9 Year End Tax Planning Tips for Small Business Owners

For numerous people around the world, the end of this year cannot come soon enough. It has been an unprecedented few months, the effects of which will be felt for many years to come. And while it has been extremely difficult for some small business owners such as restaurants and storefront retail, others have seen their businesses flourish. e.g. toilet paper manufacturers, Amazon and Zoom. Many businesses were able to pivot their business models to provide goods and services that cater to the “new normal” in interesting and creative ways. Some started selling masks while others increased their online course offerings. Beleaguered restaurants started expanding their delivery menus and offerings. To a dispassionate business analyst, this year has been somewhat fascinating and will provide a great deal of data to economists and analysts alike in the years to come.

Regardless of the state of your business, it is time for business owners everywhere to start contemplating some end of year tax planning tips to not only ensure that they can maximize their tax deductions and reduce taxes payable, but to streamline the tax filing process in the New Year.  Even if you are incorporated and your year end date is not December 31st, it is a good time to take advantage of calendar year deadlines for personal tax planning purposes.

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1. Organize, File and update accounting

Ensuring that your paperwork and accounting is organized is a natural starting point for efficient tax planning.  Many small business save all of their bookkeeping/revenue and expense tracking right to the end, which often results in missed deductions and higher taxes (not to mention unnecessary stress).  Reviewing the state of your filing system and perhaps creating a paperless office could be a worthwhile goal that could save you a great deal of time, space and hassle in the long run. This is the time to go through any unopened government correspondence from Revenue Canada(CRA) or Revenue Quebec(RQ) to see if there are any missed deadlines and/or payments due which have given rise to interest/penalties. There are several reasons why CRA or RQ might send you a letter which includes asking for documentation to support a claim or to inform you of a change in reporting deadlines. They might even send you a refund cheque! (although this is certainly rarer).   Often notices from the government are somewhat cryptic or inscrutable. In that case it is a good idea to speak to your accountant, who should be able to provide valuable guidance as you don’t want to be caught with a balance owing that continues to accumulate interest or worse, have your bank account frozen.

2. Make Instalment Payments

Many business owners ignore instalment payment notices at their own peril are then hit with significant amounts of interest (Revenue Quebec can be particularly punitive) which can be easily avoided. It is important to assess what types of instalments you might owe and make payments by the due dates, if possible. This includes HST/GST and QST and personal income tax instalments, if you are an unincorporated sole proprietor or partnership. If you are incorporated you might also owe corporation tax instalments.

CRA and RQ will generally advise you of exact instalment amounts and due dates for personal tax returns, which also include small businesses that are unincorporated.

HST/GST and QST instalments must be manually determined based on the prior year filing. If you have GST/HST and/or QST exceeding $3k in the previous year, then you must pay quarterly instalments which are equal to 1/4 of the previous year amount.

Corporate tax instalments are also based on a prior year threshold of $3k or more.

Check out our post for small business tax deadlnes for 2021 along with a downloadable tax deadline calendar

3. Advance Purchases of Supplies and Capital Assets –

If you are thinking about making a significant purchase e.g. a new computer, a more ergonomically structured office chair or perhaps you need some office supplies or an important piece of software, and your year-end falls on December 31st , it might make sense to make these purchases before the year end. If you have the necessary cash flow to make these purchases, you will be able to expense all or at least a portion of the purchases thereby reducing taxes payable.  It should be noted that high value items like chairs and computers are considered to be capital assets which cannot be fully expensed in one year, but must be depreciated. The upside is that regardless of when you purchase it during the year you can get the first year depreciation deduction. See our article on capital cost allowance for more details on this.

4. Declare year-end bonuses

You and your employees have worked hard and deserve to be compensated.  Assuming your business has been profitable and you have sufficient cash flow, declaring bonuses to employees are a great way to reduce year end profit and consequently taxes payable.  CRA allows you to declare bonuses in the current fiscal year and pay them in the following year as long as it is within six months of the date of declaration. The advantage of declaring bonuses in the current fiscal year, but only paying them in the following year is that business gets the benefit of the tax deduction right away while the employee only needs to declare as taxable income in the following year.

5. invest funds directly through your corporation

If you are an incorporated business and are fortunate enough to be earning more than you require for your personal needs, it makes sense to retain funds in and invest directly through your corporation. The benefit of this is that it allows you to defer taxes on any amounts that would normally be withdrawn as a salary or dividend from the corporation .  While you will still have to pay corporate taxes, you would save the personal tax owing which can be as high as 50% in some provinces. By retaining excess funds in the corporation you employ a variety of investment strategies that will allow you to earn interest, dividends or capital gains. Note that investment income earned within a corporation is taxed at approximately 50%, however, it can still result in significant tax deferral on the principal.

