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Again, here’s the complete list of “7 Basic Things You Need To Know During Start-up Year”:
(1) Types of Business Organizations
(2) Business Product to sell and manufacture and service to perform
(3) How to keep business records
(4) Planning to have employees or sub-contracting
(5) Year-end Requirements
(6) Dealing with the taxman (Canada Revenue Agency)
(7) Preparing for the next fiscal period
In the last issue I wrote about year-end requirements. At this time of the year, income and expenses for the tax year being reported should have been included and presented in the financial statements. Now it’s time for the company to get ready all information for Canada Revenue Agency (CRA), or other governing tax agencies (for other countries).
Each country has its own policies and procedures on their filing requirements. Most of these requirements are somewhat similar and applicable to all taxpayers worldwide, especially in Canada and the US. At this issue I will be referring more based on Canadian taxation system, as an example.
Preparing your business income tax filing requirements is mainly based on the type of business organizations you have. I wrote about types of business organizations during the first issue, and again here they are: (1) sole proprietorship, (2) partnership and (3) corporation. These 3 types are taxed according to their business formation.
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An owner of a sole proprietorship will be reporting his or her business activities through inclusion to their Individual T1 tax return. A sole proprietor will be using a calendar year end (December 31st) of reporting of income and expenses, using the accrual method. Accrual method of accounting is described as recording of income when earned and expenses when incurred during the 12-months business operation activities. However, a cash method is acceptable for commission people, thus income is reported upon received of amount and record expenses when they are paid.
The company’s Income Statement accounts will be reconciled for reporting of net income for tax purposes. Not all income and expenses stated in the company’s Income Statement can be all included as income and allowable deductions, thus reconciliation is required. A completed T2125, Statement of Business or Professional Activities form will be attached to the T1tax return. In addition, information related to net business or professional income will be added onto individual taxpayer’s T1 Total Income.
Also, contribution related to Canada Pension Plan (CPP) and Employment Insurance (EI) for Self-employment as part deduction and non-refundable credits are reported as well. A completed Schedule 8, Contributions on Self-Employment and Other Earnings, which include the contribution of CPP through employment (as per T4slips), and self-employment are combined, and contribution is required upon going over total income allowable for CPP threshold. As to Employment Insurance (EI) deduction, effective January 2010, self-employed have the choice of receiving employment insurance benefits through paying employment insurance premiums. Paid EI premiums are deductible by self-employed, a Schedule 13, Employment Insurance Premiums on Self-Employment and Other Eligible Earnings must be completed.
Filing deadline for self-employed or with self-employed spouse is June 15th of each year. However, all balance amount owing must be paid on April 30th, or else penalty charges will be charged for late payment.
Partnership taxable income is reported as a “flow through” self-employment income to each partner of the business. Depending on total numbers of partners (5 or less partners) in the business, partnership is not required to file a T5013 Partnership Information tax form; however for over 6 partners the company must file an information tax form.
Like sole proprietorship, partnership’s Income Statement accounts will be reconciled for reporting of net income for tax purposes. A completed T2125, Statement of Business or Professional Activities form will be attached to each partner T1tax return, with related information of partners’ share of the business or profession activities. Each partner’s share of net business or professional partnership income will be added onto individual taxpayer’s T1 Total Income.
In addition, a Schedule 8, Contributions on Self-Employment and Other Earnings and Schedule 13, Employment Insurance Premiums on Self-Employment and Other Eligible Earnings must be completed, just like required for sole proprietorship.
Filing deadline for reporting of partnership taxable income is the same as required for sole proprietorship, self-employed and taxpayer with self-employed spouse is on June 15th of each year. In addition, all balance amount owing must be paid on April 30th, or else penalty charges will be charged for late payment.
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Unlike sole proprietorship, and partnership, corporation’s taxable income is reported by the corporation itself, and reported by shareholders onto their T1 Individual Income tax return upon dividends received from corporation during the year. Thus, corporation taxable income is being taxed into two levels: corporation and shareholders, and double taxation happened.
Corporation has its own advantages and disadvantages as far as taxation. Besides having a limited liability obligation to shareholders, considered as a separate entity, and unlimited life of existence and easy transferability of ownership, a corporation has some advantages as far as payment of taxes as well.
Depending on shareholders’ status, location, where they file their T1 Individual Income tax return, both the corporation and shareholders can enjoy: (1) Tax Reduction (2) Tax Deferral and (3) Income Splitting privileges.
Tax reduction is enjoyed by shareholders who have higher individual tax rate. Having a corporation, shareholders can enjoy the lower tax rate of a corporation. In addition, benefits to small businesses that are controlled by Canadian shareholders are given. Not only that this type of corporation enjoys the federal tax abatement deduction, but also enjoys the additional deduction for being a small business too. Also some regions are given additional assistance in the form of investment tax credit, and some activities like, manufacturing and processing profits are given support through additional deduction as well.
