business expense

Posts

When Should I Incorporate My Business?

To Incorporate or Not to Incorporate

Should I Incorporate my business… This is a very common question, and the answer isn’t always clear. It depends on your current situation, your future plans, and some best/worst-case scenario analysis. We’ll look at the various factors/benefits and drawbacks.

If you’re not incorporated…

If your business is not incorporated, you report your business income and expenses with a schedule on your personal tax return. The net income is included in your taxable income and you pay tax based on your marginal personal tax rates. On the flip side, if you have a net loss, that amount can be deducted from your other sources of income.

What does it mean to Incorporate?

When you Incorporate a business, you create a separate legal entity. Your business operations occur within this entity.

What are the benefits to incorporating:

  1. Separate legal entity. Corporations can own property, obtain loans, and enter into contracts. If the owner happens to die, the corporation lives on.
  2. Easier access to capital. Corporations can often borrow money at lower rates or more diverse lending options.
  3. Lower tax rates. In Alberta, the small business corporate tax rate is 11%. This rate is considerably less than the marginal personal tax rate of 25%-48% in Alberta. This personal tax rate doesn’t include the Canada Pension Plan payment requirements of up to $6,332.90 (based on 2021 rates).
  4. Limited liability. A corporation can protect you from being personally liable for certain business liabilities.

What are drawbacks of incorporating:

  1. Corporate tax filing requirements. The cost of preparation of a T2 Corporate tax return is often significantly higher than that of a business schedule on a personal tax return.
  2. Record-keeping requirements. In addition to the revenues and expenses, you’ll need to track the assets and liabilities of the corporation. This can add considerable costs in record/bookkeeping.
  3. Other costs. It costs money to incorporate: the basic costs to incorporate, a name search, maintaining your corporate Minute Book, and Annual Return filings.

Should you Incorporate your Business?

Answer: That all depends on your circumstances. The benefits must outweigh the additional costs and filing obligations. Here are some factors to consider when looking at your options:

  1. What are your earnings in your business? Do you earn at least $20,000 more than what you need to live on and would appreciate saving on personal tax? This is the point where the benefits start to make sense when considering the cost of incorporation. If you have net business losses in the start-up phase of your business, it may be beneficial to NOT incorporate and use the losses to offset your earnings from other sources. In the same way, if your business earns approximately what you require to live on, there are generally very few tax savings to warrant the costs and efforts involved in incorporating.
  2. Do you have other business partners or a need to raise money? Incorporating can add flexibility in how owners are compensated. Corporations also have more flexibility in obtaining financing from lenders or raising capital through investors.
  3. What sort of risks is inherent to your business? Can someone sue you? What is the likelihood of a lawsuit? If there is a chance that you could have uninsurable losses, you may wish to consider incorporating. The corporate entity could shield personal assets from lawsuits or unforeseen business operation losses.
  4. Do you have other needs? Do you require the appearance of being a little more established or sophisticated in the business world? Will potential customers/clients respect you more if you’re incorporated? Perhaps you simply won’t qualify to obtain a sales contract if you’re not incorporated.

Let’s take a look at some real-life examples.

Scenario 1:

Dylan is a fantastic artist and his friends have convinced him to sell his works online. He works at building this dream in his spare evenings and weekends. He’s using his savings and day job earnings to fund the start-up costs for his new business. It’ll take time to establish his brand, build his website, and perfect his product before sales start to increase.

Dylan should probably NOT incorporate. He will likely have a net loss from his first year or two of operations. These losses can be used to reduce his other forms of taxable income on his personal tax return. He’s better off avoiding the excess costs to incorporate and enjoy the personal tax savings writing off his business losses.

Scenario 2:

Casey is a real estate agent. Casey has been reporting their net business income on their personal tax returns for years. Over the last few years, Casey has found that the earnings from business activities are quite a bit more than what they require to comfortably live on.

Casey could likely benefit from incorporation. When net business income is at least $20,000 more than what is required for living, earning money through a corporation (and benefiting from small business tax rates) can be a fantastic way to defer some tax. Casey would draw from the corporation when they need to live on and report the related compensation (salary and/or dividends) on their personal taxes. Excess earnings remain in the corporation and are not taxed personally. The greater the earnings over the living requirements, the greater the tax deferral. A business owner earning a net $400,000 while only requiring $90,000 can see tremendous tax savings from incorporation making it well worth the costs to incorporate.

Scenario 3:

Ava, Marissa and Lauren are Engineers. They want to combine their efforts and offer consulting and design services. Marissa is only able to work half-time as she has demanding family obligations. They wish to take advantage of as many research grants as possible.

This Engineering company would benefit from Incorporation for a number of reasons:

  • A separate entity would allow for flexibility in allocating compensation to its various owners. All three can be equal owners of the corporation, but their wages can be determined based on their efforts.
  • Many grants require that businesses be incorporated in order to receive funds. The company may also require bank financing for projects/equipment.n incorporated company may appear more sophisticated to potential customers/clients/collaborative partners. There is a strong chance that certain contracts may require the company to be incorporated.

Scenario 4:

Martin has worked as a truck driver for years. He’s always dreamed of owning his own rig and being his own boss. He has finally saved enough for a down payment on a truck and has lined up fairly steady work allowing him to quit his day job.

Martin may wish to consider incorporating. With his line of work, there is potential for accidents. Should the unthinkable happen and insurance not fully cover the fallout, his personal assets could be exposed to this liability. The separate corporate entity would allow him to declare bankruptcy within the corporation and walk away from the liabilities.

