April 2, 2013, 5:00 am

Mea Culpa Accounting Reality Bites

by: The Financial Blogger    Category: Business
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In March, I wrote a controversial article about creating a corporation for your blog. Both Jason and Glenn from Life Insurance Canada brought several good points. I already mentioned this in a previous post but I am not an accountant, dont take my blog for the absolute truth in terms of accounting.

 

After this point is clear, I have to say that part of my post was misleading. Jason & Glenn’s comment lead to a good talk I had with my own accountant. As far as accounting for my company, the only thing I do is that I put all my paperwork together and ship it to my accountant. He does all the work and determines how my financial statements should look. I’m fairly confident about what my accountant does and I already got checked by the tax guys and everything was clean (yeah!).

 

My accountant clarified some points with me so I can write this post with more accurate information. In the end, the point of having a corporation instead of operating as self employed is still good. But the reasons are slightly different.

 

Protection & Better Structure

 

The corporation in Canada is treated as an independent person. Therefore, my company and I are 2 different individuals from legal and tax perspectives. So the first advantage of having a corporation is definitely the legal protection. My company can get sued but I won’t be responsible for its actions. Therefore, if my company must pay a $5,000 fine resulting from a lawsuit, I won’t have to personally pay for it. Only my company is responsible. What’s great is that my house, cash and other assets are protected from my business activities.

 

The second advantage comes from the fact that I have a partner. It’s much easier to separate everything and take decisions when each partner owns a specific number of shares. We have signed a shareholder agreement which includes a shotgun clause.

 

The shotgun clause protects both partners. If we run into a dispute and my partner would like to buy my shares for $100K, I have the right to offer the same amount and buy his. This makes sure that shares will be transferred at a fair price and won’t let one partner use his financial strength to bust the other partner.

 

Tax Deferral

 

In tax planning, there are the 3Ds: Deferral, Deduct and Divide. You can’t write-off taxes just because you don’t want to pay them. However, there are multiple ways you can differ, deduct and divide so you can decrease your tax bill at the end of the year.

 

The corporation enables you to postpone a part of your taxes payable in time. As mentioned in my previous article, tax rates for corporations are lower than those for individuals. In my corporation, I pay 19% in taxes while my marginal tax rate as an individual is set at 49%. If I would add my blog net revenues to my individual income, I would pay 30% more in taxes than within a corporation. However, I will have to pay those taxes at one point in time.

 

By leaving the money in my corporation, I pay less taxes but I can’t use it to buy milk. I must continue to use this money for my business operations. This doesn’t mean I can’t buy a computer or an iPad for my company though… but I need a justification for business operations.

 

If you act as a self-employed individual,  you will be able to deduct several expenses from your sideline revenues but you will have to pay taxes as an individual (added to your personal income) instead of taking the small corporate tax rate.

 

The Truth about the Tax Advantage

 

The truth about the tax advantages a corporation has happens most of the time in practice and not in theory. When you study tax laws and make all the calculations, there are no advantages to earning money within a corporation as compared to as an individual. At the moment the individual receives the cash in hand, all taxes applied, the residual will be the same whether he made the money through a corporation or as self-employed person. I looked at the numbers myself and it is true that laws have been designed to void all advantages for one structure or another.

 

However, the truth is also that companies have more flexibility than individuals when identifying their expenses. This is not written anywhere and it is still true. Several businesses own a luxury company car like a Mercedes or a BMW. I’m ready to bet anything with you that the business owner is probably not forced to drive a BMW to operate his business and probably uses it on Sunday mornings as well. Then, the tax law comes back saying that each time a business owner uses a company car for his own good, he must charge himself a taxable advantage.

 

The taxable advantages are hard to determine (how can you truly prove that the guy is driving the car over weekends all the time?). But let’s be 100% clean and let’s declare everything. If I use a company car for my own good, I will note the kms and tax me for the benefit. But even if the owner declares the taxable advantage, this will be a small tax bill compared to the price of the car, the maintenance and all expenses related to the car paid for by the company. I wish I could justify the fact I need a car in my company as I would be better off being taxed for using my company car but having the company pay for my tires, oil changes and gasoline! This is why I say that there are some tax advantages to owning a company ;-).

 

Final Thoughts on Corporations

 

If I have a single piece of advice to give you this morning is go see a professional and ask for tax advice. Paying for a corporation might or might not worth it. It’s important to seek professional advice as it’s always a case by case situation.

 

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Comments

Interesting information about deferral, deductions and dividing taxes to make the payments work for you. Figuring out the best ways to pay taxes in a manageable way for your financial situation. Taxes can be very confusing but if you’re not educated getting professional advice is vital.

Interesting! I agree I feel like if you need financial advice, it is best to consult a professional in person to know that you are getting reliable, accurate, and specified information for your issue.

Great post! Aside from being a moral person, the main benefit of the corporation is that it pays taxes after expenses are deducted. For mere mortals, we pay taxes before expenses…

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