I recently re-read the book 78 Tax Tips For Canadians For Dummies.
I've found it to be one of the best resources out there that could clearly and easily explain to me how the Canadian Revenue Agency works and what I could do to pay less tax every year.
I'm writing this blog post primarily for myself. I took a lot of notes from the book and have found by writing out the main lessons, it will help me learn and implement this much faster.
If you're a Canadian and benefit from this too, then great.
I will mention that most of what I'm writing here is what I learned from the book 78 Tax Tips For Canadians For Dummies. I only took notes and really paid attention to the things that relate to my own personal situation, as a 29 year-old business owner in Canada.
Tax tips that are specific to those with a spouse, children, or are a senior won't be mentioned here, as I don't fit in any of these categories. I'd recommend to pick up the book 78 Tax Tips For Canadians For Dummies, as it covers a lot of tips that might help your own personal situation.
So let me jump into some of the things that benefitted me the most in this book.
Disclaimer: I'm not an accountant. I'm just a business owner in Canada and someone that is sharing some of what I learned from the book 78 Tax Tips For Canadians For Dummies. It's always best to talk to your accountant about any of the information provided here.
1. Keep Detailed Records Of Everything
This is a common tip that is mentioned throughout the book. If you're a business owner, this is especially important.
You need to be on top of all of your accounting and book keeping. Track everything using a software, such as QuickBooks. Make sure that you save all receipts and keep them in organized folders.
The key here is making sure you have a SYSTEM for your receipts and records. It's ideal to have a folder or use envelopes that are labeled in categories such as: Charitable Donations, Medical Expenses, Office Supplies, Parking, Advertising, and so on.
As you collect receipts throughout the year, just pop them in each folder or envelope.
You'd also want to make sure you have this set up for each business you own, rental properties, investments, etc…
Putting in the extra bit of time to do this will save you from tearing your house down looking for that investment statement or charitable receipt at the end of the year.
Having records of everything is extremely important, as CRA (Canada Revenue Agency) may ask to review it in the near future.
Your books and records must enable the CRA to determine your taxes payable for the year and must be supported by source documents to verify the amounts reported.
Another thing that is also important is keeping a logbook or journal.
For example, if you are claiming automobile expenses for a vehicle used for both business and personal purposes, you must keep a logbook for a sample period of time to support the vehicle's business use. Include details on dates, number of kilometres driven, and destinations.
You're allowed to only claim the business portion of your automobile expenses. By having a logbook or journal, you're able to provide proof to show what percentage of your auto expenses are in fact business related.
2. Keep Your Tax Records For 6 Years
It's important to keep all of your tax records and receipts for at least 6 years.
The books and records must be kept in a Canada location at your residence place of business. They also need to be available in case the CRA requests to see it.
The CRA can't go back and audit you after 6 years, which is why this 6-year window exists. However, if the CRA suspects fraud, then all tax years are fair game.
3. When In Doubt, Ask The CRA
Staying up to date with the latest tax information is crucial. It's always changing and evolving.
There's a variety of websites that can provide you with the latest tax tips, but it's always best to find out from the CRA directly.
The Canada Revenue Agency's website has a lot of the latest information. However, you can also call the CRA at any time to speak to someone and ask them questions. They have specific phone numbers that you can call them with, so you can ask them certain questions about your specific situation.
For example, let's say you want to purchase something for your business and want to make sure you can use it as a business expense. If you're unsure, why not just call the CRA and ask them?
They have advisors and experts that can help you with this.
You can contact CRA by phone, Monday to Friday (except holidays) from 8:15AM to 5:00PM. You can reach them at 1-800-959-8281.
4. Paying Tax By Instalments
Taxpayers that are earning income that is not subject to a withholding tax, and who earn sufficient amounts of this income to regularly create a tax liability, are asked by the CRA to pay their taxes throughout the year instead of just at April 30th.
The CRA will request for you to pay by instalments in the current year if your tax owing on the previous year's tax return, and in either of the two years prior to that, was greater than $3,000.
The instalment due dates are every quarter – March 15, June 15, September 15, and December 15. Any tax still owed is due on April 30 of the following year.
NOTE: The CRA will send you remittance vouchers with the dates and amounts to pay every quarter. I've found it useful to also make sure to record in a calendar or set up reminders to pay these, as it's easy to forget. Failure to pay your instalments on time will result in interest and penalties.
5. The Benefits Of A Corporation
I've learned that operating a business as a Corporation has the biggest benefits in Canada.
However, when you first start conducting business, you can operate as a Sole Proprietor and then change to an incorporated business at a later point.
According to the book 78 Tax Tips For Canadians For Dummies, it states that:
The income tax rules permit a sole proprietor to convert the business to an incorporated business without tax being triggered, provided the correct tax election is made, documented as required, and filed with the CRA within statutory limits. It often makes sense to defer the conversion of a sole proprietorship to an incorporated business until the business is profitable.
Ultimately, owning a corporation has the most benefits in Canada.
