3 Tax Strategies to Save Your Business Money

February 6, 2014


Do you apply tax strategies for your small business? If you don’t, you’re probably giving money to the government you don’t have to. Nobody likes to do that, so today, I’m going to guide you through three key tax strategies that—as an accountant—I use with my small business owner clients. I’m also a small business owner, so these are strategies that I use myself to make sure I’m paying the least amount of taxes. All of the strategies will be covered for Canadian and US small business owners.

Strategy #1: Claim the deductions your business is eligible for

The Canadian Revenue Agency (CRA) and the Internal Revenue Service in the US (IRS) have many deductions a business owner can claim on their returns. Devising an effective tax strategy involves knowing which deductions your business can claim. The following are two common deductions that I, along with many other small business owners, take advantage of at tax time in April:

1.)   Home Office Expense

If you have a home office (den, basement, bedroom, or confined space used exclusively for work), then you can deduct a portion of your office expenses relative to the area used in your house. For example, Michelle has $50,000 in office expenses for the year. Her office takes up 15% of the square footage in her house. Michelle can deduct $7,500 ($50,000 x 0.15) on her return by having a home office. Based on my experience, I would say 15%-35% of your house is a reasonable percentage for business use. Some common expenses that you can claim by having a home office can be:

–        Utilities

–        Mortgage interest

–        Property taxes

–        Repair and maintenance

–        Home insurance

For more information on business use of home expense in the US, you can visit the IRS publication 587.

2.)   Car Expenses

Do you have a car and use it for work purpose? If so, you are entitled to claim a deduction on the portion used for business use, such as driving to and from work or driving to meet clients. The CRA and IRS allow you to deduct the following expenses related to your car:

–        Fuel and oil

–        Insurance

–        Lease payments

–        Depreciation (if you own)

–        Parking

–        Repair and maintenance

–        Toll charges

–        Vehicle registration fees

For example, if Josh drives 50,000 km a year and 25,000 km is attributed to business use, then he will be allowed to deduct 50% of eligible expenses. If you are wondering whether it is better for tax purposes to lease or buy a car for a business in Canada, you can check out my advice.

Strategy #2:  Take advantage of income splitting opportunities

Both Canada and the US use a marginal tax system, which means that the more money you earn, the higher your tax bracket. Because of this, if you can split your income with a family member, you will be able to reduce your income and pay less tax. Splitting income essentially means that the business income is shared between you and others in your family, rather than going to you alone. I’ll walk you through some examples, as well as some speed bumps you will need to overcome before the CRA or IRS will allow you to use this tax strategy.

1.)   First, your spouse has to actually work for your business

Informing your tax agency that your spouse works for you is not sufficient evidence. You are required to maintain and fill out appropriate employee records throughout the year. Also, your spouse must perform daily tasks, just like any other employee.

2.)   Second, your spouse must be paid the same amount as anyone else in the same job

Paying your spouse a salary of $100,000 for basic tasks is not acceptable. Salaries must accurately represent the work completed by your spouse. For example, let’s say Mindy is the office administrator for her husband Brian’s construction company. Mindy should be paid in accordance with what a normal administrative assistant would make. Extra pay for being Brian’s wife won’t fly.

Let’s continue with Brian and Mindy. Say they also have two kids, Mark and John, and the business earns $150,000 in profit for the year. The following examples—for both Canada and the US—show the tax savings that are possible for Brian and his family through income splitting.

In Canada:

Scenario 1: Brian is the sole income earner in the business

As the only family member working in his business, Brian would be taxed at the highest marginal tax rate in Canada of 46.41%. Brian’s tax owing for the year would be $69,615 (150,000 x 46.41%).

Scenario 2: Brian, Mindy, Mark, and John all have jobs in the business

In order to take advantage of income splitting, Brian hires his wife Mindy to work as the office administrator for the construction company. Brian also hires his two children, Mark and John, to work for him when needed on extensive jobs. Brian can now pay his wife and kids a salary based on the work they performed. If Brian were to pay his wife $50,000 and two kids $15,000 each, then Brian would have left over income of $70,000 for himself. Brian’s family tax rates would be as follows:

Family Member

Salary ($)

Tax Rate (%)

Taxable Income ($)

Brian

70,000

32.98

23,086

Mindy

50,000

31.15

15,575

Mark

15,000

20.05

3,007.50

John

15,000

20.05

3,007.50

Total

$44,676

Bottom line: income splitting has allowed Brian to save $24,939 on taxes this year.

In the United States:

In the US, income splitting has been built into the tax system. The US has separate tax rates based on marital status. Married couples are allowed to file a joint return, which has lower tax rates than singles, when one member earns significantly more than the other. For example, if Brian were single, his taxable income would be $35,293. However, since he is married, he qualifies for a joint return with his spouse and would have taxable income of $29,358 (US personal tax rates).

There is one flaw with respect to this system.  Couples who earn similar incomes may end up paying more tax then if they filed separately as singles.  If Brian and Mindy both earn $75,000 and file jointly as a married couple, their taxable income would be $29,358. On the assumption that both were to file as singles, they would be filing at a lower marginal tax rate of 25% rather than the 28% on their joint return. This results in Mindy and John having taxable income of $14,348.75 or $28,697.50 together. This is commonly referred to as a “marriage penalty” and affects many American spouses with very similar incomes. Currently there is no relief for this penalty and filing a single tax return when married is considered tax evasion.

Strategy #3: incorporate your small business if it will save you money

When planning your tax strategy, a decision should be made about whether you should incorporate. To answer this question you must decide if doing so will really benefit your business. Here are a few questions you should consider before incorporating:

–        Does your business have sufficient profits to justify the costs associated with a corporation?

–        Are there any tax savings for you by incorporating?

–        Does your business take part in complex transactions, making it susceptible to errors and omissions in its financial statements?

In Canada and the US there are many tax benefits to incorporating. In Canada, small business owners who incorporate to a CCPC (Canadian Controlled Private Corporation) can qualify for the small business deduction. A CCPC’s first $500,000 will be taxed at a corporate rate of 11% compared to 15.5%. Another tax advantage is the capital dividend lifetime exemption, which entitles the business owner to claim up to $800,000 in capital gains tax-free on the sale of shares of the business.

Incorporating in the US does not offer similar tax brakes to corporations. However, companies that incorporate in certain states, such as Nevada and Delaware, do not have to pay state taxes.

Final Thoughts

There are many tax write-offs for a small business in Canada and the United States. By following tax strategies, such as the three covered in this post, you’ll be able to keep more of the hard-earned money your business makes. If you want to know which tax strategies are right for your own situation, it’s best to consult with a tax professional. Feel free to share any questions or concerns in the comments section below.

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about the author

This is a guest post for the FreshBooks blog. FreshBooks is the #1 accounting software in the cloud designed to make billing painless for small businesses and their teams. Today, over 10 million small businesses use FreshBooks to effortlessly send professional looking invoices, organize expenses and track their billable time.