There are many things you need to consider before you incorporate your business. However, the most important thing is to understand what the differences are between being self-employed and starting your own corporation – and what the tax implications are.
Corporations File Tax Returns
A corporation is its own entity and therefore must file a tax return. This means that you’ll need to file both a personal and corporation tax return. In general, it is true that corporations pay a lower tax rate than personal. However, this normally applies to corporations that are making quite a bit of money. Corporations don’t receive tax credits such as the basic personal amount, which means that all of the net income in a corporation is taxable.
Corporate tax returns should be filed within 3 months of the corporation’s year end. Unlike self-employed income, a corporation does not need to file based on the calendar year.
Payroll can be another major component of incorporating your business. A self-employed person doesn’t need to worry about how to pay themselves. Instead, they can use their business income as they please as it’s all taxable on their own personal tax return.
Once you incorporate your business, you need to decide whether you’re going to withdraw a salary or dividends. In any case, there will be an expense on the corporate side and become taxable on your personal tax return. There are benefits to both but you must decide which one is best for your business.
Another consideration regards your expenses. As a self-employed person, you may be using your home and vehicle to earn income. As a result, you’ve been claiming a portion of both on your self-employment business statement to reduce your net income and essentially save on your overall tax bill. Once you incorporate, you can no longer claim these things to reduce your income.
You can rent a portion of your home for your business if you are using it to earn income; the rent will become an expense on the corporate tax return. However, you need to claim the income on your personal tax return. For your own personal vehicle, the corporation can either reimburse your vehicle expenses or provide you with an allowance. You can expense some of the costs for business purposes, but you will need to claim the costs differently.
These are but a few key considerations for your business. Before you make your final decision to incorporate, ensure that you understand your current business and get informed on how it may change the financial outlook. We also recommend that you seek out the advice of a professional lawyer to discuss whether or not incorporating is the most beneficial from a liability standpoint.
The answer to the question of whether or not you can split your capital gain with your spouse depends on whether or not you shared in the purchase of the investment and how much your spouse contributed.
You can’t just split a capital gain 50/50 with your spouse.
This is because of the Attribution Rules, tax rules which have been especially created to limit income splitting (shifting income from a family member with a higher income to a family member with a lower income to reduce the overall tax a family has to pay).
Simply stated, the Attribution Rules say that when you transfer or loan property to your spouse (or to a trust in which your spouse has a beneficial interest), any income or loss from that property is deemed to be yours for a taxation year.
So when you transfer or loan a property to your spouse, the Attribution Rules attribute the income from the property back to the individual who may have transferred or loaned the property to split income – namely, you. And as the owner, you are the person accountable for any capital gain or loss on the sale of the property.
You can read the details about the Attribution Rules in the Canada Revenue Agency’s IT511R - Interspousal and Certain Other Transfers and Loans of Property.
The general rule, then, is that you declare your capital gain based on the proportion of your investment at the time you made the investment.
For example, if you bought 200 shares of stock and then sold them, realizing a capital gain, all of the capital gain would have to be declared on your income tax because you are the only person who paid for the stock.
If, on the other hand, you and your spouse bought 200 shares of stock, and you paid 75 percent of the purchase price while your spouse paid 25 percent of the purchase price, you would declare 75 percent of the capital gain on your income tax and your spouse would claim the other 25 percent.
Having a joint bank account doesn’t affect the rule in the slightest; the capital gain still has to be split depending on the original contribution of each spouse.
Splitting the income from a capital gain is possible, as long as you have the foresight to think ahead when you decide to purchase capital property such as stocks or real estate and arrange the split of the purchase price accordingly.
The Small Business Deduction is one of the most beneficial income tax deductions available to Canadian corporations because it reduces the amount of Part 1 tax that a corporation would have to pay otherwise.
For instance, according to the tax rates in effect as of January 1st, a corporation that qualifies for the Small Business Deduction would pay income tax at the rate of 4.5% in Ontario, while corporations of other types in the same province would pay tax at a rate of 11.5%.