Keep in mind that situations can always change in your business. If it doesn’t look like now is the right time to incorporate, it’s fairly simple to incorporate at a later date. Talk to your experienced, qualified Chartered Professional Accountant about the right path for you. If you don’t yet have a trusted advisor, we’d be happy to help!

/by

Contractor Reporting – The T5018 Slip

Have you heard of the T5018 slip?

Did you know that if your business is operating in the construction industry, you may be required to file an annual T5018 Statement of Contractor Payments with Canada Revenue Agency (CRA)?

The why

What is the reasoning behind yet another filing obligation with CRA you may ask? Well, it is estimated that the underground economy totals over $45 billion a year in unreported income in Canada and that the construction industry represents almost 1/3 of the underground economy. With those kinds of statistics, it is no surprise that CRA is taking action to combat this and one of their weapons of choice is the T5018.

The T5018 requires the payer to report to CRA who and what they have paid to subcontractors so that CRA can match those payments up to ensure that the income is being reported by the subcontractors.

So does this form impact you?

First, you need to determine if your business is considered to be operating in construction activities according to the list provided by CRA. Most of this list is the expected: drywalling, electrical, plumbing and carpentry; however, there are some less expected construction activities such as fencing and swimming pool installation.

Second, if you are in the construction, do have more than 50% of your revenue coming from construction activities? If the answer is yes, then you may have to continue to the third criteria.

Finally, did you make payments to subcontractors for construction services? Don’t forget that cash payments and barter payments are considered payments.

At the end of all of this if you are operating in the construction industry, have more than 50% of your revenues from these sources, and paid subcontractors, then you should be filing the T5018 annually with CRA.

What is the downside of failing to file these returns? The failure to file penalty is $25 a day with a minimum penalty of $100 and a maximum penalty of $2,500. And of course, these late filing penalties are not deductible for tax purposes.

If you have questions on the T5018 Statement of Contractor Payments, give us a call, and we will be happy to discuss it with you.

/by

What Can I Expense Through My Corporation?

What constitutes a business expense?

I get this question ALL the time from my business clients.

As a general rule, expenses must be incurred with the purpose of earning business income. The expenses must be reasonable and justifiable. I’ve compiled a list of the more common expense questions with the answers to perhaps paint a clearer picture.

Are haircuts a business expense?

This is a solid NO.

Personal grooming costs are not deductible… even though you may have to look presentable and professional to meet with customers and clients. Let’s be honest, almost everyone who is working with the general public should be somewhat groomed. This is a human thing—not a business expense.

What about clothing?

Canada Revenue has a stance that unless the clothing is considered a uniform, it is not deductible. A loose definition of a uniform is something that a normal person would not wear to a mall. (I purposely did not mention Walmart here). This means that your business suits are not deductible. There are occasions where clothing may be permitted as an expense.

  1. Clothing that is specifically required safety gear is a reasonable and justifiable deduction.
  2. Clothing that contains your logo for advertising purposes would also be considered deductible.

Go ahead and order your next golf shirt, jacket or hoodie from a promotional supply store and be a walking billboard (I personally think this would be hilarious if you had a numbered company with no real logo).

Is a home office a business expense?

If you are working out of your home, yes, a portion of the expenses can be expensed. If you are paying rent at an official business location (or own the space), you likely cannot also deduct for your home office. If you are expensing a portion of your home for business purposes, do be careful not to be too aggressive with those claims.

I’d be hesitant to claim more than 10% of your homes’ costs (mortgage interest, property taxes, repairs and maintenance, utilities, insurance, security system, etc.).

If you’re claiming more, Canada Revenue Agency deny a portion of your principal residence exemption when you go and sell your home. In other words, if you claim 40% of your home expenses for your business, CRA would argue that 40% of your home was for not for personal use and therefore, you’d have to report 40% of any gains on sale as income on your taxes.

How are telephones a business expense?

If you still have a landline in your home, you cannot deduct this for business purposes… just the specific charges for any long-distance calls related to business. Your business cell phone can be deductible. Communicate with your cell phone provider that you have a business as certain carriers have special pricing for business owners.

What about conferences?

Here is a brilliant way to make your next trip to Vegas a business expense! Find a conference that is somewhat relevant to your business operations. You can deduct up to two conferences per year.

Paying your children or spouse a wage.

This one boils down to the expense has to be reasonable and justifiable.

  1. Can you pay your 3 year old $10,000 a year for sweeping out the garage?
    • No. This is not reasonable.
  2. Can you pay your husband $150,000 per year for sorting receipts?
    • Likely no—because you wouldn’t pay someone you weren’t related to that kind of amount.
  3. Can you pay your teen minimum wage for sweeping out your shop? Or pay your spouse fair market value for administrative work?
    • Yes. This would probably be considered reasonable.

Keep a detailed timesheet to document and justify the expense…just as you would to any other employee that wasn’t closely related to you or sharing your bed.

How do meals and entertainment factor into business expenses?

Yes, these are deductible expenses… but don’t go too crazy.

  • Go for lunch with that potential referral partner.
  • Buy a coffee for the potential new client.
  • Take the staff out to celebrate completing a major project.
  • Order dinner in house when key staff are staying late to get the job done.

Don’t try and expense every single meal you eat through your company. Similarly, your personal groceries are not deductible. Again, these expenses need to be reasonable and justifiable.

For example, an oilfield contractor would have a tough time justifying how Oilers season tickets were a legit expense to earn business income. On the other hand, if you typically dealt with many customers and relied on referrals, perhaps you could deduct some of those hockey tickets because you gave them to clients or associates as a thank you for referring new business. Documentation is key in this case. Who got the ticket and why?

Every business is unique. If you have specific questions of what types of expenses would be considered reasonable and justifiable for your operations, feel free to contact us.

/by