small business taxes.
If you’ve ever felt like rich people play by different rules, you’re probably on the right track. As soon as the CRA closes the loopholes, there are teams of professionals trying to uncover and exploit new loopholes in the tax code. This in itself is not illegal and lawyers and other tax professionals have every right to do so.
That doesn’t mean that you, the small business owner, have access to these loopholes. These would be top secret and only offered to those who would benefit (and pay) the most. They’re a constantly moving target, so if you can’t keep a tax attorney on speed dial, they’re probably not for you. Also, even if you get away with it for a while, it can definitely catch up with you. In case you need assistance, talk to a corporate tax accountant to get help for your small business taxes.