Category Archives for "Business Income Taxes"

What is Inventory and why is it Important to your Business?

By Randall Orser | Business Income Taxes , Small Business

Your company’s inventory is what you sell to your customers.  It can either be purchased from a wholesaler and sold on-line or in your store, or it can be the raw materials that you use to manufacture products to sell.  It can also be component parts that you put together to make a product to sell. 

Inventory has value so it is an asset to your business and once you sell it you will be making money.  It also has value as collateral if you need a business loan.   The cost of selling your inventory (called cost of goods sold) is important for your business as it includes the cost of the items to make your product as well as the costs for storing inventory in your warehouse, shipping products to your customers and hiring people to work in the warehouse. 


Keeping Track of your Inventory – in both your accounting system and its physical location is important for your business:

  • To know how many items are in your inventory and their value as an asset on your balance sheet.
  • To know the costs associated with buying and selling inventory which are deductible business expenses that can reduce your business taxes.
  • Inventory costs and gross profit from sales are a major part of your business tax return.
  • The value of your inventory can be used as collateral for a loan.

Different Types of Inventory -  inventory can be divided into two categories:

  • Supplies – items sitting on the shelf waiting to be used.  These include office supplies, cleaning supplies, computer supplies and accessories.
  • Product inventory – this can be either items you buy wholesale to sell to customers or items manufactured and ready to sell, as well as components and raw materials.

Inventory and Cost of Goods Sold – Inventory is essential in calculating the cost of goods sold, which in turn is used to determine gross profit for a business that sells products whether it is a sole proprietorship, partnership or a corporation.  The cost of goods sold is calculated by:

  • Beginning inventory (your inventory at the beginning of the year, or the beginning of your business.
  • Add net purchases (calculated after discounts, allowances and returns).
  • This equals the Cost of Goods Available for Sale.
  • Less ending inventory, which is the value of your inventory at year end.

The closing inventory at the end of one year becomes the opening inventory at the beginning of the new year.  Businesses take physical inventory to make sure that what they have on record is correct.  At the same time, they can check for spoilage of obsolete goods and theft or bad record keeping which costs the business money.

From an article by Jean Murray

Should You Pay Yourself Salary or Dividends When You Incorporate Your Business?

By Randall Orser | Business Income Taxes , Personal Income Tax , Small Business

Once you incorporate your business you need to decide which is the best way to pay yourself, a salary, dividends or a mix of both. There are advantages and disadvantages to both salary and dividends for business owners.

Business Salary

Advantages:

  • If you are paid a business salary, then you will be paying into the Canada Pension Plan.  This is an important consideration for the future as the amount of retirement benefits that you will get depend on how much you have paid in and for how long.
  • Your salary or bonus will be a tax deduction for the corporation.
  • As well as paying yourself you can also do some income splitting with your spouse or children.
  • You will also be able to contribute to RRSP’s or TFSA’s for your retirement.

Disadvantages:

  • You will have a personal income which is fully taxable unlike dividends which are taxed at a lower rate so your tax bill may be greater.
  • For the Canada Pension Plan, you will have to pay both portions as you are both an employer and an employee.
  • You will have to do payroll and set up a payroll account with the CRA and file all the related paperwork.
  • If your business profits vary from year to year, paying yourself a salary will mean that you will not be able to carry back a business loss for future years which you could if you are paid by dividends.

Payment by Dividends

Advantages:

  • Dividends are taxed at a lower rate than salaries so you may pay less personal tax.
  • Dividends can be declared at any time which means that you can optimize your tax situation.
  • Not paying into the CPP will save you money.
  • It is easy to pay yourself dividends, you just have to write a cheque to yourself from the company and at the end of the year update the corporation minute book and prepare a director’s resolution for the dividends paid.

Disadvantages:

  • Not paying into CPP will lessen the amount of CPP you are entitled to when you retire.
  • Being paid by dividends does not allow you to contribute to an RRSP as you do not have any income and can mean that you cannot claim other personal expenses. 