This chart from the Canada Revenue Agency shows the lower and higher rates of corporate tax for each province or territory (except for Alberta and Quebec which do not have corporation tax collection agreements with the CRA).
However, a “Canadian corporation” doesn’t mean any corporation operating in Canada. To qualify for the Small Business Deduction, a corporation has to be a Canadian-controlled private corporation (CCPC).
To be classed as a Canadian-controlled private corporation, all of the following conditions have to be met according to Chapter 1 of the T4012 – T2 Corporation Income Tax Guide:
There is also a size limit based on a Canadian-controlled private corporation’s taxable capital.
CCPCs that have taxable capital employed in Canada of $15 million or more do not qualify for the Small Business Deduction.
CCPCs that have taxable capital of between $10 million and $15 million in the previous tax year are eligible for the Small Business Deduction but their business limit is reduced on a straight-line basis.
In addition, any CCPC that is a member of an associated group that has more than $10 million of taxable capital employed in Canada faces a reduced business limit as well.
Qualifying as a Canadian-controlled private corporation is the best possible income tax scenario for a Canadian corporation. The Small Business Deduction is just one of the income tax advantages such corporations can enjoy.
The Canada Revenue Agency does not encourage income splitting. In fact, they have specific policies against it, such as the Attribution Rules, meant to enforce the idea that whoever earns the income pays the tax on the income.
Simply stated, the Attribution Rules say that when you transfer or loan property to your spouse (or to a trust in which your spouse has a beneficial interest), any income or loss from that property is deemed to be yours for a taxation year – effectively preventing you from splitting your income with your spouse by giving them money.
(You can read the details about the Attribution Rules in the Canada Revenue Agency’s http://www.cra-arc.gc.ca/E/pub/tp/it511r/README.html IT511R – Interspousal and Certain Other Transfers and Loans of Property.)
However, one way you can split your income with your spouse is to loan them money to purchase property from you or to purchase an income producing investment such as stocks, bonds or mutual funds.
What You Have to Do to Use This Strategy Effectively
1) Make sure the loan is properly documented just like any other loan, and includes repayment terms.
2) Charge interest that’s at least equal to the Canada Revenue Agency’s prescribed rate. Currently this interest rate is one percent! This rate may be locked in until the loan is paid.
3) Make sure the lower-income spouse who receives the loan pays the interest that is due on the loan every year or within 30 days of the end of the year. A missed payment will cause the Attribution Rules to kick in and the income generated by the lent money to be attributed back to the higher-earning spouse who lent the money that year and in all future years.
How Spousal Loans Work Tax-Wise
For you to end up with a lower overall tax bill between the two of you, the money you lend your spouse has to make a return greater than the prescribed rate – and you have a really good chance of your investment doing this with a prescribed rate as low as it is.
And there is no requirement to pay back the principal, only the interest.
The lending spouse has to include the interest as income on his tax return but if the loan was used to purchase income-producing investments such as stocks, the spouse who received the loan will get to deduct the interest paid on theirs.
You May Have Business Income and Not Even Know It!
Well, any activity that you do for profit is business income, according to the Canada Revenue Agency.
So if you’ve sold a few items on eBay or Etsy or set up a table at your local outdoor market and sold things, you have been engaging in business and have business income that you must declare on your business income tax.
You see, it doesn’t matter that you haven’t made much money. The Canada Revenue Agency does not set any dollar value in its definition. So technically, you could make 25 cents and that would be business income.
It also doesn’t matter that you have not been “officially” operating a small business. You do not have to take any action at all other than engaging in an activity for profit to be considered to be in business.
You don’t have to have invoiced anyone or registered a business name or taken out a business license. In fact, in all Canadian provinces and territories, you are considered to be operating a sole proprietorship, doing business in your own name as an individual business owner, without even touching a form of any kind.
(Sole proprietorships that want to use any other name except the business owner’s legal name and all other forms of business in Canada, such as partnerships or corporations, do need to federally and/or provincially register their names; for more information, see the CRA’s website for more information.)
