Blog & Corporations; How You Can Double Your Income
If you haven’t already, you may be lagging right now; it’s tax season, so you better pack your T4’s & T5’s together and fill in your tax report Mine are already sent, but it’s not because I like to be on top of my things. It’s more because I’m expecting a nice check from my friends at the Government!
Speaking of my friends at the Revenue Agency, Ottawa Guy, a long time reader, just sent me a quick email last week and asked two simple questions: Why did you incorporate your business? What are the advantages compared to running your blog under your own name?
Almost exactly five years ago, my partner and I founded our corporation. Our goal was to be able to run a true online business and make it easy to manage and to split if we would eventually disagree. But behind the protection and the simplicity, there is a huge advantage of having a corporation, no matter how big your business is…
Note: I’m not a professional accountant and not providing accounting advice in this post. You must verify with a professional if your situation applies to having a corporation.
The major advantage of having a corporation is summarized in a single mathematic calculation:
Which one do you prefer; paying your expenses before paying your taxes or after paying them? I you are a little bit familiar with accounting you guessed that the first situation happens for corporation while the second situation is for poor mortals also called tax payers ;-).
A corporation pays taxes only on their net profit only. This means that once the company receives its income, it can spend it all before paying any taxes. Then, once you have paid for all your expenses, you will pay a small tax rate on your net profit. All right, a small rate in Quebec is 19%… depending on which province or state you live in, this could be higher or smaller. Since my own marginal tax rate is near 50%, a 19% tax rate seems like the deal of the day for me!
Once you understand that you benefit from a tax advantage compared to regular employees, you need to find expenses that make sense. For example, I have a web company with no shipping services. How could I possibly have a car paid by the corporation? It’s pretty hard to justify it, right? And this is why my company is not paying for my RX-8 ;-).
However, I need a computer, internet access, a smartphone and all other electronic devices that can help me work online and test my sites. The company can then pay for these expenses since they are vital for its business model.
If I get back to the tax advantages, I’ll give you a real example. Let’s say I pay $70 per month for my smartphone and I earn $100 this month. Here’s what happens if I pay for my phone as a tax payer or as a corporation. I’ve set a marginal tax rate of 40% for the tax payer and a 19% tax rate for the corporation.
So the tax payer pays $34.30 more in taxes and doesn’t have enough money left to pay for the smartphone (he is short by $10). The corporation ends-up paying $5.70 in taxes because they are calculated after paying for the smartphone. Therefore, for the same transaction, the Corporation pays 5.70% in taxes out of $100 earned. I know, I’m twisting numbers here but still, the example makes it obvious that a corporation definitely has a huge benefit compared to a tax payer.
You obviously cannot make-up expenses and abuse this rule. If not, everybody would create their own little corporation just to switch their household expenses into corporate expenses. However, there are several things your company will need in order to operate and they can be paid before paying taxes on the income.
Another way to reduce your income before paying taxes is to find losses. In our case, we can use currency losses depending on how the CAD vs USD evolves. Since we do not wish to trade currency to hedge our company, we sometimes suffer from a currency loss while exchanging USD for CAD. After all, most of our income is made in USD and most of our expenses are in CAD. This used to be a big advantage back in 2008 but it’s more an inconveniency right now ;-).
I’m not sure if this concept exists in the United States but in Canada, you are allowed to reduce the value of an asset on your books. This has a double effect on your financial statement:
#1 it allows you to use this asset value reduction as an expense to reduce your profits (and pay less taxes)
#2 it also reduces the value of the assets on your books and therefore, will boost the capital gains to be paid upon disposition of the asset.
Here’s a quick example:
I bought a website at $10,000. Each year I can amortize the site value by 1/5 (this is an example; I’m not sure about the actual accounting rule). Therefore, I can reduce my profit by $2,000 annually according to the 1/5 amortization rule. If I sell the site after three years, the site will show on my books at a value of $4,000 (3 years * $2,000). While I saved taxes to be paid on $6,000 over the past three years, the taxable capital gain will be based on the price of the sale minus $4,000 and not the $10,000 I paid for. If I sell the site at $15,000, my taxable capital gain will be $15,000 – $4,000 = $9,000.
As you can see, you don’t avoid paying taxes; you simply postpone them to a later date. You can’t really avoid paying taxes, but being able to delay them for several years is definitely worth it!
Because companies create jobs and contribute greatly to the economy, their tax rate will always remain lower than that of individuals. If I hadn’t created a corporation, I would have still been able to own my blogs and make money out of them. The problem is that the benefits would have been added to my current income as a worker. Therefore, instead of paying 19%, I would have paid 49% on this income.
This means that for each $100 earned, I would lose a ridiculous $30 in taxes. This is a huge difference if you aad some zeros to the $100. Last year, we finished with over $40,000 in net profit. This means I would have paid an additional $12,000 in taxes as an individual compared to a corporation. Considering the accounting fees and incorporation costs, this year alone is enough to cover several years of fees!
I guess the final question is when should I incorporate my sideline? I think that if your sideline and day job combined together adds-up to over $50,000 per year, you should definitely consider incorporating your sideline. You will save a lot in taxes and keep the profits for yourself. This is why we didn’t wait to make money to create our corporation, we knew we were serious and we knew that we would generate over $50,000 in income per year.
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