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Victoria, BC British Columbia Canada V8P 2L5Tips For Keeping Your Profits
Business expenses must be reasonableLook at you. You've become a wage slave, selling your precious freedom for a salary nearly halved by taxes.
It wasn't supposed to be this way. You'd be a free man in Paris, a writer or dealer in fine European antiques, flying from Toronto to the great capitals of the world – London, Vienna, Paris, Hong Kong.
Ah, that was years ago, before the mortgage, the kids, all those monthly payments that keep you tethered to your desk like some cud-chewing domestic animal.
Time has passed. Your waist has grown thicker, your wallet – at least the part left for you – even thinner.
So you labour for a corporation that would delete you like yesterday's email newspaper if its profits flag. The security for which you sold your very self is beginning to look a tad precarious, no?
But wait. "French is in again," you think to yourself. "Maybe I could take a week's holidays and fly over to Paris to check it out."
Stop right there. This sounds like a nascent business plan. In business, the idea comes first, but financial and tax considerations quickly intrude. Your future success may depend on how you handle them.
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Tax Tip No. 1
Don't wait until you're wheeling and dealing to get tax advice. Would-be entrepreneurs who are still working at day jobs make two common mistakes, accounting experts say: not getting full benefit from potential deductions when they're starting up; and, conversely, trying to deduct expenses they're not entitled to.
"People are reluctant to include start-up expenses on their tax returns because they didn't make any money," notes Warren Baldwin, regional vice-president of T.E. Wealth.
So he asks: "Did you spend any money?" For a printer, for example, or paper, or ink, or someone to set up your computer.
"Yes," you reply.
"And do you think Canada Revenue is going to want tax money once you make a profit?" he prods.
"Of course," you say.
"Then why not deduct expenses you're entitled to when you're starting out?" he counters.
"That's a classic," says Baldwin, a chartered accountant and fee-only financial planner. "People don't realize that when they're starting a business, getting the structure in place, as long as it's a genuine business, if the expenses are greater than the income, then you'll get a tax deduction for them."
Another lost opportunity at the beginning is home office expenses, he notes.
They differ from other business expenses because you can only deduct them from business income, not employment income.
"People pooh-pooh the idea because they're not making any money in the first year," he says. "But if home office expenses result in a loss, you can carry that loss forward to deduct against income in future years."
What can you deduct?
Say your home office is the spare bedroom in a six-room house. As a rule of thumb, you would pro-rate the expenses, taking one-sixth of them. That includes mortgage interest, insurance, taxes, heat, hydro, snow shovelling, house cleaning and lawn maintenance.
Resist the temptation to claim capital cost allowance because doing so would jeopardize the tax-free capital gain you may one day enjoy on the sale of your principal residence, Baldwin cautions.
Expenses, whether for accounting, legal, office or research, must be reasonable – and seem so to the taxman, experts emphasize.
Claiming expenses to which you're not entitled is a common pitfall of inexperienced entrepreneurs. It can be costly, even devastating, to a young business because Canada Revenue could disallow them now or later, forcing you to pay back thousands of dollars.
But we're getting ahead of ourselves.
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Tax Tip No. 2
Before you fly off to Europe, register your business. That means going down to the provincial government office and registering with them as a sole proprietor or partnership. If your business will bear the risk of liability from personal injury, like a storefront where customers could slip or trip going out the door, you may want to incorporate.
All the potential deductions in the world won't help if you don't really have a business.
"The sooner you register, the better it is for you," says Andrew Patricio of Enterprise Toronto, who helps run the Up & Running Biz Launch Program sponsored by Toronto Economic Development. You may not plan to officially open your doors until next January, but you're incurring expenses now, Patricio points out.
"It pays you to register the business now even though it's not generating any revenue" so you can claim your expenses.
(Among the courses Enterprise Toronto offers is one called "Keep your day job while you start your business" for $495, although Patricio encourages people to get out on their own as quickly as possible.)
What if you've made a little money painting houses or selling antiques without being registered as a business owner? Can you claim expenses and register later?
