Year-end tax planning: business owners and employees
The Covid-19 pandemic has not stopped CRA's tax collection efforts
The Covid-19 pandemic has, for pretty much the entire year, certainly created much disruption with the way we live every day. In the tax world, there was some relief, including extension of some tax-filing deadlines. But some things never change. Taxes will always have to be paid eventually, and the Canada Revenue Agency hasn’t stopped working to collect them. So it’s still important to do some planning to minimize the tax bill when it comes due. With that in mind, and before we put 2020 behind us, let’s look at some year-end tax planning strategies for both business owners and employees before next year’s April tax-filing deadline is once again upon us.
Tips for business owners
1. File a tax return
Many new businesses experience start-up losses in the first few years, especially so for 2020 with the pandemic hitting everyone’s bottom line. If you personally carry on a business, you should file a return for every year, even the loss years. That’s because your business’s loss can be used to reduce income from other sources in the current year, or it can be carried back three years and forward 20 years. The loss will reduce income from any source – be it the business itself, from employment – even from investment income. But to claim the loss, you must file a tax return for the year.
The year-end of an individual who is a sole proprietor or an active partner in a partnership created since 1995 is December 31. Self-employed taxpayers and their spouses (if not separated) have until June 15 to file a return, although any taxes owing must be paid by April 30.
2. Lower your tax installments
If you pay taxes on an installment basis, you’ve probably received several notices from the CRA informing you of how much your installments should be. If your income has gone down in the last couple of years (and presumably so for 2020), think twice before you send in your cheque.
CRA’s installment calculations are based partly on your income tax position two years ago and partly on last year’s. Instead of using the CRA’s method, you are legally entitled to base your installments on last year’s tax position. You can even base your installments on the current year’s estimated tax position, if lower; but in this case be careful – penalties may apply if you underestimate your taxes and your installments turn out to be lower than the other two options required.
If your income has gone down in the last couple of years, using one of the other two options can mean that you can reduce your quarterly installments without suffering interest penalties. But if you underinstall, the CRA will start to charge you interest. The interest rate is currently 5%. However, this rate is compounded daily. Worse still, it’s nondeductible. So this is an expensive way to enhance your cash position. For seriously delinquent installments, there is a 50% interest surcharge slapped on.
If, during the year, it becomes apparent that you have paid more installments than you need to, you might consider the possibility of purposely not following the installment schedule by paying deficient or late installments. Actually, this is quite “legal.”
By the way, if you’ve overinstalled or paid early, CRA gives you a credit (known as “offset” or “contra-interest”) against interest on late or deficient installments for the year. Very basically, the rule works as if you had deposited the installment in a bank account and earned interest (at CRA’s prescribed rates – currently 3% for individuals and 1% for corporations) to the extent that the installment is early or excessive. These “credits” can then be used to apply against interest penalties on deficient or late installments. The flip side of this, of course, is that you can reduce interest charges on a late or deficient tax installment by overpaying other installments, or paying them before their due date.
Deductions for most normal business expenses are based on whether the expense has been incurred by year-end, rather than whether the item has actually been paid for, e.g., office supplies, auto and other repairs, etc. Exceptions include compound interest charges – regular (“simple”) business interest can be expensed when payable, site investigation and utility service connection charges, and disability-related equipment and building modifications
Consider accelerating purchases of equipment, capital, and other expenditures before year-end. Examples include auto and equipment purchases (half of the normal depreciation can be claimed this year – next year, you claim the full depreciation rate), auto repairs, and so on. Note: Even though the depreciation rules restrict the writeoff on capital purchases, you can claim a full GST credit, for the year of purchase. So, if you buy by the end of the year, the credit will allow you to reduce the GST you owe.
If you “accrue” a salary to family members (this must be reasonable in relation to the business service they perform), you can claim a deduction as long as you actually pay the expense within 179 days of your business’s year. This may allow the recipient to defer tax on the amount until next year.
Tips for employees
Some may think that as an employee, the ability to do tax planning and reduce your taxes is somewhat restricted. However, where there is a will, there is a way.
1. Reducing your source deductions
For employees, one unlikely source of cash could be the source deductions withheld on your paycheque. Many people regularly get tax refunds because of deductions such as support payments, carrying charges on investments, and so on. If you’re one of them, call the payroll division of your local tax office. Tell them you want to apply for a reduction of source deductions under section 153(1.1) of the Income Tax Act (if you cite the section number, they’ll know you mean business). They’ll send you a form and ask you for some info to back up your application. If you do, they’ll probably cut your withholding so you can pocket the money. Most tax offices are quite cooperative when it comes to this procedure.
According to the CRA, there is no specific minimum amount below which they will not consider an application. Although technically, you are supposed to show that without a reduction you’re a hardship case, the CRA seems to be pretty easy on this requirement.
One item that may get you a reduction in source deductions is an early 2021 RRSP contribution. Contributing early in the year also means your earnings will compound on a tax-sheltered basis sooner rather than later.
Warning: if you are basing your application on a tax shelter, questionable deduction, or other aggressive tax planning, an application for reduced source deductions could bring unwanted scrutiny. Better to leave well enough alone.
2. Defer income
If possible, you should defer the receipt of employment income if your tax bracket will be lower in 2021.
3. Claim depreciation
Employees are entitled to claim tax depreciation (called Capital Cost Allowance, or CCA) on automobiles, aircraft, and musical instruments, depending on the circumstances. If you’re entitled to deduct CCA and you’re considering purchasing a new asset, you should do so prior to the end of the year. This will accelerate capital cost allowance claims by one year. The asset must actually be available for your use to qualify for a CCA claim.
4. Reduce automobile “operating cost” tax
If the personal use of a company-owned car is less than 50%, consider notifying your employer by December 31 if you want the taxable operating cost benefit based on one half of the standby charge, less any reimbursements you paid. Other ways of reducing your operating benefit include reimbursing your employer for operating costs, reimbursing your employer for 100% of the personal use portion of actual operating costs, and minimizing your personal driving.
5. Reduce “standby charge” tax
Standby charges are calculated using the vehicle’s original cost. After a few years, when the vehicle is worth less, consider buying it from your employer to avoid the high standby charge. Alternatively, have your employer sell the automobile and repurchase it or lease it back or choosing a less expensive car.
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. This article first appeared in The TaxLetter, © 2020 by MPL Communications Ltd. Used with permission.
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The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.