Contemplating the independence that a small business on the side may give to you? Thinking about starting up a small business, then having it on the side when you retire? Don’t neglect to consider the advantages one enjoys when operating a bona-fide business from your home!
Tax laws about splitting income between spouses and even to children are designed to ensure that the taxes are paid by the original ‘gifter’ rather than the recipient (in most cases). When running a home based business, you can now employ your spouse and children and pay them a fair wage for the work they do. In this case, they earn income and you, as the business owner, have an expense. When your spouse or children are in a lower tax bracket or have unused, non-transferable tax credits you are transferring income to them for the best tax advantages and lowering the overall family tax burden.
Using space in your home to operate your business allows you to write off a percentage of your home’s overhead including property taxes, insurance, mortgage interest and utilities. You can also write off a percentage of the regular (non-capital) repair and maintenance you make to the home. Note that expenditures made in the business space for business purposes only (eg putting up shelves or painting, are written off as all business expense, not just a percentage). The space must be used for business purposes on a regular, ongoing basis (eg not the kitchen table). The percentage to use is determined by the business space square footage over the total square footage of the home or the number of rooms that are used by the business over the total rooms in the home (not including bathrooms, utility rooms or laundry rooms). Use whichever calculation gives you the bigger percentage. This percentage is applied to the expenses for the home and used to decrease your business income, thereby reducing the tax you pay. Home business expenses may only be used to reduce business income to zero and can not be used to increase a loss. In either of these situations the unused home business expenses maybe carried forward, creating a tax free zone for next year. It is beneficial to claim the home based business expenses each year, particularly during startup of the business, to build up that tax free zone for that year when your business really takes off!
During the startup years of your business, it is reasonable to expect that expenses will exceed income. This creates a loss for tax purposes. This loss reduces your taxable income from other sources such as employment or investments. The loss reduces tax payable at your highest marginal tax rate. If your marginal tax rate is at 35%, you will pay less taxes equal to your business loss x 35% in general. Not only is your taxable income reduced, but you may be increasing credits such as the GST credit or Child Tax Benefit which are both income based (as your income decreases, the benefit increases). In order for this benefit to be available to you, you must have and be able to prove a reasonable expectation of profit for this business.
Losses incurred running your business can be carried back three years or forward seven years. Therefore losses incurred during the startup or formative years of your business won’t be lost but can generate tax savings by going back in time to when you had taxable income, or carrying it forward to apply against those lovely gains in the future!
Running a vehicle these days is expensive. Just imagine, now you can write off a portion of the vehicle expenses! Even if your business involves you sitting at the computer most of the time, you still need to run out and purchase office supplies, pick up mail from your box office and deposit those cheques! You must keep track of all business trips made and have backup. Backup can be the receipt for that ream of paper or a note in your daytimer regarding meeting a client. You must keep a vehicle log showing the date, where/why you went and the number of kilometers. At the beginning of the year, record the odometer reading for the vehicle. Subtract this reading from last years ending odometer reading to give you the total kilometers you put on the vehicle. Adding up the business vehicle log kilometers gives the business kilometers. Divide the business kilometers by the total kilometers and you have a business use percentage. Apply this percentage to the total expenses for your vehicle and write that amount off against your business income. Expenses you can write off include gasoline, repairs and maintenance, car washes, insurance deductibles, insurance premiums, auto club membership fees (eg CAA), drivers licence and the interest expense or lease payments.
Rita Tully, CGA is an accountant who practices what she preaches (she runs an amazing home-based business!) For more articles related to tax-time, see her web-site.