Personal Income Tax, Small Business

Tax Benefits for the Self-Employed

There are many tax advantages for self-employed Canadians who work from home and hire family members in their business.

The December holiday season is a time for home and family. This year, if you are self-employed, you may want to consider incorporating home and family into your business to create tax benefits for both the business and the family. Consider the following opportunities to reduce your taxable income and thus increase the amount of money left over to support your family.

Individuals in a 40% tax bracket save $40 on every $100 spent.

Hiring Family Members

If your business needs employees, why not hire your children or your spouse? Of course, the job must correspond to their abilities and the pay be reasonable in terms of the going market rate for such skills. It is usually more beneficial for a sole proprietor to pay family members rather than a third party for the same work. Suppose, for example, you pay one of your children or your spouse $5,000 per year for performing a task and they have no other income. Because the $5,000 is less than their personal exemption ($11,327 for 2015) they will not have to pay any income tax on the earned amount. Further, the payment is deductible from your self-employed income. If, as sole proprietor, you are in a 40% tax bracket, the $5,000 paid to the family member effectively saves $2,000 on your self-employed income while providing $5,000 of tax-free income to the family member.

If, for example, you are paying $5,000 per year for your child’s tuition and the child was not paid from your business, you are effectively paying in after-tax dollars. That means you will have to earn $8,350 (40% of $8,350 = $3,340) in order to clear the $5,000 ($8,350 – $3,340 = $5,010) needed to pay for your child’s education.

Home Office

You are allowed to deduct at-home expenses if you meet one of the following conditions:

  1. You do more than 50% of your work at home.
  2. The work space is used only to earn income and for meeting customers or clients. You cannot deduct at-home expenses if you are just using your kitchen table to do the work.

Home Maintenance Expenses

You can write off a portion of your home maintenance expenses such as heating, home insurance, electricity and cleaning supplies. A percentage of property taxes and mortgage interest can also be deducted.

Capital Cost Allowance

CRA also allows the deduction of a percentage of the capital cost allowance on the cost of the house or outbuildings. However, since there are tax consequences after the principal residence is sold, discuss this option with your CPA tax advisor before claiming the expense.

Allowable Write-Off

The method of determining the percentage of allowable write-off must be determined on the basis of the space used by each particular business. Some sole proprietorships may only need a 10 x 10 office to conduct their business; others may need a larger office or perhaps even outbuildings for additional office space or storage. The most common calculation method, however, is to take the square footage of used space as a percentage of the total usable space.

Losses

If, for instance, profit before the application of home expenses was $7,000 and the at-home expenses were $8,000, you cannot claim a $1,000 loss. Your taxable income from the business will be nil but the $1,000 that was not applied can be carried forward to the following taxation year and applied against that year’s income. If your business has a loss of $8,000, you cannot increase the loss by the application of at-home expenses. These losses would be carried forward from year to year as well.

To claim business expenses, retain all receipts.

Business Expenses

The expenses listed below are normally common to all businesses. In order to claim any of these, however, make sure they are incurred to earn income and that all receipts are retained:

  • accounting and legal fees
  • advertising expenses
  • business taxes, fees, licences and dues
  • insurance expenses
  • interest and bank charges
  • maintenance and repairs
  • meals and entertainment
  • office expenses
  • salaries, including employer’s contributions
  • motor vehicle expenses

There may be limitations to deductibility within each category. Seek the advice of a CPA tax advisor before making any claims.

Credit Cards

Interest on credit card balances incurred for business expenses is deductible. But, if business purchases are made with a personal credit card, the CRA will most likely disallow the interest expense because the interest applicable to outstanding business balances cannot be separated from the interest charged on personal balances.

Business Bank Accounts and Business Loans

Business bank accounts allow bank charges to be easily identified as business expenses; deposits and withdrawals can be more readily traced back to suppliers, customers or owner’s withdrawals or contributions. Separating business accounts from personal accounts minimizes the confusion when processing year-end tax information or when preparing for a CRA audit.

Loan Interest

Loan interest for vehicles and equipment is also a deductible expense. Make sure the transaction is transparent so you can establish that the principal went into a business bank account. If the loan is from relatives, make sure proper documentation establishes the date of the loan, the interest rate and the repayment terms.

Mortgages

Should you need to increase your mortgage to provide operational funds for the business, separate clearly in your records the mortgage for the principal residence from the funds for your business. The date the additional funds are deposited into the business account establishes the break. Your CPA tax advisor will thus be able to calculate separately the loan interest attributable to the business and that attributable to your personal residence.

Limitations of Do It Yourself Software

Certainly you may choose to complete your tax return by yourself. “Do it yourself” software can tell you how to fill in the blanks and can do the calculations accurately; however, it cannot analyze the data to determine whether it has been entered correctly or whether you have obtained the maximum tax benefit. Hiring a CPA tax advisor will be your best tax deductible expenditure. Not only will your CPA ensure accurate tax results, but also suggest additional measures you should make this year and in future years to minimize your income tax liability.


 

The preceding article is reprinted from the December 2015 newsletter Business Matters with the permission of the Chartered Professional Accountants of Canada.  Business Matters is a bi-monthly newsletter, the full version of which can be obtained on request. 

This post deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

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