Some of the biggest are:
- Liability Protection – Your corporation is a separate entity, so you're protected by any liability. If someone sues you or a creditor goes after you, then they can only go after the corporations assets. They can't go after any of your own personal assets.
- $500,000 Small Business Deduction – You get a reduced tax on on active business income (not including investment income) of only about 16% on your corporations first $500,000 of income. The corporate tax rate in excess of $500,000 is about 33 percent. The rate climbs to about 49 percent where the corporations income is investment income.
- $800,000 Lifetime Capital Gains Exemption – This is a tax exemption if selling shares of your corporation on any capital gains.
Being taxed less within the first $500,000 of of business income is a huge advantage to owning a corporation, as if you act as a Sole Proprietor then you're going to be taxed at a MUCH higher tax rate.
NOTE: It's important to note that if you're investing with corporation, then the $500,000 small business deduction doesn't apply. For example, if buying and selling stocks, you won't be able to get the reduced tax rate on any income earned from those. That's why in some ways, I've learned it can be more beneficial to invest personally as you're going to be taxed in a high tax bracket anyways and can at least take advantage of an RRSP or TFSA.
6. How Should You Pay Yourself? Salary Or Dividend?
This is one of the most important questions when owning a corporation.
There's currently two ways to pay yourself from your corporation: Salary or Dividend.
When paying yourself a salary, there's many benefits, such as:
- You're able to contribute to an RRSP. When paying yourself with a salary, your RRSP contribution limit increases every year. If paying yourself with a dividend, then you're limited in what you can contribute to an RRSP every year.
- You're paying into Canada Pension Plan (CPP). This is your retirement pension.
- The salary is a tax deduction for the corporation. This is a big one, because when you pay yourself a dividend from your corporation then you can't use it as a business expense deduction. If your corporation is making more than the $500,000 small business deduction allows, then it can be very beneficial to pay yourself a salary as you'll be paying high taxes anyway. By paying yourself a salary, at least then you can lower your income in your business, which will result in less taxes paid there.
Some disadvantages are that you'll have to set up a payroll, pay into CPP as an employer and employee, and prepare T4 slips.
When paying yourself a dividend, there's many benefits, such as:
- Dividends are taxed at a much lower tax rate than a salary, which can result in paying less personal tax.
- Not having to pay into CPP (Canada Pension Plan) can save you money.
- It's very simple. You just write yourself a check and it doesn't require a payroll or anything.
The disadvantages of this are that it doesn't allow you to contribute to an RRSP.
Also whatever you pay yourself as a dividend cannot be used as a business expense or tax deduction within your corporation.
Ultimately, I've learned that there are benefits to paying yourself both a salary and dividend. I've primarily paid myself a dividend with my corporations, up until my business income exceeded over $500,000 – in which case paying myself a salary has become useful now as well.
7. Avoid Taking Money Out Of The Corporation
If you don't want to pay personal tax, then avoid taking money out of the corporation.
Just take the minimum that you need from your corporation in order to cover your expenses.
The more that you withdraw from the corporation, the more taxes you'll pay personally.
With a corporation, the period of tax deferral is potentially unlimited. Where a business is run through a corporation ownership structure, opportunity exists to defer tax. No personal tax is payable unless money is taken out by the owners (shareholders) of the corporation. The personal tax part of the overall tax rate is deferred until money is taken out of the corporation.
A corporation offers you flexibility in determining when your personal tax liability is triggered. If personal tax rates are expected to go down, you'll want to minimize the withdrawals you make from the corporation until the year when personal tax rates are the lowest.
8. Investing Excess Funds In Your Corporation
As mentioned earlier, if you invest with your corporation (buying stocks for example), then the investment income earned by the corporation will be taxed at the full corporate tax rate applied to investment income – not at the small business deduction tax rate.
This tax rate may be higher than the personal marginal tax rates of the share holders. If this is so, then you will want to increase the shareholders incomes so that the lower tax brackets of these shareholders are not “wasted”.
A shareholders income can be increased if the corporation pays them more dividends (or you can pay yourself a salary as an employee). No tax savings from the small business deduction applies because investment income is not considered to be “earned” from operating a business. However, the first $500,000 of business income continues to qualify for the small business deduction tax rate.
9. Maximize Your Capital Cost Allowance (CCA) Claim
The money that you spend while operating your business can be classified in one of two ways:
1. Day-to-day expenditures of running the business. These expenses are not considered to have a future value and are just day-to-day expenses such as: salary paid to employees, office rent, telephone, internet, travel, bank charges, etc…
2. Capital expenditures. These are made when you purchase a capital asset – an asset that has an expected useful life that will extend beyond the end of your business's taxation year. For example: computers, office equipment, automobile, machinery, office furniture, etc…
Since the value of these assets are expected to extend past the end of your business taxation year, you CANNOT take a full deduction for these expenses in one year.
However, you are allowed to deduct a portion of the cost of the capital asset for each taxation year it is used in your business. The calculation of the portion that can be deducted on your tax return is called capital cost allowance (CCA).
