5 Year End Tax Tips for Small Business
TOP 5 YEAR-END TAX PLANNING STRATEGIES FOR YOUR BUSINESS: 2021 EDITION
- Consider government COVID 19 relief programs
The federal government has rolled out various financial assistance programs to help businesses during the COVID-19 crisis, including the Canada Emergency Wage Subsidy (CEWS), Canada Emergency Rent Subsidy (CERS), and Canada Emergency Business Account (CEBA). Although it may feel overwhelming to navigate through all the new programs, it is important to make sure that your business is taking advantage of all available support programs to help you through these difficult times.
From an income tax perspective, if your business participates in government relief programs, you should know that assistance received under the CEWS and CERS is taxable. The forgivable portion of your CEBA loan also needs to be included in taxable income in the year the loan is received. Keeping these points in mind can help you manage your business’s cash flow as you prepare to make final tax payments.
There is always the possibility that your claims may be audited by the Canada Revenue Agency (CRA)–in fact, post-payment audits of CEWS claims have already begun. As such, it is important to ensure documents supporting your claims are kept and readily available in the event they are requested by the CRA.
- Comply with new reporting requirements
2020 was anything but a typical year, so it is not surprising that there are new reporting requirements that employers need to be aware of.
New T4 reporting requirements
The CRA has introduced a new reporting requirement for T4 slips that applies to all employers starting in 2020. This information will help the CRA validate payments under the CEWS, Canada Emergency Response Benefit (CERB), and Canada Emergency Student Benefit (CESB). Employers should know that in addition to reporting all taxable employment income for the year in Box 14, employment income will also need to be reported for four separate pay periods, in four separate boxes on the T4.
The new reporting codes and corresponding qualifying periods under CEWS are as follows:
- Code 57: Employment income – March 15 to May 9 (qualifying periods 1 and 2 of CEWS)
- Code 58: Employment income – May 10 to July 4 (qualifying periods 3 and 4 of CEWS)
- Code 59: Employment income – July 5 to August 29 (qualifying periods 5 and 6 of CEWS)
- Code 60: Employment income – August 30 to September 26 (qualifying period 7 of CEWS)
As the eligibility criteria for the CEWS, CERB, and CESB are based on employment income for a specific period, these new requirements mean employers should report income and any retroactive payments made during these periods.
Keep in mind that these new T4 reporting requirements apply to all employers, even if your business did not make a CEWS claim.
10% Temporary Wage Subsidy and Form PD27
Earlier this year, the CRA released a new mandatory reporting form, “PD27, 10% Temporary Wage Subsidy Self-identification Form for Employers.”
All eligible employers who claimed the 10% Temporary Wage Subsidy (TWS) are required to complete the PD27. In addition, employers who qualified for both the TWS and CEWS but chose to apply only for the CEWS are also required to file this form with the CRA.
As benefits under the TWS program were claimed by a reduction in payroll withholding remittances, this form will be used by the CRA to reconcile the employer payroll program (RP) accounts. The CRA indicated that filing this form as soon as possible will ensure that the employer will not receive a discrepancy notice at the end of the year.
Employee home office expense deductions–T2200 requirement
If your employees worked from home during the pandemic, they may be able to deduct home office expenses, provided they meet certain criteria. Normally, one such requirement is for the employer to provide Form T2200, Declaration of Conditions for Employment, to every employee. A fillable version of Form T2200 can be found on the CRA website.
- Pay your family wisely
As a private business owner, you likely know the value of revisiting your family business remuneration strategy at least annually. In determining the best mix of salaries and dividends for you and your family members, consider factors such as each individual’s marginal tax rate and need for cash, as well as the corporation’s tax rate and the benefits of deferral.
