For incorporated businesses, tax planning is not simply about finding deductions at filing time. It is a year-round process of making informed decisions about cash flow, payments, compensation, investments and reporting (to name a few). Let’s dive into some of the key points you should know as a business owner for your tax planning.
Why should corporate planning happen before year-end?
A corporate tax return is dependent on decisions that have been made throughout the year. Tax planning, in contrast, considers the timing and structure of those decisions while the business is still able to make decisions.
Without a strategic plan, by year-end you have already paid out dividends, equipment choices have been made and other transactions have been recorded. With a strategic approach decisions are made in advance regarding payout requirements, financing plans and broader revenue goals for the business.
Here are the 7 tax planning strategies every business owner should know about that deserve a discussion with your accountant.
1. Review Salary and Dividend Compensation
Owners may be able to receive compensation through a salary, dividends or a combination of both. The best mix is not determined by the lowest immediate tax bill alone. It can also affect corporate cash flow, payroll obligations, CPP contributions, RRSP contribution room, personal borrowing capacity and the corporation’s retained earnings.
What are some of the salary considerations for business owners?
Salary is usually deductible to the corporation when it is properly reported. It also creates earned income for RRSP purposes and generally requires payroll deductions and remittances. For an owner who wants predictable persona income or expects to rely on employment income for financing, salary may serve purposes beyond tax.
What are the dividends considerations for a business owner?
Dividends are paid from after-tax corporate income and are reported to the recipient on a T5 slip. They do not create RRSP contribution room and are not treated the same as salary for payroll purposes. Whether a corporation can pay an eligible or non-eligible dividend also depends on its tax accounts and the type of income it has earned.
How to know if salary or dividends are better?
The compensation structure depends on the needs of the business owner, the corporation’s cashflow, retirement objectives, payroll history, tax balances and future investment plans. The type of compensation should be documented and coordinated rather than made through irregular withdrawals from the corporate bank account.
2. Plan capital purchases and CCA claims
When a corporation buys long-term assets such as equipment, computers, furniture, vehicles or leasehold improvements, the full cost is not always deducted immediately. The deduction may instead be claimed over time through capital cost allowance, commonly called CCA, according to applicable class and tax rules.
The timing of a big purchase can influence when an asset becomes available for use and when the corporation may begin claiming CCA. Keep in mind that buying an asset for the sole purpose of obtaining a deduction is not a good idea. A deduction only offsets a portion of the cost, so the purchase should first support an actual business need.
Established corporations should review planned capital expenditures before year-end. Be sure to retain purchase documents and assess how the acquisition fits into cash-flow and financing options. Because CCA is usually discretionary, the corporation may also need to decide how much to claim in a particular year rather than automatically claiming the maximum.
3. Monitor shareholder loans before they become a tax problem
A shareholder loan account records amounts moving between a corporation and its shareholders outside of ordinary salaries, expenses or dividends. These balances can arise when an owner pays corporate expenses personally, advances money to the company, or withdraws corporate funds for personal use.
Problems occur when withdrawals are not classified and resolved correctly. Depending on the facts and timing, an amount owing by a shareholder may be included in the shareholder’s income. Repayment rules, exceptions, interest requirements and documentation ca be technical, so the account should not be treated as a convenient long-term source of personal cash.
Review shareholder loan balances throughout the year, not only at year-end. Make sure personal and corporate transactions are clearly separated, expense reimbursements are supported, dividends are formally declared where appropriate and any repayment plan is reviewed before the relevant deadline.
4. Use corporate losses deliberately
A business that has incurred losses may be able to apply them against income from other taxation years (depending on the type of loss). This can create an opportunity to recover tax previously paid or reduce tax in a future, more profitable year.
The decision is not always automatic. Management should consider expected future profitability expiring balances, changes in ownership, reorganizations, and whether the business activity that generated the loss will continue. Acquisitions of control and corporate structure can restrict how certain losses are used.
The best thing to do is maintain an accurate loss continuity schedule so the business (and accountant) have a clearer look at what is available. It also prevents potentially valuable balances from being overlooked during periods of rapid growth, acquisition or organizational change.
5. Review associated corporation rules when ownership becomes more complex
Business owners can operate through more than one corporation for operational, liability, investment or succession reasons. Separate legal entities do not automatically receive completely separate access to every corporate tax benefit.
Under Canadian rules, corporations under common or related control may need to share the federal business limit used for the small business deduction. Relationships among shareholders, family members, voting control and ownership percentages can all matter. The rules may apply even when the corporations carry on different activities.
Before creating a new corporation, changing share ownership or bringing family members into a company, review how it can impact business taxes. A structure that appears straightforward from an operational perspective can create unexpected filing obligations or alter the tax rate apply to corporate income.
6. Watch passive investment income inside the corporate group
Retaining excess cash in a corporation can provide flexibility for future hiring, acquisitions, equipment or economic downturns. However, when funds are invested rather than used in active operations the resulting passive income can have different tax consequences from active business income.
For Canadian run, private corporations, adjusted aggregated investment income earned by the corporation and associated corporations can reduce access to the small business’ business limit once specified thresholds are exceeded. Investment decisions should therefore be considered alongside the operating company’s projected income, cash requirements, risk tolerance and long-term plans.
This does not mean corporate investing is inherently undesirable. It means that the investment portfolio, corporate structure and operating forecasts should be reviewed on the regular. The after-tax outcome may differ depending on whether capital is retained, invested, distributed or reserved for future purposes.
7. Build a year-round tax planning process
The best corporate tax planning strategy is often a reliable process that ensures clean records and timely reports. Spotting issues before they become a problem can be achieved from keeping a regular eye on both accounting and bookkeeping. For example, completed bookkeeping on a regular basis makes it easier to distinguish an actual transaction from an error.
What does year-round tax planning include?
A practical planning cycle can include monthly or quarterly reports to review taxable income, instalment, payroll and GST accounts, shareholder loans, capital purchases, related party transactions loss balances, compensation and major contracts. Forecasts should be updated when revenue, staffing and financing or ownership plans materially change.
Why is corporate tax planning an on-going process?
No list of corporate tax planning strategies can determine the right answers for every company. The value comes from applying the rules to the corporation’s actual numbers, ownership, goals and timeline.
Is there something you want to know more about? The tax rules can be complicated. At Crescendo Accounting, we aim to make your situation the best for your financial success. We are always happy to discuss your corporation’s tax position, reporting and year-round tax planning.
Schedule a Consultation
Could you be missing out on thousands?u00a0
Is corporate tax planning only useful at year-end?
No. Some year-end decisions can be made late in the taxation year, but many opportunities depend on actions, documentation, or transactions completed earlier. Regular reviews make it easier to forecast taxable income and respond before deadlines pass.
Can every corporation use the same tax strategies?
No. A strategy that works for one corporation may be ineffective or inappropriate for another. Ownership, income sources, compensation needs, associated companies, available losses, investment income, and future plans can all change the result.
When should a corporation speak with a CPA?
A corporation should consider a planning discussion before major purchases, compensation decisions, ownership changes, reorganizations, financing, acquisitions, or the creation of another company. It is also useful when profitability changes significantly or financial records reveal unusual shareholder or related-party balances.