So the bad news is that you have to declare all your income on your income tax return, including your business income, even if the business income doesn’t amount to much or if you’re not actually “officially” running a business.
If you fail to report all your income, you may be subject to a penalty of 10% of the amount you failed to report after your first omission, and, “if you knowingly or under circumstances amounting to gross negligence participate in the making of a false statement or omission on your income tax return” (Canada Revenue Agency), the penalty is 50%of the tax attributable to the omission or false statement (with a minimum penalty of $100).
The good news is that having business income makes you eligible to claim business expenses. See our blog article on eligible business expenses so that you can save more on your taxes.
Guest Blogger Robin Taub is a financial literacy consultant, speaker and blogger and the best-selling author of A Parent’s Guide to Raising Money-Smart Kids. She holds a Bachelor of Commerce (with High Distinction) from the Rotman School of Management at the University of Toronto and earned her Chartered Accountant designation in 1989.Robin is also passionate about improving opportunities for women CPAs to advance into positions of leadership and is Chair of the Chartered Professional Accountants of Canada’s Women’s Leadership Council. She is an avid cyclist, snowboarder, music lover and concert goer and is the mother of two teenage children.
As we finally say goodbye to winter and welcome in spring, there is another short season most of us will encounter: tax season. This is the time of year when we’re busy gathering and organizing our tax information in anticipation of the April 30 filing deadline. I stay on top of my taxes throughout the year by filing my slips and receipts in a large accordion file as they come in. By the end of March, I’m ready! With tools like TurboTax, preparing and filing my return becomes a fairly quick and painless process.
But maybe your according folder looks more like a shoebox, with your receipts, T-slips and other documents in one big disorganized pile?! Then the first step is to spread out (take over the kitchen or dining room table) and start sorting and organizing your receipts.
Your kids may notice that you’re up to something, so why not use this as a teachable moment – an opportunity to talk to them about taxes. Although your kids are unlikely to be income taxpayers until they have their first real job, they’re not too young to understand the basic concept: you are taxed on the income you earn, and the more money you make, the more tax you pay! Explain that the reason we pay taxes is because the government needs money to provide us with the programs and services we use every day, like roads and highways, visits to the doctor or the hospital, or skating at the community centre. If your kids go to public school, let them know that it too is funded by the government with taxes.
You can even get your children involved in tax season. When my kids were young, they would help me sort and organize my business expenses from the receipts I had collected, making piles for parking, gas, meals and entertainment, and office supplies, to name a few. I explained that I was able to deduct any reasonable cost of running my consulting business against the revenues I earned and that these receipts were the proof. (They were even more helpful once they took grade 11 accounting!)
Tax Credits & Deductions
You can make taxes relevant and interesting to your kids by explaining that some of the things they do actually help lower your taxes. For example, if your kids attend a parochial school, you may be entitled to claim some of the tuition as a charitable donation (the school will provide a receipt with a breakdown). Some of their extracurricular programs provide tax savings too. If they take gymnastics or hockey, you can claim the children’s fitness amount; or if they’re enrolled in guitar lessons, you can claim the children’s arts tax credit. And because raising kids is “taxing”, you can claim a child tax credit for kids under 18.
Your kids may be interested to learn that the amount you pay their babysitter or nanny, daycare centre, or day camp, while you go to work (or school) may be deductible as a child care expense. The maximum is $7,000 for kids under 7 and $4,000 for kids 7 and older, up to age 16 ($10,000 for children who qualify for the disability tax credit).
In my next post, we’ll look at how to teach teenage and young adult children about taxes.
Sound familiar? New Year’s resolutions can tend to fall by the wayside as people start to get busy in the spring. Filing your tax return can quickly get relegated to the bottom of your to-do list, leaving you scrambling the week before the deadline.
Procrastinators rejoice! The tax deadline has been extended to May 5 this year, but the best thing you could do for yourself is to forget I just told you that. If you are expecting a tax refund, it’s in your best interest to file now. Even if you anticipate paying income tax this year, filing early will save you from worrying about penalty fees.
