Canadian entrepreneurs are some of the best in the world when it comes to starting, managing and growing their small to medium-sized businesses. But most have little or no accounting experience, particularly in the start-up years when their energy is focused on making their company a success.
All too often this results in avoidable–and potentially costly–tax mistakes.
Does that mean that all entrepreneurs should immerse themselves in accounting and tax courses? Obviously not. But they should seek the advice of an experienced accounting professional. In some cases, an accountant specializing in tax where, depending on the structure of their company and complexity may require establishing and managing a comprehensive tax-planning strategy tailored to the specific needs of the business.
Even after taking those steps, entrepreneurs should be mindful of several traps that tend to catch even the most tax-savvy business owner. Here are the seven common tax mistakes that small business owners make (and how to avoid them):
Separating business from personal finances
One of the advantages of incorporating a business is that entrepreneurs are essentially forced to separate their personal finances from that of the business. This makes accounting far easier and avoids the confusion and potential tax and other liabilities that emerge when an entrepreneur uses his or her business account to fund lifestyle needs.
To mitigate this potential threat, be organized and avoid mixing business with personal expenses. For example, if you operate an unincorporated business, open a separate bank account for your business and run your expenses through that account. The same goes for credit cards. Use a business credit card for business expenses and a personal credit card for personal ones, then pay each from their corresponding accounts. Doing so will save a raft of headaches at tax time, while also helping you monitor important metrics such as cash flow.
No business owner wants to play the role of federal tax collector, but those who generate more than $30,000 in annual revenue are required to do exactly that. That’s why it’s best not to delay the inevitable.
If you own a start-up, consider registering for HST right away (even if you haven’t reached that $30,000 annual sales threshold). At least this way you’ll be able to claim input tax credits during the period when you may have little or no income and can claim back the HST that you’ve paid on business-related expenses.
If you have an existing business you might want to consider using the simplified method for paying HST. Under the simplified, or quick method, you don’t have to track the HST that you have paid–a potentially onerous process for a small business owner. You still charge HST at 13% (in Ontario), but you remit based on 8.8% of your sales (including HST). This way you get to keep the difference. For example, HST collected on $1,000 would be $130. Under the quick method the business owner would have to remit 1,130 x 8.8%, or $99.44. He or she would be able to keep the remaining $30.56. This method is available for sales up to $400,000 per year. Remember that in order to adopt the quick method, an election must be filed before the due date you choose.
To incorporate or not–a very big question, indeed
In many cases, it’s prudent to incorporate from the get go for limited liability purposes. However, if you decided to start a business and you’re not concerned about potential legal liability, you may be better off starting up as an unincorporated business. Why? There’s no point incurring significant upfront legal and accounting costs if you aren’t sure whether your business will take off. Equally important for start-ups, you could incur business losses in the first year or two until your business is fully established and generating significant revenue. The advantage of this approach is that your tax losses can be applied to all other personal income. Let’s say you kept your job for the time being and are still drawing a salary. You can apply your business losses to your salary income or other investment income right away and reduce your personal taxes. If these losses are incurred in a limited company, they’re trapped and can only be utilized when you’ve generated a profit â€¦ which might not happen for a long time.
The other point to remember is that you can always transfer your unincorporated business into a limited company at a later date (on a tax-deferred basis) when you start making a profit. This way you’ll get the protection of limited liability, but at lower corporate tax rates.
Keep copies of all business receipts, even if you’re paying for expenses by credit card. The Canada Revenue Agency (CRA) will not accept credit card statements as valid evidence of the expense you’re claiming. So, be sure to keep those pesky little gas receipts you get from the pump. For restaurant meals or promotional events, make sure you mark on the back of the chit who joined you. That way you can ascertain if it should be allocated as a business or personal expense.
If you’re claiming vehicle expenses for your business, make sure you keep a log of where you’re driving, as well as your daily mileage. Driving from home to the office is not considered a business expense. So, plan your day to maximize the business use of your vehicle. Leave your house in the morning and visit a client or supplier, then drive to the office. On the way home, if possible, plan to visit another customer or supplier first. That way, all of your mileage for that day would be deemed for business use for tax purposes.
At a minimum, the CRA requires you to provide them with a log for at least 3 months in a year as proof of business vehicle usage. Mobile apps such as MilelQ and Mileage Expense Log digitize the task and make it even easier.
If you use your home for an office, then it’s important to keep your receipts for utilities maintenance, mortgage interest, taxes, etc., really anything that could be connected to the operation of your business. Designate a specific area in your house for your office. If the amounts are reasonable, you should be able to claim that percentage of your house used for your office space. If you renovate your home, you need to be careful when claiming a certain portion of your renovations as a business-related expense. It could be considered capital in nature and not deductible. After all, it is your principal residence, so you wouldn’t want to run afoul of the CRA and lose part of your exemption.
Failing to Report Cash or Trade Payments
If you accept cash or trade in exchange for work, you’re still required to report it. In fact, the CRA has severe penalties in place for contractors or freelancers who fail to report cash payments. If you’re caught not reporting cash payments, you may be assessed taxes, interest and penalties, as well as court fines and in extreme cases possibly jail time.
Hartley Cohen, Partner