Quite likely, advisers say, because it will be easier to persuade Canada Revenue that you're a business when you have income.
But I can see you're getting impatient. Is that trip to Paris tax deductible or not?
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Tax Tip No. 3
Keep detailed records of all your expenses, noting what portion can fairly be claimed as business and what portion is personal. This can be particularly complicated with auto expenses, where tax software can help, Baldwin says.
Quite likely, your European trip will only be partly deductible against your emerging business because you will spend some time taking in the sights and tastes of Paris. Dinner with an antique wholesaler would qualify as a business expense; with a spouse or friend it would not.
Cruelly, the very people who stand to be the most successful entrepreneurs are often the worst at keeping clear and organized records, such as separate bank accounts, parking receipts or long distance telephone logs, because their minds are so focused on their business.
If that sounds like you, you will need someone to keep your records and organize your books for the accountant.
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Tax Tip No. 4
The trip paid off and you came back from Europe with a load of fine French antiques. The money is rolling in and you need some help.
Where it's genuine – that is where you'd have to hire the help somewhere – you can hire family members to work in your business and deduct the expense from your income.
If your spouse or sibling is a good interior decorator or salesperson or marketer, you can hire them to help out in your shop or to launch a decorating sideline.
If your children are computer whizzes, you can hire them for a reasonable fee to help build your antiques website.
"Your daughter can be your IT department," Baldwin quips.
"It's not uncommon to have family members involved in the business," he says. "It gives children a chance to spend more time with their parents and gives them an interest in the business."
Besides, having children do photocopying, collating and filing frees you as an entrepreneur to make key phone calls that may bring in more business, he notes.
It also affords the opportunity for income splitting because while you would have to pay someone anyway, the money flows back to your household in a more tax-effective way than if you earned it all yourself.
One of those children might just grow up to be president.
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Tax Tip No. 5
A few years have passed and you're thinking of slowing down. Give long and serious thought to what will happen to your business when you retire, and seek professional advice ahead of time to make the transition tax effective for you, your heirs and successors.
Robert Kerr, chair and founder of Kerr Financial Corp., has been doing just that, so he speaks from experience. His daughter, Krista Kerr, is president of the company. Two other children are not involved in the business.
"When you're passing on the business, is it more valuable to receive a business or get cash?" Kerr asks rhetorically.
"Thousands of parents are being faced with that question right now. It's a boomer thing. People have operated a business for some time and are thinking of passing it on, perhaps leaving the business to their daughter and giving their son cash." Or finding a buyer outright or selling to the employees.
"Often the owner is so proud of the business, he puts in so much time making it work, he thinks it's a valuable thing and wants to pass it on to his children ...
"When we do planning for business owners, we make sure they provide for equalization among children, and consider the question of whether the owner is passing along a burden or a gem."
Do your heirs have an entrepreneurial bent?
"Small business has been a way people most often made millions of dollars as opposed to being salaried workers," Kerr says. "Yet you have to be able to deal with that kind of activity, be a jack of all trades, who's proactive, has a real marketing bent and great attention to detail."
When you sell a qualifying small-business corporation, you get a tax break on the first $750,000 of capital gain, he says. The vendor can reinvest up to $1 million of the sale proceeds in another small business, thereby deferring taxes on capital gain.
"Those things are attractive advantages. If you can put up with the heat of a small business, the fact that you're your own boss, you don't have to work 9 to 5, there's a lot of psychological benefits.
"You're in control, in charge. You have more control over your time – if your clients don't take it all – and opportunities to build family members into the business and give them jobs."
If no one in your family is interested and you want to keep the shop open, you may consider selling. Don't just hang out a For Sale sign. Selling a business is a bit like selling your home, says Kerr, a chartered accountant and fee-only financial planner.
"It's something you don't do very often, so you need specialists to help you get the most value. It's another opportunity to reorganize things in order to sell and pay the least amount of tax."
Acknowledgement to Dianne Maley of theToronto Star.