Tax deferral is a strategy applied by corporation in minimizing tax payments, and also related to the double taxation of the corporation’s income. The earnings are left in the corporation instead of paying shareholders right away. Depending on retained earnings that corporation would like to keep, and each shareholder’s individual income tax rate during that year, tax payment is being deferred on earnings in the corporation for lower corporate tax rate, and timing the declaration of dividends to shareholders.
Income Splitting is commonly used for corporations owned by family members as shareholders. Earnings are spread out and paid as dividends to family members who have lower individual income tax rates, available deductions (like RSSP) and non-refundable credits and other credits for individual taxpayers.
As to preparation of corporation’s T2 tax return, Income Statements will be reconciled for tax purposes, and some items will be added back and deducted upon reconciliation process. The T2 Corporation Income Tax return will be filed by the corporation after 6 months of the end of fiscal period. For example, if the fiscal year-end of the corporation is March 31st, therefore the filing deadline will be September 30th.
Lastly, the following procedures can be helpful in the preparation of your personal and business income tax returns.
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(1) Hiring a Professional Tax preparer or Do it yourself tax preparation
Defending on the complexity of your business, ask yourself if you need the service of a tax professional or you prefer to do it yourself.
(2) Using the right T1 or T2 tax forms and schedules
If you prefer to prepare your T1 or T2 tax return yourself, find the right income Tax Form or Tax Software approved by CRA for your type of business. You can visit Canada Revenue Agency (CRA) website for information, download and print, or request the forms by mail. In addition, just for T1 preparation, a few tips from this related blog: Tips in Preparing T1 Canadian Tax Return
It is easier to use tax software than a T1 or T2 paper tax return since it does the calculation and places the amounts to related appropriate boxes automatically. But if you prefer to use a T1 or T2 paper return, make sure to design a T1 or T2 tax form template (from scratch) using a spreadsheet (Excel) to work with your T1 or T2 paper form to eliminate calculation errors and avoid erasures for corrections.
With the use of a spreadsheet, make sure the T1 or T2 tax form are connected to all related schedules. This might take a little work for the first year of using this spreadsheet tax template, but it will become easier for the following tax years since you only need to edit little information, like changes in tax rates, deductions and credit amounts). Most of all, having an accompanied spreadsheet T1 or T2 tax form format is inexpensive, and guaranteed your calculations are almost error free (as long as items are perfectly placed themselves).
(3) Read all items listed on T1 or T2 tax forms and schedules
If using a paper tax return, before filling in the amounts, first read all the items on your CRA T1 tax form (for sole proprietorship and partnership) and CRA T2 tax form (for corporation), and all related schedules accordingly. This procedure is applicable if using tax software too. You can browse CRA T1 or T2 tax forms, or print a blank hard copy for easy reading.
(4) Gather all required information for your T1 or T2 tax forms and schedules
Once you know what items are listed in this CRA tax forms, gather all information like source documents (receipts, T-slips, and related statements) and financial statements (income statements and balance sheet) that are related to your business.
(5) Start your T1 or T2 tax form by filling in information for the first page only
You can start filling in the personal or business information on the first page of the T1 or T2 form boxes, but wait before filling in information for the next pages.
(6) Complete all the required schedules before filling in the rest of T1 or T2 tax form
Before you start filling in the rest of the pages of your T1 or T2 form particularly related to personal or/and business income, deductions, credits, and taxes payable parts, make sure you have completed all the schedules first required to complete your T1 or T2 form. It’s easier that way.
(7) Check required items and related information before sending T1 or T2 tax return to CRA
Before sending your T1 or T2 tax return to CRA, make sure to check all the items that are required to be sent along with your tax return. These items might be required attachments like, receipts, schedules, statements, and payments for the balance owing tax amount and other related items.
8) Missing information after sending T1 or T2 tax form to CRA
After sending your T1 or T2 tax return, and you suddenly remembered that you missed to include information that should have been included in your recently filed T1 or T2 tax return, don’t worry.
For T1, download a T1-ADJ, T1 Adjustment Request Form from CRA website or request it to be sent by mail, or you can send a signed letter to CRA with details of the taxation year that needs adjustment, with your Social Insurance Number (SIN), address, phone, and details of the changes, and attached required statements or schedules, as supporting documents. You do not have to prepare another T1tax return, just send the Adjustment form, or your signed letter and CRA will adjust it for you accordingly.
For T2, if you are the authorized representative for your corporation, you can access your business account online and make the changes, or you can phone or send a signed letter stating your corporation’s name, taxation year that needs adjustment, with your Business Number, address, phone number, details of the changes, and attached required statements or schedules as supporting documents. No need to send another T2 tax return, just the signed letter with details and send it to the CRA Tax Centre that serves you.
Note: The continuation of this topic, “7 Basic Things You Need To Know During Start-up Year of Business?” will be continued on the next post, “Part 7 of 7: Preparing Your Business for the Next Fiscal Period".