September 9, 2008, 6:00 am

How Having a Company Can Make More Money Through Tax Management

by: The Financial Blogger    Category: Assets and Net Worth,Financial Planning
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As many of my readers know already, I started a web company a few months ago. After going throughout the whole process, I can say that Canada is probably one of the best countries to have a start-up. It is definitely not perfect (it is a small market for several products and services for example), but it gives us one of the biggest advantages we could be looking for: we are living in a country with a high tax bracket.

Why a high tax bracket is a good thing?
The answer to this question is very simple: if my marginal tax rate is at 42%, it is incredibly tempting to start a company where its tax rate will be 21%. So I am cutting down my tax rate for my alternative source of income by half!

However, there is another problem. The money earned belongs to the incorporation, not the individual. If I want to access this money, the company must pay me through a salary (42% tax rate), dividend (33%) or bonus (again, 42% tax rate). So technically, there are no advantages to start a company since you are paying 21% first, and than another 33% at best. So on $1,000, you get $529 in your pocket after paying taxes for the company and your personal taxes. This is what we call double taxation (or getting pretty much fooled 😉 ).

There is another way
The government is not always sucking up the blood of our wallet till death. He can give us some ways to pay fewer taxes. For example, my company can pay me a rent of $300 a month for example. That $3,600 yearly expense will be fully tax deductible in the hand of my company. However, it will be fully taxable in my hand. However, I am allowed to deduct a part of my expenses (interest charges, municipal and school taxes, maintenance cost, renovation (for the office)) as well. Than, if my office takes 20% of my property (about half of your basement for example), you are able to deduct 20% of all your expenses. Therefore, it would result into a net rental income of about $300 a year 😉

This is only one example of how you can legally apply tax rules to your personal situation in order to benefit from the fact of having a company. I must insist on the point that everything that is being deducted from your company income must remain within the tax laws. I have seen too many people going crazy about expenses and never paying any taxes… until the government knocks on their door one day to claim their due.

This is why it is so important to leave this kind of calculation to an accountant or a tax expert. It may cost a few hundred dollars or even a couple of thousand bucks, but operating legally is definitely more important!

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Comments

Yes FB, that is ingenius! It’s kind of like being a landlord for the business where you can claim the expenses to upkeep the space.

by: The Financial Blogger | September 9th, 2008 (10:04 am)

MDJ,
There is always room to make money from Canadian Laws ;-D Not my fault if they created such loopholes!

If your office is in your home, put it in the farthest possible place from the door. Every thing a client could touch or see is part of “the office” and is thus deductible.

Landscaping out front, the way through the house, and the room it self. All the square footage can be written off. At least this is true in the US.

by: The Financial Blogger | September 9th, 2008 (10:21 am)

Richard,

We are not that lucky in Canada, you can only deduct the space used in your house for your office and it depends on which kind of business you have. It is very difficult for self employed reps to have office expenses for example.

Damn that does suck.

Here, the moment you are classified self-employed, what ever is required to run the business can be written off. Cell phone, gas, eating out at restaurants (as long as business was discussed or a business card was left), etc.

Now the home office exemption used down here is quite specific though. The office space must be used solely for business use (not a shred of personal in there). The path though, can be free reign, so long as it doesn’t move from year to year and is the shortest possible to the office.

According to CRA (the Canadian equivalent of IRA), you can only write of the percentage of your house’s expense as calculated by number of rooms or square footage.

Also, make sure the rent you’re charging your business is fair market value. Don’t give CRA any excuse to accuse you of committing tax fraud. 🙂

@Richard: Here in Canada, mortgage interest on your principal residence is not tax deductible, and we have basically no real way of income-splitting between working couples. Talk about sucks. 😛

@sundae1888 I believe you mean IRS (Income Raping Service). IRA is a retirement account.

I guess we are fortunate in that regards, if done with a competent accountant, we can write off the interest, part of the mortgage payment, part of all expenses, etc. It can even be argued the internet and TV can be written off.

But then again, the taxes have always favored businesses and not individuals.

Hi there,

I ran your suggestion by my corporate accountant (former auditor for CRA).

She said that this method is acceptable, but the same result can be achieved by having the corporation re-imburse you for the “business portion percentage” of your household expenses.

Less paperwork involved and no negative impact on your personal tax liability…woowoo!

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