To avoid any confusion when filing, correctly outline all your business expenses in one category and your personal expenses in another (Getty Images/ Maskot Bildbyrå)
Incorporating your business, as opposed to remaining unincorporated, means you create a separate legal entity to run your business. This often translates into generating advanced business opportunities, such as easier access to capital and limited liability among shareholders. But, once you incorporate, there are also a different set of tax rules to follow when filing your year-end taxes.
As tax season approaches, the biggest difference between an incorporated business and an unincorporated business is how you will file your business’ tax return. For starters, incorporated businesses must set their filing date, which is six months after the business’ year-end. So, if your fiscal calendar closes on Dec.31, you have until June 30 the following year to file.
Here are four other things to look out for when filing for your incorporated business:
1) KNOWING WHAT TO FILE
Many businesses will bill for work that is in the midst of being completed but may not yet be finished by the time the filing deadline rolls around. Or perhaps the work has been completed but the payment has yet to be received. In both cases, the payment in question must still be filed on the business’ T2.
“If you’ve issued an invoice, for example, and you haven’t yet been paid, you still have to include that in income,” says Kim Moody, a personal and small-business tax expert based in Calgary. Fishers and farmers are the exception to this rule, “but, outside of the basic exceptions, you still have to pay tax or record revenue on an actual basis.”
2) MISSED DEDUCTIONS
Entrepreneurs will often know their business like the back of their hands, which makes missed deductions uncommon, but not all that unusual, says Moody. One of the more frequent missed deductions are in the form of the amounts that have been expended and not been properly accounted for, says Moody. “So, a lot of the missed deductions per se would be a result of not reporting the outlays correctly,” he says.
Moody explains this can happen in situations such as if you record an asset that perhaps was a one-time purchase with a minimal shelf life—as opposed to the required lasting life of more than one year to qualify as a business expense, such as a new laptop. “That might be a missed deduction,” he says, “because if you didn’t record it correctly, then that’s something that you should be looking at carefully.”
Moody notes that capital items are not immediate deductions, as you need to amortize the amount over time. That is complicated by the Income Tax Act’s many rules regarding the timing and required amounts for writing off capital expenditures, which makes errors common.
3) PHANTOM DEDUCTIONS
Phantom deductions do not exist, says Moody. If there are instances of missed reporting, it’s because something was not properly declared, such as whether an automobile is truly a business expense versus a personal expense. This is where people with incorporated businesses may mistake what can be deducted, especially if lines are blurred between filing their T1 and T2.
“I always tell entrepreneurs, start with everything that you’ve spent money on and think about whether or not that’s a business expense or personal expense,” he says. “And then you won’t miss anything.”
Bruce Ball, CPA Canada’s vice-president of taxation, agrees. “For those using a corporation for the first time, you will save time and reduce costs if you make sure that you incur business costs in the corporation and personal costs in a personal bank account.” The work needed to do corporate tax returns will be reduced and you will reduce the risk of creating tax problems associated with personal benefits paid by a corporation.
4) FILING WITHOUT AN ACCOUNTANT
Despite the numerous CRA-approved tax-filing software available online, there is a reason tax accountants are still popular. “There’s lots of mistakes, especially if [business owners] do it on their own, which is becoming quite a trend,” says Moody of potential filing errors.
The most common mistake he has seen is missed reporting of revenue “because a lot of people don’t understand how they have to record revenue.” He notes that anyone defined as a professional must include income work in progress—and this is often a point that gets missed.
Moody points to 18th-century economist Adam Smith’s vision, which suggests that a good tax system is convenient and, in modern times, that includes filing online. “But, for a business owner, you can go from simple to complex in a real hurry,” he says. “That curve can accelerate very, very quickly.”
The average corporate return is more complex than filing a T1 return. Moody notes the difficulty in finding software that recognizes the same complexities that a trained CPA would find. “That’s something that I get a little concerned about,” he says, “because the average entrepreneur who’s going to try and do it on their own, there’s a high chance that they’re going to miss something, especially as the business gets more complicated and grows.”
Another complication when using a corporation is determining how the owner-manager will receive funds from the corporation to pay for their personal expenses. Often, these funds will be paid as a salary or dividend, or perhaps even both. Hiring an accountant can help you determine the most efficient remuneration strategy based on your personal circumstances and to ensure all the compliance steps are completed. A salary or dividend has to be reported on a T-slip and source deductions are required on a salary.
ADDITIONAL TAX RESOURCES
Stay current on Canadian tax news and COVID-19 updates, and get practical information and fresh perspectives on tax with our tax blog.
Make filing easier for your clients with these pandemic tax season tips. Here’s a breakdown on home office expense claims for those who have been working from home during COVID-19 and what to do if you’ve realized something was missed on your return after you’ve filed.