Over the years in having clients come over with the files to our accounting firm I have noted the following area’s where incorporated businesses make the biggest mistakes.
Tax Preparer vs. Accountant
Several small business and professional corporations have tax preparers and not accountants. Tax preparers prepare the returns for filing based on the information provided by owners without any verification, planning and tax compliance assessments. Small business owners now more than ever require accountants for tax planning, corporate tax structures, ensuring tax compliance with the ever-changing tax environment. I have seen clients get in trouble with the CRA and miss out on thousands of dollars of tax savings strategies due to this particular point.
The shareholder structure of the corporation is a key ingredient in proper tax planning and future challenges and opportunities from both a tax and legal perspective.
Common voting shares vs. Preferred non-voting shares
For incorporated Professionals mostly the individual can hold the common shares. As such other family members may only qualify for non-voting preferred shares. This is very critical to give different amounts in dividends for tax planning.
Small businesses that have a family structure also have to organize the shares from the beginning in a way that gives the corporation flexibility to pay different amounts to different shareholders. Also this also impacts the LCGE (Life-time Capital Gains Exemption). If family members are not shareholders and are actively involved in the business then at the time of selling the business they would not qualify for 835,716 exemption. So effectively the one common shareholder would be exempted but the remaining amount would be subject to tax on 50% of the capital gains.
A husband and wife setup a business together but the husband only is the common shareholder. The business is sold for $2 million after 10 years. In this case the first $835,716 is exempted from capital gains tax but the remaining $1,164,284 is subject to 50% tax or $291,017 has to be paid to CRA. If the wife was a common shareholder and setup properly as she was contributing to the business then $1,671,432 would be exempt and only $82,142 would be paid to the CRA upon the selling of the shares of the business.
That is a difference of $208,875 right there.
Also in many cases dividends can be a better tax strategy for income splitting between the various shareholders and one shareholder could get up to $40,000 in tax free dividends. With the proposed changes this might be different for incorporated professionals and traditional small business owners. Scenario’s have to be considered with the current regulations and tax changes.
Shareholder agreements are key to take back shares of spouses in case of future disputes. With the divorce rate in Ontario at close to 50% these are options that need to be carefully looked into especially for incorporated Professionals and small business owners whose spouse may not be one of the primary contributors to the business.
Pro-Active vs. Reactive
Many business owners show up at the end of the year with their books and traditionally year end entries are made and the corporate taxes filed with a notice to reader. The problem with this method is that many times tax savings opportunities are missed and not managed in the year concerned. As an example a business owner needed some extra money for renovating his home. Instead of taking out a shareholder loan which would be payable in the year following the current fiscal year end or 18 months he paid himself an extra bonus with salary and dividends increasing his personal tax rate. His renovation which cost $100,000 ended up costing with personal taxes paid $140,000. If he had taken a shareholder loan and defer the taxes between two years he would have saved $25,000 in personal taxes.
Separating Personal verses Business
How many times have I seen small business owners carrying personal credit cards to pay for business related transactions and business credit cards with personal expenses on them. There has to be a clear segregation between personal and business. Even cell phone plans should be put under a corporate plan and paid via a corporate credit card for example.
Vehicles that are primarily used for the business should also have lease and purchase agreements under the corporation. All related insurance, repairs, fuel should be paid via the corporation only. If a personal vehicle is used for business then a tax free KM allowance should be paid and no other vehicle expenses put in the corporation.
I have seen clients with registered corporations for several years paying their life insurance from the personal account thereby creating tax triggers that cost several thousand dollars more annually due to not having a plan within the corporation.
Tax Triggering and Tax Deferral
With the corporate tax rate being soon 14% and the marginal tax rates touching 53% it is fair to say that owners of corporations should be very careful how they withdraw money from the corporation to manage the personal tax obligations. Clients too often are totally unaware of the tax obligations that could have been deferred thru other ways of paying shareholders when special needs arise. As a corporation can outlast a shareholder money in the corporation can be taken out over an extended period of time to manage the personal tax obligations.
Most corporations are required to pay installments for corporate and GST depending on the previous year’s declared income. Many times we have discovered that due to missed payments interest and penalties occur and the balances for GST and corporate taxes are not kept accurate.
It is best for corporations to have an accountant retained who regularly monitors the books and is available throughout the year to give pro-active advise. At our firm we put our clients on block fee’s for the accounting cycle so these errors don’t occur and opportunities are not missed to reduce the tax obligations.