Payment by a Mix of Salary and Dividends

Whether payment in a mix of salary and dividends is the best way to go for a business owner is dependent on their personal circumstances including income level, cash flow needs, and the corporation’s predicted income for the next year.  The owner needs to understand if he needs to have room to contribute to his RRSP and if income tax deductions are important.  The decision to pay in a mix of salary and dividends should be made after discussions with an accountant or financial planner.   

Sometimes a mix of salary and dividends is paid out by the company to ensure that it does not earn over $500,000 as this is the limit up to which a privately-owned company pays the lower rate of income tax. If earnings are greater than this, it can be better to pay the owner a salary thereby reducing the corporate income.

Sole Proprietorships or Partnerships

As these types of businesses are not owned by shareholders, they cannot issue dividends and the owners cannot be salaried employees with payroll deductions.  Business income and personal income become the same thing, so you have no choice but to report your earnings on a T1 income tax return.

From an article by Susan Ward

Five Common Mistakes That Small Business Owners Should Avoid

By Randall Orser | Business Income Taxes , Small Business

Small business owners, and those who work freelance or are self-employed must submit an annual tax return to the Canada Revenue Agency.  Most people only focus on their taxes a week or two before they are due, but you should really be thinking about them all year round so that you maximize your deductions and credits thereby reducing the amount of taxes that you have to pay. 

Here are five common mistakes that self-employed people make when filing their annual return.

1.  Failing to Write off Business Expenses

As a self-employed person the CRA allows you to deduct reasonable expenses that you incur while earning business income.  These expenses include start-up costs, business fees, memberships and subscriptions, salaries, wages, employee benefits, accounting legal and other professional service fees, telephones, utilities and office expenses. If you use your vehicle or home for business, you may be able to deduct related expenses for these too.  It is important that you are aware of which expenses you can deduct to have a lower taxable income, but you should also make sure that the expenses you are claiming are reasonable so as not to attract a CRA audit.

2.  Claiming Expenses that are not Deductible

If you claim expenses that are not deductible the CRA sees it as a failure to report income which can mean a reassessment and interest and penalty charges on the unreported income.  Make sure that you are fully aware of the expenses that you can claim when submitting your return.

3.  Forgetting to Track Your Expenses

Just keeping receipts in a box is not the best way to track your expenses.  You should be keeping records of all your expenses as they occur.  Use accounting software or a smartphone app to record everything immediately.  At tax time you will have a more comprehensive record which will make doing your return so much easier than trying to remember what each receipt was for long after the purchase.

4.  Failing to Report Cash or Trade Payments

If you receive payment for work by cash or trade, you must still report it.  Failure to do so can result in severe penalties from the CRA.  These can include more assessed taxes, interest and penalties, court fines and even jail time.  

5. Insufficient Proof Related to Meal and Entertainment Costs

Self-employed people can claim a partial deduction for meals and entertainment.  This is 50% of expenses incurred to expand your business or for travelling for work.  You may also be able to deduct all of your expenses for holding a holiday party for your employees or for buying food for a charity dinner.  If you are a long-haul truck driver you can claim 80% of your meal expenses and self-employed couriers can claim a flat rate of $17.50 per day.

Just saving receipts for these expenses is not enough for the CRA.  You must be able to prove that they were necessary for your business.  You should record information such as the event, who came, what was discussed and how it relates to your business on each receipt. In addition, credit card receipts showing the amount that you paid must be accompanied by a restaurant or event receipt showing what was purchased.  Truck drivers and couriers should record expenses along with mileage in a log book with information showing where they travelled and where work was done.

For more information see:

CRA Business Expenses

CRA Interest and Penalties

CRA "Will you do the job for cash? It's risky business"

CRA "Line 8523 - Meals and entertainment (allowable part only)" 

From an article by Turbo Tax

Do You Know Why the CRA Uses a Profit Test for Business?

By Randall Orser | Business Income Taxes , Small Business

The CRA defines a business as “an activity that you conduct for profit or a reasonable expectation of profit”.

The profit test is used by the CRA to determine whether or not a person is actually running a business.  The test asks, “Was the activity conducted with an actual expectation of profit?” and “Was that expectation of profit reasonable?”  Only a person (or legal entity) operating a business can claim business expenses or business tax credits on their income tax or GST return.  If the business does not pass the profit test, then all credits and expenses will be disallowed.

