Are you a self employed Canadian? Learn the top 8 tax saving strategies that we would recommend to reduce your taxes!
1. Home Office Expenses
If you are self employed and work from home, you can deduct a portion of your home office expenses. The portion of Home office expenses that can be deducted, is determined by dividing the area of your home office, from the total area of your home.
I.e. Charles’s is an accountant and works out of his own home. His home office takes up 700 square feet of his 2800 square foot house (25%). If Charles has office related expenses that total $25,000 during the year, he could deduct $6,250 ($25,000 x 25%).
The following household expenses can be deducted:
• Mortgage Interest
• Maintenance & Repairs
• Condo Fees
Make sure you do not claim dual purpose rooms, such as a bedroom or a kitchen. If you intend to designate a part of your house as a part of your home office, it can only be used for the purpose of business activities. The CRA is also asking home office users to submit a floor plan of their house, upon audit.
2. Pay Salary to Family Members
Self employed Canadians, should pay family members a reasonable salary to save taxes.
This strategy works if you as a self-employed individual are earning more than your family members. Those earning less than you will be in a lower tax bracket, allowing you to save tax.
The first $11,474 dollars of employment income is tax-free. If your children are not working, you can pay them $11,474 each; the salary will be tax deductible to you and tax-free for your children.
An employment agreement should be prepared that specifies the duties that your family members will be performing, as well as their hourly wage and salary. In addition, a weekly log should also be kept to support the time spent working by each family member. The reason for doing this, is to ensure that there is a bonafide relationship between yourself and your family members. This will help refute any challenges made by the CRA.
Let’s look at an example:
Stephan earns $150,000 a year. His average tax rate is 32.1% (2016), so he owes $48,172 in taxes.
Stephan can split his income with his family to reduce the taxes he owes:
1. Stephan pays his wife, Amanda, $50,000.
2. Then he pays his 2 daughters, Kristie and Rebecca, $15,000 each.
3. This leaves $70,000 of income for Stephan.
Now, each family members income will be taxed at their own 2016 rates:
Stephan’s income will be taxed 21.14%, which equals $14,801 of taxes payable.
Amanda’s income will be taxed at 17.14%, which equals $8,571 of taxes payable.
Both Kristie and Rebecca’s income will be taxed at 5.4%, which equals $810 of taxes payable for each.
Before incorporating, Stephan owed $48,172 in taxes. After splitting income with his family, the total they owe in taxes is $24,992.
Therefore, Stephan has saved himself $23,180! ($48,172 – $24,992 = $23,180.)
3. Lease a Vehicle
Canadians who own their own business can save taxes by leasing a vehicle for their business. The following vehicle costs can be deducted for tax purposes:
• Repairs and maintenance
• Toll charges
• License and registration
• Lease charges
The maximum monthly lease amount that can be deducted is $800 + taxes. Anything over and above this limit is non-deductible.
The percentage of the vehicle operating costs that can be deducted is calculated as: (Total KM’s Driven for business purposes / Total KM’s Driven in the year) x 100.
For example, if you drove 12,000KM for business purposes during the year and 20,000KM in total, then 60% of your vehicle operating costs can be deducted.
To substantiate the KM’s that you drove for business, you must keep a daily log. The daily log should include:
• Date of trip
• Location of trip
• KMs driven during trip
• Purpose of trip
4. Keep Accurate Books
How can accurate books and records help save taxes for self-employed in Canada? Accurate books and records ensure that all expenses are captured on your business’ financial statements and personal tax return. This way, nothing is missed.
The best way to keep accurate books and records is to purchase an accounting software program such as QuickBooks or Simply Accounting. For very small businesses, a spreadsheet can also be used to record business expenses.
5. Incorporate To Save Taxes For Self Employed In Canada
By incorporating your company, your business profits will be subject to a very low tax rate of 15%. On the other hand, the business profits of unincorporated businesses are included in the owner’s taxable income, which are taxed at 53.5% (the highest income tax bracket in 2016).
Incorporating your company you will also open yourself to more tax saving opportunities through income splitting.
6. Individual Pension Plan (IPP)
For individuals who are higher income earners, you may want to invest in an Individual Pensions Plan (IPP). Unlike a Registered Retirement Saving Plans (RRSP), an IPP will allow you to continue living a high-income lifestyle upon retirement.
An IPP is a defined-benefit pension plan that is registered with the provincial government as well as the CRA. Defined-benefit pension plans will provide the investor with a specified monthly benefit..
The annual contribution amount of the IPP is established by an actuary and is tax deductible. The annual limit of an IPP could be greater then that of an RRSP.
7. Health and Welfare Trust
Another way to save taxes for Canadians who are self employed, is through a health and welfare trust. This trust, is a tax-free vehicle used for your corporation to finance its employees health care expenses. The main step towards establishing a health and welfare trust, is setting up an account exclusively for the purpose of health care spending by employees.
By setting up a health and welfare trust, you can take advantage of 2 key tax saving strategies:
1. Contributions made to the trust are tax deductible to your corporation
2. When the trust is used to pay for a medical expense incurred by an employee, funds can be withdrawn from the trust on a tax-free basis.
8. Multiplying the Small Business Deduction
Another saving tip is the Small Business Deduction. In Canada, Canadian Controlled Private Corporations (CCPCs) will pay tax at a rate of approximately 15% on taxable income up to $500,000
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.