If you’ve already filed your taxes, congratulations! If you haven’t yet, you are probably from Manitoba, which is the top procrastinating province in Canada based on the number of people who have filed with TurboTax. According to TurboTax data, Calgary is leading the pack with 46,196 people having filed their taxes. At a close second is Toronto (44,626), followed by Edmonton (27,503) and Vancouver (22,216).
Generation Y is leading the way in filing their taxes this year, making up 38.7 per cent of total returns filed. It might be time to pay a visit to mom and dad for a quick tax tutorial as Baby Boomers are lagging behind with only 21.9 per cent having filed so far. The good news is, it’s never been easier to get your taxes over with by filing online.
Fantasizing about what to do with that big cheque? Here are the top three things you can do you’re your refund, and why filing earlier can save you some money:
When filing taxes electronically, most Canadians receive their refund within eight days after filing. This is most likely the biggest cheque you will receive all year. What are you waiting for?
Unfortunately, receiving grants and/or bursaries also affects your income tax.
In most cases, grants and bursaries are considered taxable income.
If you are a self-employed artist, grants that are intended to help you produce “a literary, dramatic, musical or artistic work” (Canada Revenue Agency (CRA)) are included as part of your business income.
The case is much the same if you’re employed as an artist, whether you’ve been selected through a government program to become a writer-in-residence, had one of your works chosen for the Art Bank Purchase program or taken a position that exists because of a Canada Council grant.
Unless it’s a prescribed prize…
Prescribed prizes are not considered taxable income. However, winning any old prize won’t do; a prescribed prize is defined as “any prize that is recognized by the general public and that is awarded for meritorious achievement in the arts, the sciences or service to the public.”
So if you win an award such as the Governor General’s Literary Award or the Sobey Art Award, the amount of the prize won’t have to be included in your income. It doesn’t have to be a nationally known award, though; many community service awards would fit the criteria too.
Do you qualify for the scholarship exemption?
The scholarship exemption lets you exclude the first $500 of total scholarships, fellowships, bursaries and prizes that have been included in computing your income in a given tax year.
If you’re a part-time student, you can still claim the scholarship exemption; you just can’t claim all of it. The Canada Revenue Agency’s Scholarship exemption – Part-time enrolment worksheet will show you how much you can claim in this case.
And if you received an artist’s project grant (a scholarship, fellowship, bursary or prize used in producing a literary, dramatic, musical, or artistic work) you may claim more than $500 under the scholarship exemption – “an exemption in excess of $500 where a scholarship, fellowship or bursary is received in connection with a taxpayer’s enrolment in certain educational programs or is used by a taxpayer in the production of a literary, dramatic, musical or artistic work” (CRA).
To apply this deduction, commonly known as the art production grant exemption, you have to have used the amount of the grant to compute your income. You can read more details about this and about the rules governing Scholarships, Research Grants and Other Education Assistance in the CRA’s Income Tax Folio S1-F2-C3.
The good news
…is that whether you were a self-employed artist or an employed artist in the previous tax year, you can deduct appropriate expenses.
Self-employed artists can deduct the usual business expenses while employed artists can deduct the expenses they paid out to earn employment from an artistic activity in a particular tax year if they:
The amount you can claim is limited to the lesser of 20% of your employment income from artistic activities or $1,000 but if you have expenses that you can’t claim because of this, you can carry them forward and deduct them from artistic income you earn in a future year.
If you win the lottery, your prize is tax-free. (And you don’t have to pay any kinds of taxes or fees to the Canada Revenue Agency (CRA) before you claim your prize; this is a scam and if someone tells you that you need to pay to receive a prize you’ve won through a lottery or sweepstakes , you should immediately report them to the Royal Canadian Mounted Police.)
However, if you’ve won a prize through your workplace, it will be taxed in most cases.
For instance, if you win a prize draw, and the draw was only open to employees of the company, your prize is considered a benefit of employment and becomes a taxable benefit.
It’s the same story if you’re part of a team that wins a prize for top performance; the “thanks for a job well done” is, in the eyes of the Canada Revenue Service, performance pay – another taxable benefit to the employee.
