If you honestly think you’re paying too much in taxes, you probably are. As a financial advisor, some of the common queries (*complaints) I receive from my clients have to do with their tax bill. As it usually turns out, the clients are right. They have been shelling out too much in taxes.
The good news is that there are many ways a business owner, doctor, or any other incorporated professional can reduce the amount of taxes they pay.
Below are seven of my tips to beat the taxman.
1. Keep profits inside your corporation
Many business owners withdraw income or dividends in excess of their lifestyle needs. In Ontario, a larger income can result in paying up to 49% in taxes on that income.
An alternative is to keep your company profits inside your corporation. The benefit is that the tax rate in Ontario on the first $500K of profits kept in your company is only 15.5%, a considerable savings compared to 49%.
An added benefit is that you can set up your corporation to be owned by a holding company (owned by you and whoever you wish) in which the funds are flowed through. This not only helps to creditor-proof your assets, but can allow you to income split with family members or anyone else you want.
2. Keep that income smooth
By now, you’re well aware that owning a business can be a volatile experience. Some years wax, while others wane.
Instead of taking a big salary during the strong years, keep a surplus of funds in the corporation. This lowers your tax bill in the good years, while leaving a reserve for future years that may not be as profitable. The result often decreases the average percentage of tax you pay over a number of years.
3. Pay for postsecondary
Many people rely heavily on the RESP program to fund a decent portion of their children’s education. Although they are taking advantage of the government grant, they are using after-tax dollars which may be taxed as much as 49% in Ontario.
Consider using your corporation to fund part or all of this expense. When your children reach 18 years old, they are eligible to receive dividends as an adult if they are an owner of your corporation. This allows you to flow funds from your corporation to your children’s hands instead of your own. That means the tax rate will likely be considerably lower (often as low as $0) on the dividends as university students usually don’t have any other significant sources of income. This strategy can often save thousands of dollars in taxes.
I’ll be exploring this topic in greater depth in a future post.
4. All in the family
Every Canadian is entitled to a $750K lifetime capital gains exemption on the sale of their business. However, if you can sell your business for more than a $750K profit you have options. You may want to consider setting up a family trust to take advantage of the exemptions of multiple family members.
It’s important to start thinking about the sale of your business early so that you can take full advantage of the capital gains exemption
5. Income split with family members
Income splitting works if one of your family members legitimately works in your business or you pay them a salary for the work they do. This should be thought of less as income splitting and more as hiring someone to provide a service to your company.
6. Make it HAWT (Health and Welfare Trust)
Setting up a Health and Welfare Trust allows a business owner to deduct personal medical expenses (such as, dentistry, orthodontics, and physiotherapy) by using pre-tax corporate earnings. This is a powerful strategy that is one of the major benefits of having a corporation.
7. Take out a loan
Although not recommended for every entrepreneur, there are times when a business owner can take a loan from his/her corporation for a specific purpose, such as, buying a house or a car for business. The loan should be structured as a specific agreement where the funds are repaid over a reasonable amount of time. The interest rate must be equal to the prescribed rate of the loan back to the business owner’s company.
These seven tips will ensure that you take full advantage of your corporation and reduce the amount of taxes you pay. If you are still deciding whether to incorporate or not, check out my blog post on the topic and read through my cheat sheet to help you decide. Feel free to email me with any further questions.