Criteria that the CRA uses to determine whether or not you are running a business:

  • The profit and loss of the business in past years.
  • The amount of gross income if any reported over several years.
  • The length of time in which the business can be reasonably expected to be showing a profit, relevant to the nature of the activity.  
  • The extent of the activity related to businesses of a similar nature and size in the same locality.
  • The amount of time spent on the activity.
  • The qualifications of the business owner, including training, experience and education including eligibility for membership of a professional association.
  • The individual’s intended course of action for the business to make a profit, for example preparing a business plan.
  • That the business has enough capital to make it capable of showing a profit after depreciation, and the individual has the resources available to allow the business to develop and expand.  This includes the ability to secure financing to make the business viable.  
  • That a degree of effort is spent in promoting and marketing the product or services supplied by the individual.  This includes the registration of a trading name and opening and maintaining books and records.
  • The type of expenses claimed and how relevant and reasonable they are to the activity, and if this expenditure will help the business to make a profit.
  • The nature of the goods or services provided is such that a market exists or can be developed and there is potential for profit.

For more information see the CRA's   P-176R – Application of Profit Test to Carrying on a Business

What is Income Splitting and How Can it Reduce Your Tax Bill?

By Randall Orser | Business Income Taxes , Personal Finances , Small Business

Income splitting is the transfer of income from a person in a higher tax bracket to a family member in a lower tax bracket.  The more you earn the higher your income tax bracket so “transferring” some of your income to a person whose income is lower than yours will result in having to pay much less tax.

The Family Tax Cut that allowed individuals to split their income with a spouse up to a tax credit of $2000 is no longer available, but businesses can use income splitting strategies still available to them.

There are two ways in which you can split your business income: 

  • By paying some of it in salary or wages to a family member 
  • Transferring some to family members in the form of dividends

Paying salary or wages to a family member means that you actually hire your spouse or children as employees and pay them from your business income thereby reducing your net income.  For example, if you earn $75,000 and pay your spouse $30,000 this reduces your income to $45,000 which is a lower tax bracket, and your spouse will be taxed even less as $30,000 is even lesser tax bracket, resulting in double tax savings for you both.  As great as this sounds there are strict rules on income splitting which involve hiring members of the family as employees.  

  • They must have duties to carry out the same as any other employee.  As with any other employee you must keep employee records to prove that your family member actually worked in the business.
  • You have to pay your family member the same wage as you would pay anyone else to do the same job.  You cannot overpay them for the job they do, the rate must be the same as other employees earn in the same industry.

Income splitting by Dividends is another way to pay your spouse or children, but you can only do this if your business is incorporated.  This tax strategy is very flexible in that the value of the dividends and those receiving them can vary from year to year.  Your corporation must be set up so that your spouse and children are shareholders then dividends can be distributed between them.  You can also structure your corporation so that there are non-voting share classes for family members so that they can receive dividends but not vote on decisions made relating to the company. 

For the 2018 tax year, the rules on split income received through dividends is changing.  For more information go to Revenue Canada guidance on split income rules for adults.  


Self Employed? Do You Know What Your Tax Obligations Are?

By Randall Orser | Business Income Taxes , Freelancing , Home Based Business , Sales Taxes , Small Business

While self-employment comes with some great benefits, such as a flexible work schedule and freedom to select your work projects, you also have big responsibilities, when it comes to tax time. You are totally responsible for reporting your income and filing and paying your taxes.

It’s a good idea to get familiar with the CRA required self-employment tax forms. When you understand what you have to do, you can organize your finances, keep great records, and make tax filing much easier.

Do you need to file self-employment taxes? You are considered by the CRA to be self-employed if your business is one of the following: 

  • A sole proprietorship
  • An unincorporated partnership
  • An unincorporated limited liability partnership
  • An unincorporated general partnership

Your business income is then part of your personal tax return which means that you will pay the personal income tax rate rather than the corporate rate if your business was incorporated.  

