Preparing For Year-End As A Corporate Owner-Manager
Year-end tax returns for a small business owner can be a lot of work whether you have a sole proprietorship, a partnership, or an incorporated company. However, the record-keeping requirements, government filings, and planning strategies are all more complicated when you have a corporation.
Here are some tips and tricks for incorporated business owners to prepare for and maximize their year-ends.
Bookkeeping
When you are an unincorporated business owner, an accountant can file a tax return with income and expense totals provided by you. There is no requirement to see the documentation for the transactions, nor reconcile the bank account and credit card statements used for your business activities. Many people file their own personal tax returns including a statement of business or professional activities without the need for an accountant.
The requirements can be more stringent for a corporation. Bank and credit accounts usually need to be reconciled, with statements matched to the records to ensure accuracy.
Very few people take a do-it-yourself approach with their corporate tax return filing. However, some business owners do their bookkeeping with varying degrees of success. Others have their accountant do it as part of their year-end. Some have internal employees or external bookkeepers who maintain their books throughout the year.
Good bookkeeping can make a corporate accountant’s job much easier. Bad bookkeeping can drive up the time and the cost of preparing a corporate tax return. Your accountant may even need to duplicate your efforts if the bookkeeping is poor.
If the volume of transactions is sufficient, it can be advantageous to do bookkeeping regularly, potentially monthly or even daily. In addition to being better prepared and providing prompter records for your accountant, you can have better insights into your business performance in real-time.
Beyond tracking transactions, a business owner should consider other software including:
- Receipt storage and automation into bookkeeping software
- Customer payment processing solutions
- E-commerce sales applications
- Inventory management if applicable
Bookkeeping software often integrates with third-party business apps and combining them can expand your business capabilities and help maintain better records for year-end and beyond.
Compilation, Review, or Audit
There are three types of year-end accounting reports that a business can prepare. Business owners may or may not have a choice between them.
A compilation is the simplest method to compile a corporation’s financial data. It used to be called a notice-to-reader, but this method was replaced in December 2021 by the new compilation engagements standard. This involves reporting a company’s numbers from the corporation’s ledgers without specific assurance that the numbers are accurate.
A review is a more thorough filing process that involves rigorous validation using statements, records, and other support for a company’s income, expenses, and other transactions. There is a limited level of assurance provided by an accountant that the financial statements are accurate using generally accepted accounting principles.
An audit involves a meticulous evaluation of all transactions by a company where an accountant provides their opinion on the accuracy of the corporation’s financials. This provides the highest level of assurance to a business owner and other interested parties that the records and reporting are valid.
For most owner-managers, a compilation engagement will suffice. It will be the easiest and least expensive option as well.
A lender may require a review engagement when loans or credit are extended to a business, to ensure a higher level of due diligence and more reliable credit approval sources.
Publicly traded companies are generally required to have audits, but some private companies might find them beneficial or necessary as well. Investors may insist upon an audit engagement, or if a company might be sold in the future, having audited financial statements may provide more assurance and expedite the due diligence process with a prospective buyer.
Tax Planning
Owner-managers who control their compensation have decisions to make about how they pay themselves and what they do with their corporate profits. Every taxpayer’s situation is different, but some generalities often apply.
A business owner who is also a shareholder can pay themselves a salary as an employee, or a dividend as a shareholder. There are differences in the tax implications.
A salary is tax deductible by a corporation. So, if a corporation pays out all its income as salary, there is no taxable income left in the corporation, nor corporate tax to pay. The income is then fully taxable personally.
By comparison, a dividend is a distribution of a corporation’s after-tax profit. The dividend is not tax deductible for the corporation. So, if a corporation earns income and then pays out a dividend from that same income, there will be both corporate tax and personal tax payable.
The corporate tax payable on business income for small business owners generally ranges from 9 to 12 per cent depending on the province or territory of residence. The shareholder receiving the dividend pays a special, lower rate of tax compared to other sources of income. The dividend tax credit mechanism that accomplishes this lower personal tax rate is meant primarily to account for the corporate tax already paid. This concept is called integration.
The problem with integration is that it is not perfect. In fact, in most cases, the combined corporate and personal tax payable to issue a dividend is more than the personal tax payable to pay a salary from the same corporate income. As a result, most business owners are slightly better off being paid a salary than dividends.
There are other advantages to paying a salary. Salary is considered earned income for registered retirement savings plan (RRSP) purposes and creates RRSP room for contributors. Dividends are not considered earned income, so they generate no RRSP contribution room.
In most cases, business owners are better off contributing to their RRSP, even if they need to take the extra profit out of their business, compared to retaining the after-tax profit and investing it corporately. The reason is that the corporate tax on business profit of at least 9-to-12% leaves less to invest corporately compared to making tax-deductible contributions to an RRSP.
The same typically applies to tax-free savings accounts (TFSAs). A business owner is generally better off contributing to their TFSA compared to investing corporately, even though they may have to pay more tax up-front. Although TFSA contributions are not tax deductible and taking extra withdrawals from a corporation to invest in a TFSA results in more current-year tax, the long-run tax savings on investment income are often advantageous.
Paying salary requires a business owner to contribute both the employer and employee Canada Pension Plan (CPP) contributions up to the yearly maximum pensionable earnings limit of $81,200. The effective long-run rate of return for these contributions when calculating the future CPP retirement pension income is comparable to a moderate-risk investor contributing to an RRSP. So, while not compelling, CPP does provide a simple retirement income source with no effort required by the retiree.
Incorporated owner-managers should not make the mistake of letting cash sit idle in their corporation. Some people are unaware they can open a corporate investment account to invest corporate savings for retirement. Once RRSPs and TFSAs are maxed out, profit not needed for business or personal spending is generally best allocated to a corporate investment account to grow it over time.
It may make sense to move corporate investments to a separate investment holding company for creditor protection, especially if an operating business may someday be sold. This purification may be necessary so that a business owner can claim the lifetime capital gains exemption (LCGE) for the sale of their shares, which can otherwise be compromised if they have too large an allocation to passive assets within their company.
Summary
There are administrative, accounting, and tax planning considerations for business owners when year-end rolls around. A savvy owner-manager will be more organized, collaborate better with their accountant, and pay less tax if they plan proactively for the year ahead. So, if your year-end is always a retroactive exercise, maybe this is the time to turn things around and become better prepared.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.