High Impact Tax Strategies for Business Owners & Their Corporations
Let’s face it – running a business isn’t easy. As an entrepreneur, you face many challenges in building your business, fending off the bank, delighting customers, dealing with suppliers, handling employee issues, winding your way through government bureaucracy and red tape, and the myriad of other issues that keep you awake at night.
But for those who persevere and conquer the challenges by creating a well-run, sustainable business that provides adequate compensation, the reward can be bitter sweet. After all, success comes at a price and the government wants a piece of the pie. In the end, a big fat tax liability owed to the government can be hard to swallow for any business owner.
The good news is that there are a number of high-impact tax strategies that are available to business owners and their corporations to – legally – reduce the amount of tax they have to pay on current earnings, future profits and the proceeds that will come from an eventual sale of the company. Why pay more to the government than you have to?
This month’s column features several strategies that can be employed to reduce income taxes on current earnings of a corporation and its owners:
Reduction of Income Taxes on Current Earnings:
In Canada, the much-chagrined income tax system levies tax on both the earnings of the company as well as income taken out of the business by the owners. If not properly planned, this can result in some double taxation. In other words, more tax would be payable by the company and its owners than would be the case if the income were earned directly by an unincorporated individual. However, other than for very small businesses, there are significant advantages in earning income in a corporation, and thereby avoiding this potential double taxation.
1) $500,000 Small Business Deduction
When profits are earned by a Canadian controlled private corporation resident in Ontario, the first $500,000 of profits are taxed at a combined Federal and Ontario rate of 17% in 2008, which has been reduced to 16.5% in 2009 (with further potential reductions pending the passing of recent legislation). This is significantly less than the tax which would be paid by an unincorporated individual.
For a company earning $500,000 profit, the corporate tax paid is about $110,000 less than the tax that would be paid by the unincorporated person. Of course, these funds have not been removed from the company and are not available for the personal use of the owner. However, for companies that need to retain funds for growth or expansion, this is the only tax that needs to be paid until such time as the funds are removed by the owner.
2) Paying Bonuses to Owners of Income in Excess of $500,000
In the past, the general tax strategy of businesses with income in excess of $500,000 was to pay a bonus to the owner of the business in order to bring the income down to $500,000, and avoid the “high rate” corporate tax. However, in recent years, the high rate has been reduced to 33.0% in 2009 and 32.0% in 2010. Given these reductions in tax rates, it may no longer be the most effective strategy to “bonus down” to $500,000, particularly if the funds cannot be removed from the company due to cash flow or reinvestment requirements.
As of 2007, business income in excess of the small business deduction limit has been included in a notional tax account called the “General Rate Income Pool”, and dividends can be paid out of this amount at a significantly lower tax cost than was previously the case. As a business owner, it is crucial that you re-visit the “bonus down” strategy EVERY YEAR with your professional advisor, as the planning may change depending on the circumstances of the business and the owners.
3) Individual Pension Plans (“IPP”)
There are significant potential tax deferral and compounding opportunities in setting up IPP’s for individuals who are already making maximum RRSP contributions, but wish to set aside additional amounts for retirement. These payments are tax deductible to the company, and provide higher annual pension contribution limits than an RRSP. Questions that you should ask to determine if these plans may be of benefit to you, include:
Are you and your spouse at least in your mid to late 40’s?
Have you and/or your spouse earned at least $100,000 of salary from your company for a number of years?
Do you own a company that pays out bonuses each year to you as tax planning to reduce your corporate income to the small business deduction level?
Do you hate paying 46+% income tax to the government on those bonuses each year?
Would you like to be able to make annual pension contributions to your retirement fund in excess of your annual RRSP limits?
4) Retirement Compensation Arrangements (“RCA”)
This is a very valuable planning opportunity for specific business and personal situations, particularly where a taxpayer is planning to emigrate to other countries which have tax treaties with Canada. It is a very tax-effective exit strategy, as there are potentially very low tax withholding rates to be paid once the funds are received by a non-resident of Canada. The questions you should ask to determine if this may be a suitable strategy, include:
Do you have a profitable company that you believe is saleable one day?
Would you consider emigrating and severing your ties with Canada for a period of approximately 24 – 30 months in order to save hundreds of thousands and maybe millions of dollars of income taxes when you leave Canada?
To be certain, it is extremely important that you involve proactive professional advisors when implementing tax minimization strategies in your business. Effective tax planning either cannot be done or simply does not work after the fact. The tax planning must be done properly in order to be deemed acceptable by the Canada Revenue Agency and thus avoid the many pitfalls that result from inadequate tax planning.
About the Author
Mitch Silverstein is a Partner at SBLR Chartered Accountants. 416.488.2345 x 274 or at email@example.com. SBLR is a full-service accounting and business advisory firm located in mid-Toronto. With 7 partners and over 40 team members, including a full-time senior tax department, SBLR is passionate about providing creative income tax solutions and high-level growth and exit strategies for profitable, privately-held companies.
Financial Tip…from James Phillipson
Remember that income tax legislation has grown from 20 pages in 1917 to over 2,000 pages today and is so complex that many businesses are saving a lot of tax by focusing on the opportunities that can be available with some careful tax planning. You are entitled to your share of the opportunities that are waiting for you to discover them. A little bit of focus on the issues often results in substantial savings.
Ensure that you regularly ask a qualified tax professional to review your business’ tax return(s) in detail with you and to proactively consider how you can save tax in future. Ask about:
The corporate organization – is there a way to improve the tax effectiveness in your circumstances;
Review your personal/family situation to see if that leads to creative ideas on maximizing tax opportunities;
Are there additional allowances that could be available;
Are there losses available for future use;
Are their accounting practices adopted by the business that could be changed or modified to achieve a better tax position;
Review the timing of transactions to maximize any tax benefits sooner;
Review the timing and amount of payment of tax installments;
Review compensation and benefits policies for yourself, your staff and members of your family;
Ask them what they would do if the only consideration was to minimize tax and see how you can work the idea into how you run the business; and
Review the key strategies and changes that you will be making in the future – there often are ways to structure the opportunity to be more tax effective.
Just one creative idea will almost certainly recover much more than the fees for his/her time. If you have never done this or any significant tax planning before, there are likely to be substantial opportunities just waiting to be found.
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