The one potential exception to this if you win a prize in a draw by a social committee in your workplace.
If the social committee itself paid for the prize and the committee is “funded entirely by the employees through fundraising activities” (CRA), then any gifts or awards the social committee gives out are non-taxable.
But if the committee is funded entirely by the employer, then any gifts or awards the social committee gives out are taxable benefits.
And if the employees and the employer jointly fund the social committee, generally, the percentage that is employer funded represents a taxable benefit to the employee, while the percentage funded by employees is not – which could make figuring out the taxable portion of the giant striped tiger the committee presented you with extremely problematical!
And If the Prize Is Taxable?
If the prize you’ve won is a taxable benefit, then your employer has to include the value of it in your income.
If the prize was something other than money, he or she has to calculate what the prize item is worth by determining its fair market value – “the price that can be obtained in an open market between two individuals dealing at arm’s length” (CRA).
Depending on what the item is, your employer may also have to include the GST/HST in the value of the benefit for income tax purposes, as well as provincial sales taxes.
Then he or she will add the value of the item to your income, taking and withholding payroll deductions in the usual fashion.
You’ll see the taxable gift on your T4 slip, included in box 14, “Employment income” and in the “Other information” area under code 40 at the bottom of the slip.
Congrats, you’re a dedicated employee by day and a self employed ninja by night. Kudos to all your extra work since let’s face it, there’s no way it’s easy to balance both. Whatever your reason for earning extra cash, don’t forget to dot your i’s and cross your t’s come income tax time.
When you hold a full-time job, your employer automatically deducts income tax from your bi-weekly earnings. At the beginning of every year, you receive a T4 slip in the mail, which lets you know how much money you earned during the year and how much tax you paid. With the slip, it’s easy peasy to do your taxes since everything you need to know is on the slip of paper.
But when you’re an independent contractor, it’s a whole different ballgame. You’re the only one who knows how much money you made that year and it’s your responsibility to report the accurate amount to the government. (Saying “Oops, I did it again” won’t cut it with the tax man.)
Since the government hasn’t charged you income tax on your extra earnings, they’ll do so when you file your income taxes. (RRSP anyone?)
Whether you’re considered self-employed or as another employee of the business makes a difference to the CRA. If you’re considered another employee, you’ll have less deduction options. The contract you’ve signed with the company can help determine what sort of business arrangement you’re in. There’s also certain criteria the CRA users to determine your status: how much control the worker has, who provides the tools used in the job, how much financial risk the worker takes on, what is the worker’s opportunity for profit and can the worker subcontract work or hire additional help.
If you’re raking in some extra dough, good for you, but how much you earn makes a difference in your income tax. If you earn less than $30,000 as an independent contractor, you don’t have to pay the government HST. If you earn more, you will have to. The good news is that you can tack on HST for your product or service when you sell it to a customer. The bad news is that you get to act as the go between the government and the client. Don’t forget to visit the CRA website and sign up for a business number.
If you’re fretting about the extra income tax you may need to pay during tax time, the government offers what could be a saving grace. No matter how much extra income you’re earning, you can now deduct some business expenses. Whether you have a home office space where the extra work magic happens or you drive your car to meet your clients (during off hours, of course), you’ll be able to claim a portion of those necessary expenses that helped you earn some extra moolah. But most importantly, keep it real. If you’re claiming 100 per cent of your vehicle was used for work purposes, we all know that’s a lie. Visit the CRA’s website for all the details on legitimate business expense claims and as always, make sure you hold onto all your receipts as proof.
Earning extra money is great, but chances are that you’re more likely to either receive a lower income tax return or be required to pay some extra income tax. Hang on to more of your hard earned cash by taking advantage of RRSP contributions, income splitting, business expenses, tax breaks or selling a losing stock for a capital loss. Find ways to cut your tax bill year round.
But in the unfortunate scenario that none of these can lower your tax bill, you better make sure you have some extra money on hand to pay up during tax season.