Dean Constand
Certified General Accountant
42 Mossgrove Trail
Toronto, Ontario
M2L 2W3
416-575-8271
“Dedicated to Small Business Needs
And Personal Income Tax”
Newsletter #1
September2008
Dear Client,
I hope that you had a terrific summer, and let’s cross our fingers for the good weather to extend into the Fall. This is the first of my quarterlynewsletters; my goal is to keep you informed of issues relating to small business needs and personal income tax. The newsletter is divided into two sections: Small Business Needsand Personal Income Tax.
Small Business Needs
Advantages and Disadvantages of Incorporation, and the Business Life Cycle
Whether you have an existing business that is unincorporated or incorporated, or whether youare thinking about starting a business and you have to decide to incorporate or not, you need to be aware of the advantages and disadvantages of incorporation. For those of you who have an unincorporated business, knowing these advantages and disadvantages, and knowing what stage your business is in during its life cycle, will help you determine if and when to incorporate. Others who have incorporated businesses should be aware of the advantages of having a corporation, so they can use the corporation effectively to minimize taxes, and to help them take the next step in their business life cycle. There will come a time when your participation in the business will end, either by selling it, or by transferring it to children, or by closing the doors of the business, winding it down or by dying! There are tax issues relating to every one of these decisions. Death and taxes are indeed the only certain things in life.
Advantages of Incorporation
- limited liability to the extent personal guarantees are not required by creditors
- lower small business corporation income taxes
- income splitting with family members
- flexibility in the timing of the receipt of income personally
- estate planning
- use of the capital gains deduction to shelter $750,000 of capital gains on the sale of small business corporation shares
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Disadvantages of Incorporation
- business losses are not available personally to offset other income
- additional costs of maintaining a corporation
In this newsletter, I will discuss two of the advantages of incorporation: limited liabilityand lower small business corporation income taxes, intertwined with the disadvantages of incorporation noted above.
Shareholder Limited Liability and Director Liability
One advantage of incorporating is limited liability; it allows your personal estate to not be exposed to creditors in the event of a loss that exceeds the corporation’s assets.Your liability as a shareholder of the corporation is “limited” to what you have invested in the corporation, and limited to any personal guarantees you have been required to provide for the debts of the corporation. Usually, it is only a bank that will demand such a personal guarantee, although major suppliers may require one.
As a directorof a corporation, you may be personally liable for certain debts of the corporation, if the corporation “fails to deduct, withhold, remit or pay tax” such as payroll deductions, GST (goods and services tax) or PST (provincial or retail sales tax). This liability of a director does not extend to the corporation’s liability for income tax.Directors of a corporation are elected by the shareholders of a corporation at an annual meeting for the purpose of managing the corporation.
Protection from Insurance and WSIB
Surely, protecting one’s personal estateshould be a concern for everyone, but is incorporation the only way to reduce personal risk? Small business liability insurance protects against potential loss or damage. Professional liability insurance (also known as Errors and Omissions insurance) provides protection for professionals against claims that result from errors or omissions in their professional work. WSIB, or the Workplace Safety and Insurance Board,provides workplace insurance coverage for all of your workers. I attended a seminar given by the WSIB and was informed that the worker’s right to sue your business for work related injury iswaived if your business is registered with WSIB. Most businesses in Ontariothat employ workers (including family members and subcontractors) must register with WSIB.Employers in Ontario are classified and pay premiums based on their industry. To give you an idea or the premium range, the lowest rate group is Accountants, at $0.17 per $100 of payroll, and highest rate group is Wrecking and Structural Demolition, at $16.02 per $100 of payroll. I urge all of you who have businesses to contact me and discuss registration with WSIB. It protects you and your business, and it is the law!
Unincorporated Business Losses Available Personally
Having discussed insurance coverage as a means of reducing personal risk,my rule of thumb is to keep the business unincorporated in its beginning stages to reduce your personal income taxes.The reason for starting up unincorporated is that your business will usuallyhave high start up expenses which will allow you to pay less personal income tax on your other types of income, such as investment income, or income from employment that you may have maintainedalong with your business. The way it works is that your unincorporated business gets filed in your
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personal income tax return along with your other types of personal income, and the losses from the unincorporatedbusiness offset some of your other income, resulting in lower personal
income taxes. If you jump into incorporating your business from the start, you run into the disadvantage of your start up losses getting trapped in the corporation. The corporation files its own income tax return, and these losses cannot be used in your personal income tax return. They can only be used by the corporation at a time when it becomes profitable.There are, however, special circumstances when you can recoup some of your investment in a small business corporation through your personal income taxes. I will discuss this topic in a future newsletter.
