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For entrepreneurs, starting their own business is always a high risk choice. In an economic climate where multinational corporations dominate every corner of the street, it is essential that these small business entrepreneurs maximize every possible avenue in order to compete. This brings us to the focus of our article, tax mistakes committed by entrepreneurs. Large corporations minimize their tax mistakes and therefore maximize their tax savings, so it is extremely important that small business owners do so as well.
Not Claiming Business ExpensesDeducting business expenses is the simplest method to decrease tax liability. Yet many entrepreneurs are not aware of all the business related expenses that may be deducted for tax purposes. Generally, any expenses that were used to generate income for the business can be deducted. The most common business related expenses include: accounting and tax preparation costs, advertising, capital cost allowance, inventory purchases, lease payments, legal fees, meals & entertainment (50% only), rent, salary and wages, sub-contractors, supplies, office equipment and tools.
Entrepreneurs who have a home-office can also make significant tax write-offs. Home-office expenses that can be deducted include: mortgage interest on your residence, utilities, property taxes, repairs & maintenance and home insurance. The percentage of the home-office expenses that can be deducted is equal to the amount of space that the office takes up within the house.
For example, John has an office in his home that takes up 500 square feet and the total size of his home is 2,500 square feet. This means that John can deduct 20% of his home-office expenses because 500/2500 = 0.25. If John has $5000 in home-office expenses for the year, he can then claim $1000.
For more information regarding deductions for business-related expenses, please consult this article on tax write-offs for small businesses in Canada.
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Not Incorporating the BusinessFor small business owners, choosing the right type of business structure is crucial especially in the early stages of their business. They have the option of sole proprietorship, corporation and partnerships. While the best structure for each entrepreneur is dependent on the type of business that they have, corporations do generally offer a better tax structure than their counterparts.
Entrepreneurs that choose to incorporate their business will be eligible for the small business deduction (SBD). This deduction allows for the first $500,000 of operating profit to be taxed at a much lower corporate rate. In Ontario, the combined federal and provincial rate for the SBD is 15.5%. Sole proprietorships on the other hand, are not eligible for the SBD. Instead business income for sole proprietorships are included as part of personal income and therefore taxed at the personal tax rate. A sole proprietorship earning $500,000 would be subjected to a marginal tax rate of 46.41%, this is a 30.91% difference!
The second tax advantage is the $800,000 lifetime capital gains exemption. If an entrepreneur sells private company shares, then the capital gains of up to $800,000 will be exempted from tax. Only Canadian-controlled small business corporations are eligible, so this rules out both sole proprietorship and partnership structures.
The third major tax advantage for corporations is income splitting. The incorporated business can split business income with family members through dividends which are also taxed at a lower rate.
In addition to the tax advantages of a corporation, there are many legal advantages; the most significant being limited liability protection. To learn more about this, read this article on converting a sole proprietorship to a corporation.
Not seeking Professional Tax HelpIn the early stages of a small business, many entrepreneurs will try to cut corners in order to minimize costs. The problem is that most small business owners do not have the necessary knowledge for tax planning and to ensure that all of their tax compliances are met. While not seeking professional tax help may save them money in the short-term, a proper tax planning strategy for their business will exponentially save them much more money in the long-term. The priority for any entrepreneur is innovation and the operations of their business, so they should delegate accounting tasks to a tax professional, normally a CPA who specializes in small businesses.
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About The Author – Allan Madan
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.