6. Transfer Savings to TFSA and RRSPs

A Tax free savings account (i.e. a TFSA) is a savings vehicle where all investment revenue - dividends, interest, capital gains etc. accumulate tax free. The limit for both 2020 and 2021 is $6,000 and the total amount since the plan was introduced by the government that you can invest is $69,500. And while there is no tax deduction for actual contributions to a TFSA, it is still an excellent way to save taxes on savings and investment. It is simple to open an account with a bank or investment brokerage. It is important to make sure that you don’t overcontribute since the penalties for overcontribution to a TFSA can be quite high. Another point to note for US citizens who live and pay taxes in Canada is that TFSA income earned is usually taxable in the US. It is good to get advice from an accountant on this.

A Registered retirement savings plan (RRSP) is also a savings vehicle that is earmarked for retirement. Contributing to an RRSP is perhaps the single best tax reduction strategy for most individuals and business owners. The benefits of investing in an RRSP increase in proportion to your tax rate. For example, if your marginal tax rate is 40%, you will essentially reduce your taxes payable by $4,000 for a $10,000 RRSP contribution as compared with a $3,000 reduction if your (marginal) tax rate is only 30%.  Deadline to contribute is end of February. It should be noted that RRSP contribution room only accumulates on active income, which means that dividends that are withdrawn from a small business corporation by a shareholder are excluded.

The difference between an RRSP and a TFSA is as follows:

1. while TFSA contributions are made from after tax income ( i.e. there is no tax deduction for investing in a TFSA), there is a deduction for investing in RRSPs of 18% of your earned income which reduces your taxable income.

2. All investment revenues that accumulate in a TFSA are not taxable while RRSP contributions and earnings are taxable but only upon retirement. The maximum age before you can start withdrawing from an RRSP is 71 after a minimum amount must be withdrawn every year for tax purposes.

Both RRSPs and TFSA are excellent investment saving plans that everyone who can should take advantage of.

7. Donate

It is a great time of year to be generous as, not only do you get that soft fuzzy feeling, you are also entitled to a tax deduction.  Keep in mind that only donations to Canadian charities are tax deductible unless you have income from US sources which then allows you to deduct donations to US charities up to the amount of US based income you have earned.  While the deadline to contribute for the current year is December 31st, donations can be carried forward up to 5 years.

8. Write off Uncollectible Balances and Inventory:

No matter how hard you try, there are certain customers who won’t pay or specific inventory items that don’t sell, have gone out of style or are obsolete . Prior to the year end is good time to evaluate

1. Your accounts receivable listing and determine which customers are not likely to pay what they owe. Once you have made this determination accounts receivable can be written off as bad debts. Also make sure to reverse any sales taxes that were charged so that you can recover them.

2. Your inventory listing to determine items which no longer have any value or have reduced in value. Once identified, any items in inventory can be reduced to their specific net realizable value i.e. whatever you can expect to receive from sale of the items. If you do plan to do this, it is always good to have backup to support revisions to value (an estimate from a customer, price list or an estimate of fair market value from a reputable website etc.)

The benefit of writing off accounts receivable and inventory is that it reduces your taxable income and taxes payable.

9, Review taxes payable and ensure that you have earmarked the necessary funds

Once you have finished updating your accounting it is always a good idea to review your tax filing obligations estimate how much you will owe in taxes for:

• Personal taxes payable for unincorporated business owners

  Personal taxes can be estimated by checking out this excellent simple tax calculator where you can enter your net business income.

• Corporate taxes payable for corporations

  Corporate taxes payable can be roughly estimated by going to this link depending on which province you are located.

• Sales taxes payable for any businesses that are registered.

  Sales tax should be calculated via your accounting system. Note that the net amount is calculated by adding amounts collected from customers and deducting sales taxes paid on expenses.

BONUS TIP#1: Covid tax reporting

Make sure you know how you are going handle tax reporting relating to Covid subsidies including CERB, CEWS, CECRA and CERA. You should be aware of how this affects your own personal tax situation, your company taxes and what type of reporting is required on employee T4s. Additional information on this can be found here.

Bonus tip#2: Time to Incorporate?

Finally sole proprietors and unincorporated partnerships should ask themselves whether it might be time to incorporate which allow for tax deferral opportunities, although this is offset by higher administrative costs. See our guide that takes you step by step through the process of setting up a corporation and your corresponding tax obligations.

While you don’t have to spend days on tax planning (which may or may not be less fun than Christmas shopping), it is prudent to ponder what you might need to do in the next month or so to ensure that you take advantage of some tax planning opportunities before this year (finally) ends.

Ronika Khanna is an accounting and finance professional who helps small businesses achieve their financial goals. She is the author of several books for small businesses and also provides financial consulting services.

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