Lower Small Business Corporation Income Taxes
Timing is everything. Once your business is viable and making profits, this is the time in its life cycle to incorporate and take advantage of the lower small business corporate tax rate. The rate is 16.5% for business income in the corporation up to $400,000. I draw your attention to the chart belowthat compares the low small business corporate tax rate of 16.5% to the higher rate that you would pay personally for different levels of business income.The governmentallowsthe low small business corporate tax rate as an incentive for small businesses to prosper. Small business is the driving engine of the Canadian economy. The idea is for small business corporations toreinvest these tax savings in the business.
Keeping Profits in the Company
If you take profits out of the corporation and pay yourself a salary, the company would pay less tax since it could deduct the payment, but you face tax on those dollars personally at the levels shown on the chartbelow. The strategy is to try to keep the profits in the company so the tax savings are not lost. For example, if your company made $150,000 income (which is within the income range in the chart between $123,063 and $400,000), and your company paid you a salary of $150,000, 46.41% in your hands is a much greater tax hit (about 30% more) than 16.5% in the company.Being aware of the rates below would help you to reconsider drawing more money from the corporation for personal needs than is necessary, since it will be taxed at a higher rate. However, there are ways to access dollars from the company on a tax-free or low-tax basis.That is a topic for my next newsletter.
Income Personal Income Small Business Income
Range Tax Rate % Corporation Tax Rate %
$36,020 24.15 16.5
$37,847 31.15 16.5
$63,424 32.98 16.5
$72,020 35.39 16.5
$74,726 39.41 16.5
$75,695 43.41 16.5
$123,063 46.41 16.5
$400,000 46.41 16.5
Additional Costs of Maintaining a Corporation
I have mentioned already one disadvantage to incorporating with respect to start up losses becoming trapped in the corporation and not having access to them in your personal income tax return. Another disadvantage is the additional legal and accounting costs to maintain a
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corporation. A corporation has a life of its own; it is a separate, legal entity that can exist forever, after we are all long gone. A minute book is a record of the corporation’s life, and must be
updated on a yearly basis. This is a lawyer’s job, who typically keeps the minute book at the office unless you decide to keep it. The corporation will be billed by the lawyer accordingly for updating the minutes on a yearly basis, which is a tax deductible expense. What if you do not maintain a minute book? I have been advised from my legal colleagues that Canada Revenue Agency can disallow the small business deduction (which is responsible for the low small business corporate tax rate) for years thathave been filed without appropriate updated minutes.A lawyer can do a catch up in the minute book for years that need updating. I urge all of you who have corporations to contact me so that the necessary steps are taken to update the minutes of your corporation.
The accounting fees are typically higher for corporations because corporations have to file their own tax returns, there is more tax planning involved, and T4s and T5s have to be prepared to remunerate the owners for draws out of the corporation for personal needs in the form of salaries, dividends or both. Information on dividends distributed to the owners must be recorded in the minute book, and this information is provided by the accountant to the owner’s lawyer. In summary, the accounting and legal costs are some of the extra costs associated with maintaining a corporation, and again, they are tax deductible. The advantages of incorporating a growing profitable business, however, outweigh the necessarylegal and accounting costs.
Conclusion
In conclusion, whether you are unincorporated or incorporated, or whether you are about to make that decision to incorporate, having the above advantages and disadvantages in mind throughout the business life cycle is critical to improving your overall tax situation. Remember to maintain the company minute book if you have a corporation, and to determine if your business should be registered for WSIB.
Stay Tuned….
My next newsletter will discuss ways to draw money from the corporationon a tax-free or low-tax basis. I will also begin to discuss the tax issues associated with the end of your participation in the corporation’s life, whether it be by selling it, or by transferring it to children, or by closing the doors of the business, winding it down or by dying! Notice how I’ve used the word participation, as the corporation has a life of its own. The corporationcan be a vehicle that allows you the flexibility to plan for your retirement and personal estate.