Tax on split income rules
Since 2018, this process has become more complex due to the expansion of the tax on split income (TOSI) rules. These rules further restrict the use of a private corporation to split income with family members. They do this by applying a high rate of tax to certain types of income—in particular, dividends paid from private corporations. When these rules apply, they eliminate the benefit of income splitting. However, there are situations where you can still split income in a tax-efficient manner with family members. The TOSI rules are very complex. Therefore, it is important to work with your financial advisory team to determine an optimal remuneration strategy.
Pay reasonable salaries to family members
Keep in mind that the TOSI rules do not apply to wages paid for actual work performed. If your spouse or children work for your business, consider paying them salaries for their work. You should always remember that salaries must be reasonable and consistent with the services performed. A good rule of thumb is to pay them what you would have paid a third party doing similar work at a similar age and to maintain adequate documentation to support such payments.
Also, remember that payment of salaries and bonuses accrued in this fiscal year must be made within 179 days of your business’s year end for the amounts to be deductible in the current fiscal year. For example, if your fiscal year ends between July 6, 2021 and Dec. 31, 2021, a bonus for the 2021 fiscal year can be paid in 2022 (but within 179 days of the 2021 fiscal year end). This means that your business will get a deduction in the 2021 fiscal year, but your family members would not be taxed on it until 2022.
Withholdings on family salaries
Whenever you pay salaries to your spouse or children, ensure that withholdings for income tax, Canada Pension Plan, employment insurance, and any applicable provincial payroll taxes are remitted as required.
Where the remuneration is paid in 2021, the remuneration and related withholdings must be reported on T4 slips for 2021, which are due on or before Feb. 28.
- Take stock of the small business deduction, the passive investment income rules, and their impact on your business.
The small business deduction (SBD) reduces the corporate tax rate for qualifying businesses and therefore creates a greater deferral of tax than for business income taxed at the general corporate rate. The SBD is one of the most common tax advantages available to Canadian-controlled private corporations (CCPCs).
The small business limit is currently $500,000 federally, and in all provinces and territories except for Saskatchewan (where the limit it $600,000). In 2020, the combined corporate tax rate on income up to the small business limit is 14% or less in all jurisdictions—at least 12.5 percentage points lower than the general corporate tax rates, and as much as 19 percentage points lower in some jurisdictions. This allows for a significant tax deferral where active business income is retained in the company.
How passive investment income rules restrict small business deduction
The passive investment income rules limit access to the SBD and apply to taxation years that begin after 2018. Specifically, CCPCs that earned investment income over the $50,000 threshold in the previous year are generally subject to a reduction in the amount of SBD that can be claimed for the current year.
Under the rules, the small business limit is reduced by $5 for every $1 of adjusted aggregate investment income (AAII) above the $50,000 threshold. Under this formula, the SBD will be eliminated when AAII reaches $150,000 in a given taxation year. Note that investment income is aggregated for all associated corporations for purposes of this threshold.
Generally, AAII includes investment income, such as interest, rent, royalties, portfolio dividends, dividends from foreign corporations that are not foreign affiliates, and taxable capital gains that are over current-year allowable capital losses from the disposition of passive investments. Since AAII includes income net of expenses, it might make sense to consider the related expenses that were incurred to earn investment income. For example, interest expense, investment counsel fees, and a salary paid to the owner-manager incurred to earn investment income could reduce AAII, as long as the amounts are reasonable.
Ways to preserve access to the small business deduction
Because the SBD restriction is based on AAII earned in the previous year, annual planning may make sense in situations where the amount of AAII changes from year to year so that the following year’s SBD can be managed. There are strategies to reduce investment income within your corporation while retaining investment funds within the company (as withdrawing the funds from the company will be taxable to you). Keep in mind that any such action to reduce investment income must make sense from an overall investment perspective and not just with an idea to minimize taxes.
Adjust your investment mix
You could adjust the investment portfolio in your company to be more tax efficient. One way to achieve this might be to hold more equity investments within your corporation rather than fixed income investments. This would be helpful because only 50% of the gains realized on the sale of shares would be taxable, whereas investment income earned on bonds is fully taxable. This means that only 50% of the gain on the sale of equities is included in AAII compared to 100% of the income earned on fixed income investments.