These calculations are best discussed with your accountant. However, this is important to know when writing off expenses for your corporation.
10. Choosing Tax-Smart Investments
The various forms of investment income is taxed differently (dividends, capital gains and interest).
A dividend is a distribution of a corporations profit to its shareholders after all expenses and income taxes have bene paid. Investors receive dividends on the stocks they purchase in their investment portfolio. If you're looking to generate dividend income, you want to invest in Canadian equities (either directly or via a mutual fund) that pay dividends throughout the year.
Canadian dividends are a tax efficient source of investment income because they qualify for a special dividend tax credit, which keeps the tax burden low. Canadian dividends are always taxed at lower rates than capital gains.
With interest income, you're taxed at your marginal tax rate. Therefor, interest income is not the most tax-friendly investment.
Because of all of this, I've learned that it's always best to have any interest-earning investments (bonds for example) in a TFSA (Tax Free Savings Account) or a RRSP (Registered Retirement Savings Plan), since you aren't taxed in it.
And because dividends get taxed the least, then all dividend-earning investments can be most useful in non-registered investment accounts.
11. Maximize Your TFSA
As a Canadian, it's crucial to open and maximize your TFSA contributions. You can put up to $5,000 of savings per year (although recently raised for 2015 to $10,000 I believe) and earn tax-free income and/or gains for life.
Withdrawals aren't taxed, don't negatively affect your eligibility for government-tested benefits, and can be re-contributed the following calendar year.
12. Maximize Your RRSP Contributions
It's also important to take advantage of one of the greatest tax shelters Canadians have, an RRSP (Registered Retirement Savings Plan).
An RRSP is a account that allows you to save for your retirement, with your contributions being tax deductible. Every year (if receiving a salary), you can contribute a certain amount to your RRSP.
Besides the tax deduction, one of the biggest benefits is that your money inside this account will grow tax free.
However, when you withdraw any money from your RRSP, you are forced to pay taxes on that money that you withdraw. That's why it's best to only withdraw from your RRSP when you retire, as most when they retire are in a lower tax bracket (so you're taxed less on the money).
With an RRSP, it's important to contribute only at the right time. For example, if you're in a high tax bracket is when an RRSP is most useful, because it can lower the amount you're paying in taxes.
If you are in a low tax bracket, then an RRSP might not be as beneficial for you.
Also, if you're planning on being a high income earner in your retirement, then an RRSP might not be as beneficial to you as you'll still be taxed in a high tax bracket.
13. Avoid Getting Audited By The CRA
The last thing you need in your life is to be audited by the Canada Revenue Agency. I've heard this can be a nightmare.
First, understand there is a difference between an Audit and a “Request For More Information”.
Often times, the CRA will send requests for clarification on things on your tax return. This is not an audit.
To avoid being audited, here's a few things I've learned:
- File Your Tax Return Every Year.
- Report ALL Your Income. The CRA gets a copy of all information slips you've received (T4's, T5's, etc…) and they cross check them by computer to make sure everything is reported.
- Have A Reasonable Expectation Of Profit. Your business shouldn't be reporting losses year after year.
- Be Consistent With Your Expenses. Your business expense deductions must be reasonable, and the expenses MUST be incurred to earn income. This means that claiming your personal expenses is a bad idea – it's not allowed under the tax law. You also need to make sure your expenses are consistent from year to year. A significant jump in meal expenses or travel costs might cause a red flag with the CRA.
- Don't Cheat. The CRA has identified industries that have higher incidences of cheaters in the past. Some of these industries are construction, subcontractors, auto repair, direct sales, childcare, cleaning, and restaurants. Also, it's important to note that the CRA can also pay attention to you online – Facebook, social media, your blog, etc… so they might be aware of things and watching you.
- Think Twice About Taking Cash Under The Table. It can be risky and there's been stories of customers of people working for CRA and reporting businesses doing this.
- Learn From Your Mistakes. If you get caught or audited, the CRA will likely look at previous tax years or future years and pay extra attention to you and audit you further.
- Don't Give The CRA Something To Audit. Try to make your tax returns simple. Someone with just one T4 slip has less of a chance of being audited. The CRA likes to flag more risky items, such as: tax shelters, business losses, significant interest deductions, big business expenses, etc… Make sure all of your deductions are legitimate.
- Keep Your Fingers Crossed.
Conclusion
There you have it!
These are some of the biggest lessons and Canadian tax tips that I learned that have benefitted me, after reading the book 78 Tax Tips For Canadians For Dummies.
There's obviously a lot to Canadian taxes. That's why we hire accountants and professionals to look after this stuff for us.
However, I've found a lot of benefit in learning and understanding this stuff myself.
It's recommended that you do your own research, learn where you can, study the CRA website and talk to accountants.
Hopefully some of what I mentioned here could benefit you.
Please leave a comment below or let me know any questions you have. I'd love to hear what you think!