Sole proprietors do have planning opportunities to minimize their taxes. This includes using start-up losses against other personal income as well as considerations of timing of acquiring business assets and income spitting opportunities. Tax planning is an ongoing process that involves arranging your income tax affairs to legally minimize your taxes as permitted under the Canadian income tax system.
While start-up losses incurred by a corporation are not personally deductible, sole proprietorships can use business losses against other income. It is best practice to put together a business plan for a new venture and this would include a forecasted budget. If you anticipate start-up losses over the first year or two, consider starting your business as a sole proprietorship or partnership and only incorporate once you become profitable.
You may also be able to offset income taxed at the higher tax brackets in the current year and maintain losses to offset future high-rate income in the future. If you have business losses from prior years, you may only want to use sufficient losses to offset income taxed at the higher tax brackets. You should not use losses to reduce income below your non-refundable tax credits.
To minimize income and potentially incur tax deductible losses – ensure that you take advantage of all available deductions, including automobile expenses, parking, business association fees, home-office expenses (except for depreciation that may reduce your principal residence exemption), entertainment, convention expenses (a maximum of two per year), cell phone, depreciation on your computer, private health-care premiums as a business expense instead of a medical expense, and one-half of Canada Pension Plan paid in respect of self-employed earnings.
Registered Retirement Savings Plans (RRSPs) may also be used as part of a sole proprietorship strategy. RRSPs often have funds trapped in them that would be taxed when withdrawn. If you have business losses in the current year or carried forward from a prior year, consider taking money out of an RRSP to shelter the tax that would otherwise be payable. RRSPs are not necessarily for retirement – they are a tax minimization tool that should be contributed to when in high tax brackets and they should be drawn down on in tax efficient manner. The funds can always be reinvested in other vehicles to save for retirement. Funds that are withdrawn from the RRSP can be reinvested in a Tax Free Savings Account (TFSA) to the extent you have contribution room or, invested in stocks or other capital property that would give rise to capital gains that are subject to a lower rate of tax.
It should also be noted that the RRSP rules allow individuals who are self-employed to save substantial amounts through RRSP’s comparable to those which can be provided to employees on a similar basis through pension plans.
Gains or losses on capital assets within your sole proprietorship can also be used against your general capital assets. If you have, or expect to have, any net capital gains or losses from the disposition of capital property used in the proprietorship, consider realizing any net capital gains or losses from the disposition of securities held in your investment portfolio to shelter or offset the resultant gain or loss to minimize your overall tax burden.
Business assets may also be acquired near the calendar year end to decrease your personal taxes. Business assets acquired before December 31 may be eligible to claim capital cost allowance (depreciation for Canadian income tax purposes) in the current year. However, to benefit from a tax deduction, the assets must be “available for use.”
If you are thinking of disposing of business assets, remember that, the disposal of assets that have appreciated in value can create significant income tax liabilities. Although it’s generally recommended that you dispose of an asset at the beginning of the next fiscal period, there may be options available to defer or reduce the potential tax liability on the sale of a significant capital asset, including the replacement property election.
Also consider income splitting opportunities by paying your family. If your partner or other family members participate in the business, a reasonable salary paid may be deducted. You might also consider making another family member the owner or partner in the business to split income.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2021 Shajani LLP.
Shajani LLP is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services