Accountants, lawyers, financial planners and insurance advisors all throw this term around: tax planning. But what exactly is Tax Planning? And how is it done?
The goal of tax planning is to minimize your taxable income. One example of a tax planning strategy would be to shift, or “defer” income (and it’s related income tax), from your high income earning years, to later years when you would be in a lower tax bracket, like retirement.
Here a few things to think about as you plan for your 2019 tax year. Not to be confused with the 2018 tax return.
Owner’s Compensation: Wages or Dividends
Who takes it? When do they take it? How much do they take? What do I gotta do?
Perhaps the biggest tax planning opportunity for small business owners is owner’s compensation.
When your corporation earns income, the corp must choose to pay the owners dividends or wages. You should talk to your accountant about what the right decision is for you for the year ahead. Just remember that a corp’s cash does not belong to the owners. You cannot use the cash or assets of the corp for your personal use without paying tax. Your corp can’t even lend you money without tax consequences. Here is a summary of the differences:
DIVIDENDS: You get paid as the owner (aka shareholder) of your business. Dividends are a distribution of the profits, which means the business has profit, so the corporation will pay some of the tax, and then you personally will pay some of the tax.
WAGES: You get paid as an employee of your own business. Your corporation pays taxes for you and your wages are a tax deduction for the business.
Buying and Selling Decisions
Vehicles, equipment, real estate, securities and businesses: When to buy? When to sell? What’s taxable? What are capital gains? Tell me how to save some cash!
When it comes to tax, the timing of an asset purchase or sale can make a big difference on your tax bill. Here are a couple decisions a financially fit business owner might discuss with their accountants right before their year end:
The new accelerated depreciation rules are in effect now, so buying equipment or vehicles right before your year end could save you tax this year.
If you have capital gains this tax year, you can sell some loser investments. The losses will offset the gains, and save you tax.
Talk to your accountant if you have any of buy-sell decisions coming up in the next couple years.
How do life insurance policies save you tax?
Many life insurance policies are tax free when they are paid out. And everyone dies. In certain circumstances, when your corporation pays for your life insurance policy, it’s a tax write-off. This is a powerful tax planning strategy that many business owners use to increase the size of their estate. You can also use life insurance policies to increase the size of legacy gifts to charities close to your heart.
Borrowing: how can debt save me tax?
Interest payments are full tax write-offs to the business. In finance theory, there is a level of debt that is healthier for a business than zero debt.
For example, if you have a business or a rental property, a tax planning opportunity would be to minimize your personal debt and principal residence mortgage, shifting the loan or mortgage to the rental property or business, where the interest is tax deductible.
Rule of thumb is that if you spend money to earn money, it’s a write-off. A write-off just means you can deduct the cost from your income, which reduces your Net Income, and therefore reduces the amount of tax you pay. Track your mileage and know when you can write off meals, drinks, travel, and courses.
A tax planning opportunity would be to plan your family vacation around a convention, course or client site visit. There is a big accounting convention in Hawaii every year just for that reason.
Investing In Your Business and Tax-Free Money
The shareholder loan account is used to track the money an owner has invested in her corporation. When you have loaned your corporation money, when it pays you back, it is not income, so it is not taxable. Here are a few practical ways small business owners can build up their Shareholder Loan account:
Declaring compensation you didn’t even take. In a low income year, you can exercise some “tax planning” by declaring income you didn’t even need (or even really receive). You can declare a dividend, pay tax on it, and then just pay it right back to the company, as a loan. You can then withdraw it later, and pay no tax on it. If you plan on being in a higher tax bracket down the line, this can save you some serious cash.
When you started your business, it probably required more money than it made. These investments in your business are loans that can be paid back tax free.
As you run your business, there are write-offs that you’re entitled to, but aren’t getting paid for. Home office. Cell phone. Internet.
Using personal stuff for business purposes? Get that credit. Vehicle use. Computers. Cell phones. Furniture.
If you have ever paid capital gains tax in your corporation, you might have a balance in your Capital Dividend Account. This is tax-free money that you could get your hands on. You just have to do it right. You will need your accountant to handle all the paperwork for this tax-free money, but it’s worth it. Especially in a high income year.
RRSP: Save tax dollars now, but pay them back later. Also pay tax on all your earnings as you withdraw cash from your RRSP.
TFSA: Investing after-tax dollars now, but no earnings or growth is ever taxed in the future. There is no tax benefit now, but there is tax benefit in the future.
Tax planning can seem intimidating at first. And that’s what we’re here for - to know all of the tax laws and opportunities so that you can make the best decisions for your small business. Contact us if you want to talk about how we can help you tax plan for this year and beyond.
Read more about Corporate Tax topics that may be helpful to you and your small business.
Like what you hear?
Are you on the hunt for a more proactive small business accountant? That’s us.