Do you need a T4A?  Unlike when you are employed and receive a T4 from your employer, if you are self-employed as an independent contractor then your clients should send you a T4A slip which will include the dollar amount for each job you do for them.  To figure out your income you need to add the amounts from each slip.

However, you will not always get a T4A especially if you are selling goods direct to customers, they will not give you one. You will then be responsible for keeping accurate records of all of your income from receipts, invoices and any other proof of income.  It is a good idea to use a program such as Quickbooks to keep track and you can run a report to find out your total income for the year.

What is a form T2125 for?  This a Statement of Business or Professional activities which helps you to calculate your gross income as well as your business expenses which you deduct from your income to lower your taxable income.  On the T2125 you will have to provide the following information:

  • Information about your business including a description of your products and services.
  • Income from internet activities such as affiliate sales or ad traffic revenue.
  • Business or professional income.
  • The amount of GST you paid 
  • Costs incurred while making and selling your goods
  • Business expenses
  • Expenses paid for while running your business from home
  • Information about your business partners if you are in a partnership

Once you have completed form T2125 you will know your gross and net income for the year which you will enter on your T1 form. If you run a few businesses, then you will need to fill out a T2125 for each of them.

When Do You Need to Pay GST?  If your business makes more than $30,000 per year then you are required to register for a GST number and collect GST from your customers.  You will submit a GST return either monthly, quarterly, or annually.  

Tax Deadlines  If you are self-employed you will have until June 15th to file your tax return instead of the April 30th deadline.  However, you should still pay any taxes you owe by April 30th.  If you are employed in addition to running your own business, then you will have to file your T1 return by April 30th. Your clients have until the last day of February to send you any T4A slips.

 

How Can You Claim Expenses on a Business Loss?

By Randall Orser | Business Income Taxes , Small Business

If you are a sole proprietor or partner and file your income taxes on a T1 you need to fill out a Statement of Business or Professional activities on a T2125.  Should your business expenses exceed your business income then you will record a business loss on this form.

"Using" this business loss depends on whether or not you have other income.  If you do you can use the income from your business to offset your other income. This is an advantage for people who work full time and have a side business as you can write off business losses against your regular income.  If you don’t have other income your business loss will not be a tax advantage for you.

Using Your Business Loss in a Different Tax Year  If you have personal income you can offset your business loss up to three years back or seven years forward from the year of your business loss, therefore it can make sense to use your business loss to offset a larger tax bill in the future or the past.

Beware! you Cannot Write off Business Losses Forever  According to the CRA your business should have a “reasonable expectation of making a profit” and will eventually generate more income, reduce losses and become more profitable.  If you continue to write off business expenses for a number of years, then the CRA will decide that you decide that your business does not meet this expectation and will deny your claim for business losses in the current year and will assess your losses in previous years.  See Canada Revenue Agency Profit Test.

Your Business Must be Legitimate  Your business must be seen to be “clearly commercial in nature”.  If you have a full-time job and start a side business, you must have customers and revenue. Otherwise your business expense claims may be denied by the CRA if they decide that your business is not a sufficiently commercial operation.

Incorporation  If your business is incorporated you cannot use business losses from the corporation to offset your other income, except in some cases where investment losses result may from share dispositions or debt. 

Claim Reasonable Expenses  To avoid raising red flags which may result in a CRA audit you should always be reasonable with your expense claims.

From an article by Susan Ward

What are Input Tax Credits?

By Randall Orser | Business Income Taxes , Personal Income Tax , Small Business

Input Tax Credits are the amount that your business paid, or the allowable portion of the GST you paid.  They allow you to recover GST you paid out on business purchases or expenses.  You must be registered for the GST to use Input Tax Credits.  Once you have done this you need to start keeping track of the GST you have paid and enter it into your bookkeeping system.  As with all expenses you need to keep all your receipts to support your claims.

What qualifies as Input Tax Credit?

