Every penny counts when it comes to running a successful small business. As a passionate and successful consultant or independent contractor, you want to take your tax spending down and increase the profit margins. You may know that there are myriad ways to reduce a business tax bill, but only a few of these methods are effective for your small business. Read on to find out the best methods to increase tax savings for small-business owners.
Operate Through a Corporation to Qualify for Small Business Deductions
The best way to tame the stress that comes with paying small-business taxes is to ensure that your consultancy firm or any other small business is entitled to small-business deductions. To be eligible for the deductions, you need to register your business as an independent contractor rather than a personal services business, as personal services businesses are not entitled to small deductions. The actual income tax rate may vary from province to province, but for companies eligible for the small-business deduction, the combined federal-provincial rate is usually a little below the 15% range.
Small-Business Deduction Explained
A small-business deduction is an important tax savings that may help your company cut down on business expenses. In a nutshell, the reduction is a broad-reaching business deduction that many corporations are entitled to. To qualify, the owners and controllers of the company must be Canadians. The deduction effectively lowers the federal tax rate to 10.5% for profits up to $500,000. Some provincial rates are lowered up to that same amount, but others use different ceilings. In Quebec and Alberta, the corporate tax systems are separate from the federal government, but these provinces also have similar rules.
What Is a Personal Services Business?
Under the Income Tax Act, small-business deductions don’t apply to personal services businesses. As a consequence, the tax rates of incorporated personal services businesses are higher – namely 15% at the federal level. The combined federal-provincial rates for personal services businesses are usually somewhere between 25% and 30%. The total tax payable, when you take into consideration the eventual payment of dividends to shareholders, is also much higher for personal services businesses.
Personal services businesses are often called “”incorporated employees.”” Essentially, if you incorporate your business but could reasonably be regarded as an employee of the person to whom you are providing services if there was no corporation involved, you could be classified as a personal services business. A fairly common example is when IT professionals and consultants incorporate their business but continue to perform the same tasks that they used to.
To determine whether a corporation is a personal services business, the Canada Revenue Agency (CRA) criteria are essentially the same as the ones the courts develop to decide if an individual is an employee or an independent contractor. Basically, the employer controls an employee’s work and methods, whereas an independent contractor undertakes to achieve a promised result, but has maximum control over all processes.
Have Multiple Clients
As stated above, you want your company to fall under the category of independent businesses, and not personal services businesses, to meet the small-business deductions threshold. The best way to achieve this is to have multiple clients, as one of the characteristics of an independent business is its independence from a single boss. Additionally, make sure that your written contracts state that you are independent, and that the actual execution of your contract bears this out. You might want to consider returning to employee status if you’re unable to identify yourself as a corporation.
Know What You Can Write Off
As an independent contractor, you can legally claim a wide range of costs as non-taxable business expenses. What you can claim as an expense largely depends on the nature of your business. For example, if you work from home and have a dedicated space you use only for work, you may claim a percentage of your rent and utility costs equal to the ratio of that space in relation to your home’s overall square footage. Likewise, a freelance writer could feasibly claim office supplies, such as printer ink, paper, and computer repairs. A non-union background performer might be able to claim a percentage of a gym membership if they’re frequently required to perform physical feats on the job. Keep in mind, however, you should only claim expenses that you can prove are related to your job. You may want to use cloud-based accounting software such as QuickBooks Online to keep track of business expenses and calculate federal tax rates.
Set Money Aside for Owed Taxes
Obviously, you want to get a refund at the end of April when you make the switch from employee to contractor. However, as a responsible businessperson, you still need to save some money to cover any taxes owed. As an independent contractor, your income is not taxed up front; you need to report how much you made and pay income taxes, either as a lump sum or by instalment.
The CRA website offers up-to-date figures on federal and provincial income tax rates. Keep track of your overall income throughout the year, and use these figures to estimate how much tax you owe at the end of the year. Ideally, you want to set aside enough to cover taxes on your gross income to ensure that you’re well prepared just in case your deductions are lower than expected.
Define Your Employment Status
You may have asked yourself several times whether the Canadian tax law identifies you as self-employed or not. Before you file your taxes, ensure that your work fits the general criteria for filing tax for consultants and small-business owners. To be considered self-employed in Canada, you should:
- Have near-total control over your work output, schedule, and hours
- Own or provide your own tools for the job
- Shoulder the risk of any monetary losses when you agree to a contract
It’s prudent to make sure that any contract you sign clearly identifies you as an independent contractor and not as an employee. If you understand your position as a contractor, you may want to keep track of your expenses and set aside some money for taxes owed during the year.
Working as an independent contractor can provide you with great freedom when it comes to your schedule and income. Understanding your income tax claim as an independent contractor ensures that your business runs smoothly all year-round and helps to minimize your tax expenses.
To be eligible for small-business tax deductions and maximize your tax savings, you may want to operate as an independent contractor, define your employment status, know what you can legally claim, have multiple clients, and set extra money aside for taxes. This should help you get your taxes right every time. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.