INCOME TAX TIPS FOR SOLE PROPRIETORS

Do you own your own company? Are you interested in how you can save taxes on a one-person business? In this article, I will show you several real-world management tips. I will explain how using these sole proprietorship hints can help save you money and reach your goals. Before we do that, however, let us look at what a sole proprietorship is.

WHAT IS A SOLE PROPRIETOR?

A sole proprietorship is, in simple terms, a single person in business for themselves. You may have employees, but you own the company alone. There are several benefits to a sole proprietorship. Set-up is relatively low cost and largely free of government regulation. The only requirement is that you might have to register your name with the provincial government, and you can bypass this by running it under your own name.

Though it may seem easy, a sole proprietorship has its own drawbacks. As a sole proprietor, the government sees you and your establishment as one entity. This means that you will face unlimited liability for the obligations and debts of the company. The government can take your personal assets (car, house, and jewelry, for example) to pay off any incurred business debt even though they are not part of the business. In addition, people who run their own establishments may find it difficult to raise money to start or expand. Lastly, there is less flexibility to plan and direct because you are also involved in the day-to-day operations.

All profits of your business are yours personally. Therefore, you must report all income and expenses of both yourself and the establishment on your return. You do not pay yourself a salary; you take money out of the business for personal use. Now, I am going to give you some pointers on how to save money as a self-employed businessperson.

#1 INCOME TAX TIP FOR SOLE PROPRIETORS: SMART DEDUCTIONS.

The first strategy to save on income tax in a sole proprietorship is to maximize deductions for your home office. Many entrepreneurs choose to run some or all of their business operations from the comfort of home. Before you start claiming, however, there are some rules. If you meet either of these conditions, then your space qualifies as a home office. The first one is that your home must be your principal (synonymous with chief, primary) place of business. The other is that you use a section of your house exclusively for earning income and you meet clients there on a regular and ongoing basis.

The following is a list of business deductions that might apply to sole proprietors. Keep in mind that most of these are percentage-based, and not completely deductible. To see an example of home office reduction, please visit our forum at (How much can I deduct for a home office?)

• Rent
• Mortgage interest
• Property taxes
• Utilities (hydro, heat, water)
• Home insurance
• Repairs and maintenance (100% if directly related to area of office)
• Landscaping
• Snow plowing
• Capital cost allowance
• Telephone (if it is a separate line, this is 100% deductible)
• Internet

You will also be entitled to a deduction for using your car, though you will have to determine how much of the time you use your car for business purposes. To do this, it is best to keep a logbook for each trip and maximize your business usage. For example, make a business stop on the way home from work. There are also a wide range of automobile expenses to deduct, such as license fees and vehicle repair costs. As you are now running a company, you can deduct your car under what the CRA calls the capital cost allowance.

INCOME TAX TIP 2: QUALIFY FOR THE CAPITAL COST ALLOWANCE

The next suggestion for entrepreneurs we are going to look at is maximizing your eligibility for capital cost allowance (CCA). There are a number of things you can purchase that depreciate (lessen in value), and these can be claimed under the CCA for a deduction. The thing to remember here is that these assets are for the business, so try to avoid personal usage if you can. Examples of assets that qualify for capital cost allowance include vehicles, printers, software, and office supplies. Each of these falls into its own category (known as a class), and is subject to its own rate of depreciation. In the first year you buy the asset, you are able to deduct half of the prescribed rate. We call this the half-year rule.

When dealing with CCA, here are some additional pointers.

1. If you are going to buy new assets, consider acquiring them before the fiscal year ends and make sure they are available for use as soon as possible. This will allow you to make a CCA claim for them sooner than if you had waited until the next year.
2. If you are going to sell an asset, delay the sale until early in the next fiscal year. This will allow you to make a CCA claim this year.
3. Realize that the CCA is not mandatory. If you do not make a claim on an asset, you are not forfeiting your deduction. You are simply pushing it to another year. If your business does not make a lot of money, you may not need a CCA deduction to bring your taxable income down.

For more information on deductions, please visit our resource (What Can I Deduct?). To learn about the Capital Cost Allowance, please visit the Canada Revenue Agency’s website (Claiming capital cost allowance)

TAX STRATEGY TIP 3: HOW TO TAKE LOSSES

The next sole-proprietor hint we will look at is how to take losses. In the first few years, it is very likely that you will face some losses. Even if you have been operating for a long time, you may still face some costs from time to time. Whenever your expenses are greater than your income, we call this a non-capital loss. If you are not incorporated, you can apply non-capital losses to reduce any other sources of income you may have reported on your personal return.

If possible, you should use your non-capital losses to offset other incomes in the year they you incur them. If you do not have any other sources, then you can use the losses offset taxable income three years in the past or up to twenty years in the future. If the losses are not used up by the twentieth year, they expire.

Your goal here is to apply the losses against the dollars that will provide the most savings. Therefore, you should never use them to reduce your income below the threshold set by your basic personal tax credit. Because your tax bill is nil below this threshold, it would be a waste of your losses. Instead, consider saving the losses if you can to offset future taxes.

To learn more on Capital Losses, please visit the CRA’s website on (Capital Losses).

SMALL BUSINESS INCOME TAX TIP 4: PAY SALARIES TO FAMILY MEMBERS

Next, let us look at a little known hint for sole-proprietors. If you are self-employed, there is a good chance that you have family members who work for you. Have you ever thought of paying them salary? If you do so, you may be able to receive a number of tax benefits. Here is why.

Firstly, there are personal tax savings if you pay salary to a person in your household who will face either no tax or less tax than you will have attracted. Secondly, paying salary provides RRSP contribution room to the family member. Thirdly, this keeps the money in the family and prevents it from going to a third party. For example, let us say that you run a small pizza shop and you pay your child a salary. If this is below the child’s only source of income and it is below their basic personal credit, then it will not be taxed. If you had kept it, the money would have been taxed as business income. The child is then able to use it for other goals, such as saving for education. For more on the subject, please visit our resource on Income Splitting.

SOLE PROPRIETORSHIP TIP 5: CONSIDER INCORPORATING YOUR BUSINESS TO MAXIMIZE TAX SAVINGS

Our last tip for one-person businesses is to consider incorporation. As a sole proprietorship, you have several deductions that are unavailable to you until you become a CCPC (Controlled Canadian Private Corporation). The first one of these is the Small Business Deduction. Simply put, it is a reduction in tax on the first $500,000 in active income. To learn more about the small business deduction, please visit our resource (The Small Business Deduction in Canada). Additionally, the government allows corporations what is known as the capital gains exemption. This allows shareholders of your company (this includes you!) to sell their shares without having their gains taxed at a regular rate.

Ultimately, the decision to incorporate depends on how profitable your company is. If you are just starting out or your company is not very profitable, it does not make much sense to try to incorporate. Since you do not have a lot of taxable income in the first place, you will not be able to take full advantage of the reductions to reduce it.

If you do choose to incorporate, income tax rules allow a sole proprietor to incorporate without tax being triggered provided a number of conditions are met. As long as you make your election, document it properly, and file it within the correct time, you should not trigger any tax.

To learn more about this process, please consult our article on converting a sole proprietorship to a corporation. I hope you have learned a lot from these sole-proprietorship tips I have given you.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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