Personal Income Tax
Personal Tax Credits – Claim them earlyatwork for extra money in your pocket
If you are an employee, youshould get a form called a TD1 (see attached) at the beginning of the year which explainsthe personal tax credits that you are allowed to claim in order to reduce the tax deducted from your pay. For example, every resident in Canada is allowed the basic personal amount of $9,600, which means that the first $9,600 of income you make in Canada is tax-free. On the attached TD1 form,the basic personal amount is the first item highlighted. When it comes time to fill out the rest of this form in a few months, my objective is for you to understand all the credits available to you, because the earlier you claim them through your work, the better
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your cash flow will be throughout the year.If you plan for things in life, they usually come to you easier and cheaper. If you havenot properly chosen these personal credits allowed to you at the
beginning of the year, the government will be taking more tax from your pay than it should every time you get paid. Yes, you will get this tax refunded to you in April when you file your personal income taxes(if you don’t claim them early at work), because these credits that appear on the TD1 form are the same credits that appear on your personal income tax return. But why loan the government your money, interest free, during the year, when you can save and invest it yourself? There are actually two TD1 forms that need to be completed, one federal and one Ontario (see attached TD1 and TD1ON forms), but the Ontario form essentially deals with the same credits as the federal but with different allowed amounts.
If you own a business, you will be better equipped to explain to your employees the personal tax credits when you hand out these TD1 forms at the beginning of the year. Your employees will be happier to know that less tax willdeducted from their pay, the more personal tax credits they are allowed to claim.
I will deal with the following personal tax credits in this newsletter: the basic personal amount, the child amount, the age amount, and the caregiver amount.These personal credits focus on families who have children under 18 years old, on individuals who are 65 years old or older, and on families who are responsible for the in-home care of parents/grandparents (including in-laws) who are at least 65, or who are responsible for the in-home care of relatives who are at least 18 years old and are mentally or physically impaired.
Personal Tax Credits – You may hear about them in the upcoming election campaign, but what do these thousands of dollarsmean to you in actual tax savings?
The calculation to determine the actual tax savings on personal tax credits is the following: takeeach amount from the federal TD1form, multiply it by 15%, then take each corresponding amount from the Ontario TD1ON form (which is likely a little different), multiply it by 6.05%, and combine the results to determine your tax savings. Let’s use the basic personal amount for example: $9,600 from the federal form, multiplied by 15% is $1,440; the basic amount from the Ontario form is $8,681, multiplied by 6.05% is $525; the sum of $1,440 and $525 is $1,965. This means that every Ontario resident doesn’t pay $1,965 of taxes on the first $9,600of income.So the next time there’s a federal government budget, or during the upcoming election campaign, and personal tax credits are announced on the newsin thousands of dollars, you can quickly estimate in your head that the tax savings for you in Ontario are about 21% of those amounts announced (15% federally and 6.05% provincially).
Child Amount–under 18 years old on December 31
If you have children under18 years of age at the end of the year, the child amount can be claimed by one parent: the child amount from the federal TD1 form is $2,038 per child (there is no corresponding Ontario amount for this credit from the TD1ON form), multiplied by 15% is $306. If you make this claim, you will save $306 in taxes for each child under 18 from being deducted from your pay throughout the year.
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Age Amount – 65 years old or older on December 31
Individuals 65 or older in the year are entitled to a federal age amount of 15% on $5,276, or $792 in tax savings. Provincially, Ontario taxpayers 65 or older are entitled to an age amount of 6.05% on $4,239, or $256 in tax savings. If you make this claim, you will save a combined $1,048 in
taxes. And if you are 65 and working, claiming the age amount on the TD1 form at the beginning of the year will prevent the payroll department at your work fromdeducting the $1,048 from your pay throughout the year. Note that the tax savings from the age amount are reduced when your net income exceeds levels of about $31,000,and is completely eliminated once your net income reacheslevels of about $66,000. You can still make a partial claim and obtain the tax savings if your income lies within this range.
Caregiver Amount – for the “Sandwich Generation”
Lastly, the caregiver amount is a claim you can make for exactly that: in-home care of a parent/grandparent (including in-laws) who is at least 65 years old, or in-home care ofan infirm, dependant relative who is at least 18 years old. The caregiver amount reduces your taxes by up to $614 (15% of $4,095) federally and $248 (6.05% of $4,092) provincially, for a total savings of $862. Similar to the age amount credit where income plays a factor, the tax savings from the caregiver amount are reduced when the dependant’s net income exceeds about $14,000, and are completely eliminated when the dependant has net income of about $18,000.
Conclusion
In conclusion, my objective was threefold with respect to discussing personal tax credit amounts: Firstly, to make you aware of them, whether you are part of the “sandwich” generation and taking care of both a parent and child at home, or whether you have celebrated your 65th birthday during the year. Secondly, to help you understand that you can claim these amounts earlier in the year and improve your cash flow during the year. Lastly, to better equip business owners with the knowledge of these credits, so that that they in turn can explain and help their employees achieve less tax deductions from their payearlier. Your employees will be happier to understand this, instead of just handing them another government form for them to fill out.I am a firm believer that your employees are your biggest asset, and happy employees give your business a competitive advantage.