Some of the expenses that you can claim as Input Tax Credits include:

  • Rent
  • Equipment Rentals
  • Advertising expenses such as business cards, ads and flyers
  • Accounting, legal and other professional fees
  • Home office and motor vehicle expenses
  • Office expenses including postage, computers, pens etc.
  • Travel including hotels, airfare, car rentals

These capital expenses also qualify:

  • Capital property
  • Machinery and vehicles
  • Furniture and appliances
  • Improvements to capital property

You can only claim Input Tax Credits for anything related to your business not for personal expenses.  The purchase or expense must also be what the CRA deems reasonable in nature as well as cost.  You cannot claim Input Tax Credits on:

  • Taxable goods and services bought or imported to provide exempt goods and services
  • Some capital property
  • Memberships or dues to any club whose main purpose is for recreation – this includes fitness clubs, golf clubs and hunting and fishing clubs unless the membership is bought to resell in 

For more information a full list is available on the CRA website

Common Income Tax Business Deduction Myths

By Randall Orser | Business Income Taxes , Small Business

If you think that running your own business means you can write off all your expenses well sorry to disillusion you but that is a common myth about Canadian Income Tax.  In reality you can only write off business expenses if you meet all the requirements as defined by the CRA.  If you do not comply with all the requirements, then you could find yourself with a hefty bill.  Here are some other tax myths you might want to consider:

Your volume of sales does not determine if you have a business or not – NOT TRUE

You may think that making and selling a few things or do some things as a hobby does not mean that you have a business.  The CRA does not see it this way, they define a business as “any activity that you do for profit” so you need to file your taxes to include any additional income you make from your hobby. 

If you run a business from your home, you can write off all your home expenses – NOT TRUE

You can write off some expenses specific to your home-based business, but there is a limit.  If you claim excessive expenses, it might cause the CRA to take a closer look and disallow some of them.  You can basically claim for home-business expenses under the same rules as for any other business.

You can write off all your entertainment expenses – NOT TRUE

There are very strict rules for business tax deductions for entertainment.  You can usually only claim up to 50% of the cost of meals or entertainment, and club membership fees are not deductible when the main purpose is for dining, recreation or sporting activities such as golfing.

You can write off all the equipment that you buy – NOT TRUE

The CRA sees the equipment that you buy as being depreciable.  When you purchase these items, you cannot deduct the total cost of the item, you will deduct the cost of the item over the several years of its life through a Capital Cost Allowance claim.  How much you can claim each year depends how the item is classed for more information see Capital Cost Allowance for Depreciation (CCA).


Rather than believing the myths, make sure you are up to date on all the income tax rules pertaining to your home-based or small business.  Your accounting professional will be able to help you with this or you can consult the Revenue Canada Website at:

https://www.canada.ca/en/services/taxes/income-tax/business-or-professional-income.html

 

 

How to Keep a Mileage Log for Business Vehicle Expenses

By Randall Orser | Business Income Taxes , Small Business

If you have used your vehicle to earn business income over the past year then you can claim the related expenses on your income tax. However, you must be able to verify your claim with evidence in the form of a mileage log book which is maintained for the entire year. 

You need to record the following information in the log book each time you use your vehicle for business purposes:

  • The date
  • The starting point
  • The destination
  • The purpose of your trip
  • The vehicle starting mileage
  • The vehicle ending mileage
  • The total kilometers driven

Mileage log books are available at office supply stores or it is easy to make one up yourself.  Alternatively, there are apps available for Apple and Android smartphones such as:

Business Use vs Personal Use 

Claiming excessive use of your personal vehicle for business purposes is a sure way to attract extra scrutiny and possibly an audit from the CRA.  So, it is important that you know how many non business-related kilometers you drove in a year.  The best way to calculate this is to record your odometer reading at the beginning of the year and at the end of the year, this will give you your total mileage for the year.  When you deduct your recorded business mileage this will leave you with the total for personal use.  

Employees who use company vehicles must also keep track of the mileage driven for business vs personal use.  Mileage for personal reasons is a taxable benefit that must be included in employee income.  Mileage recorded between home and place of business is considered to be commuting and is classed as personal use.

For more information about claiming business expenses related to the use of your vehicle to earn business income see What Motor Vehicle Expenses Can You Claim on Income Tax in Canada?

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