Invest in exempt life insurance policy
Alternatively, you could consider investing excess funds in an exempt life insurance policy, because investment income earned within an exempt life insurance policy is not included in AAII.
Set up individual pension plan
Finally, you should also consider setting up an individual pension plan (IPP). The passive investment rules do not apply to these plans, which makes them an attractive retirement savings option for business owners.
An IPP is a defined benefit pension plan available to owners of incorporated businesses. Under an IPP, the benefits are set by reference to your salary, and contributions are made to build sufficient capital to fund a defined pension benefit. The contributions made by your company are tax deductible, and the investments inside the plan grow on a tax-deferred basis.
For eligible individuals, the use of an IPP can allow for greater contributions (which generally grow with age) when compared to a registered retirement savings plan (RRSP). Over time, the use of an IPP can produce substantial tax advantages over an RRSP. Additional benefits of an IPP may include the ability to make up for poor investment performance and higher retirement benefits.
- Plan the timing of depreciable asset purchases and sales
Purchase depreciable assets before year end
If you are planning to purchase depreciable assets for use in your business in the near future, you should consider doing so before the end of your fiscal year. If such assets are acquired and in use before your fiscal year end, you can claim tax depreciation, or capital cost allowance (CCA), to reduce your business’s income in this fiscal year. Bear in mind that title to the asset must be acquired and the asset must be available for use in the current fiscal year in order to claim CCA this year.
Accelerated investment incentive property rules
The tax benefit of making depreciable asset purchases before year end is magnified with the accelerated investment incentive property (AIIP) rules. For eligible property acquired after November
20, 2018 and available for use before 2028, the AIIP rules provide for enhanced first-year CCA, with the highest rate of CCA available to property that is available for use before 2024.
For 2020, eligible manufacturing and processing machinery and equipment, as well as clean-energy equipment, can be fully written off in the first year under these rules. Other classes of eligible
depreciable property can benefit from an enhanced first year CCA claim equal to three times the first year CCA that could be claimed prior to the introduction of the AIIP rules.
Purchases of certain zero-emission vehicles on or after March 19, 2019 that become available for use before 2028 are also eligible for enhanced first-year CCA.
Generally, these vehicles must be new vehicles that are fully electric, fully powered by hydrogen, fully powered by a combination of electricity and hydrogen, or plug-in hybrids with a battery capacity of at least 7 kWh. For eligible vehicles that are available for use before 2024, the new rules allow for full write-off in the year of acquisition.
Note that there will be a limit of $55,000 (plus sales taxes) on the amount of CCA deductible for each zero-emission passenger vehicle. If you took advantage of the federal point-of-sale incentive for zero-emission vehicles administered by Transport Canada, your new vehicle would not be eligible for full CCA write-off.
Earlier this year the government expanded on these rules so that certain off-road zero-emission vehicles and equipment that were previously excluded can now benefit from the enhanced first year CCA. These off-road vehicles and equipment must generally be automotive (i.e., self-propelled), fully electric or powered by hydrogen, acquired on or after March 2, 2020 and become available for use before 2028. For eligible off-road vehicles and equipment that are available for use before 2024, the new rules provide for full write-off in the first year.
Accelerating the purchase of capital assets before the end of your fiscal year and claiming the enhanced first year CCA on eligible property will allow for faster tax write-off of these investments, provided that the assets will also be available for use prior to your fiscal year end.
Delay the sale of assets with accrued gains until after year end
If you plan to sell capital assets with accrued gains, you should consider delaying the sale until 2022 (or the start of your business’s next fiscal year). This will allow your business to claim one additional year of CCA and will also postpone the inclusion of any recaptured CCA and capital gains in taxable income by one year. Note that this planning applies to depreciable property, real property that is capital property, and investments.