Written by Anthony Gordon, Certified Financial Planner at FiduSure Financial
Starting a business is no small feat, with both the thrill and anticipation of launching a concept that one has worked hard to bring to fruition. However, what many often overlook before starting up is the financial challenge that comes with it; most notably, taxes. As a startup founder, minimizing tax liability is crucial for maximizing profitability and ensuring long-term success of the company. In this article, I will share 20 tax-saving tips to help your startup save money on taxes and ultimately boost your bottom line.
If startup founders considered taxes from the outset, they could take advantage of various tax benefits and structures to minimize their tax liabilities while increasing earnings. Effective tax planning can help businesses avoid costly mistakes, ensure adherence to tax laws, and create a tax-efficient plan that can grow with your business and bring long-term success.
Even before creating a plan, there are things you can do that will keep your startup tax-efficient. Below are 20 of the top strategies I’d recommend for any startup. By implementing these tax-saving tips, founders can create a solid foundation and achieve tax planning success.
1. Keep accurate records
The bedrock for proper tax planning begins with keeping accurate records. As a founder, you should track everything, even startup costs, that you incur before incorporating the business. Keeping these records will allow you to claim eligible deductions and credits and provide clarity and insight into the business’s financial health, allowing the founder to make informed decisions about investments, expenses, and funding.
As a founder, you may be working so hard that you’re burning candles on both ends, and keeping track of your financial records is the last thing you want to focus on, so consider hiring a bookkeeper.
2. Hire a bookkeeper
As a founder just starting your business, you may be frugal with your finances and want to spend on something other than a bookkeeper. However, as a founder focused on driving revenue and needing more time, a bookkeeper will help maintain your financial records while you bring in new business. Tracking records, invoices, statements, and expenses will be instrumental in providing the necessary documents for an accountant, who will ensure your finances are in order and your tax liabilities are minimized. For specific industries, you may want to work with a bookkeeper with expertise or a niche working with similar businesses.
3. Hire an accountant
Many people think of an accountant as someone who files taxes and deals with payroll remittance. However, a good accountant can provide you with information and guidance on so much more; even protect your business from non-compliance, which may lead to costly penalties or fines. Beyond tax planning and compliance, a good accountant who has experience with startups can assist your business with finding funding and inform you of the latest tax laws and regulations.
4. Deduct business startup costs
A business deduction refers to an expense that a business can legally subtract from its taxable income, thus reducing the amount of tax it owes. Before you get excited and start tracking every coffee order and computer purchase, remember that a startup cost must have been incurred within the same tax year (or fiscal period) that your business commenced for it to qualify for a tax deduction. Additionally, the startup cost must have arisen after the official start date of your business to be considered eligible. Costs include expenses incurred before the business generates revenue, such as legal and accounting fees, marketing, and travel costs. To deduct these costs, business owners must keep accurate records of all expenses, including receipts, invoices, and other documentation. Feeling more inclined to hire that bookkeeper now?
Regarding deducting business startup costs, not all startup costs are treated the same. Different rules and limits depend on the type of cost. Specifically, some expenses may be fully deductible in the year it was incurred, and other costs can be amortized over several years. With the proper records and assistance of an accountant (or tax professionals), founders can take advantage of eligible deductions and ensure that tax liabilities are minimized.
5. Use a tax-friendly business structure
When dealing with tax liabilities, it is essential to choose the proper business structure that not only meets immediate needs but also helps build long-term profitability. Before starting a business, there are various factors to consider, including but not limited to business size, industry, ownership structure, and long-term objectives. For most small or medium-sized firms, incorporating is often seen as the optimal choice as it provides liability protection and many benefits including the small business deduction. Yet, incorporation may be suitable only for certain business owners. On the other hand, some business owners may prefer to go with a sole proprietorship or partnership if those structures better match their particular needs and goals.
A sole proprietorship, an unincorporated company owned by one individual, is more suitable for companies run by one person exposed to limited liability risks. It’s simple, straightforward, and low cost and is a popular choice for freelancers, consultants, and small business owners who are not subject to legal or regulatory requirements. This structure is also ideal for someone who does not need any significant capital investment or long-term planning.
A partnership is an unincorporated relationship or association between individuals, corporations, partnerships or trusts that come together to carry on a trade or business. Partnerships allow the partners to share resources, management and risks, making them ideal for entities or individuals with complementary resources or skills.
Sole proprietorships and partnerships provide the simplicity and flexibility you will not find in a corporation. However, partnerships, like sole proprietorships, do not provide the liability protection you would receive from a corporation. Thus, partners may be held personally liable for debts and legal conflicts. Ultimately it is strongly recommended that you consult with your account and tax professional before deciding on the best structure for your startup.
6. Tax-free transfer of assets to the business
A section 85 rollover is a Canadian tax law provision allowing founders to transfer property to a corporation without triggering an immediate tax liability. This provision can be used when a founder wants to incorporate their sole proprietorship or partnership business. Instead of selling the business assets to the corporation and paying tax on any capital gains, the taxpayer can transfer them at their adjusted cost base, effectively deferring any tax liability until the corporation sells the assets. In order to qualify for the section 85 rollover, the transfer must be done in exchange for shares in the corporation, and the taxpayer must own at least 10% of the shares after the transfer.
The section 85 rollover provides a tax-efficient way for founders to incorporate their startups and take advantage of the benefits of operating as a corporation. Transferring the business assets at their adjusted cost base allows the taxpayer to defer any tax liability until the corporation sells the assets. This can be particularly beneficial if the assets have appreciated over time, as the taxpayer can avoid paying tax on any capital gains at the time of the transfer.
7. Claim home office expenses
The ability to deduct home office expenses is also available for startups in Canada, which is especially relevant since many people are bootstrapping their businesses from home. In order to qualify for a deduction from home office expenses, the home office space must be used primarily for business purposes, or it must be used exclusively to earn business income on a regular and ongoing basis to meet clients or customers. It must be a designated workspace that is not used for personal activities.
This deduction cannot be used to increase or create business loss, and any unused home office expense can be carried forward to the following year. The types of expenses covered under home office expenses include but are not limited to rent, mortgage interest, maintenance cost, heating, electricity, property tax, and insurance.
8. Claim vehicle expenses
Many Canadian entrepreneurs use their personal cars for business-related activities, such as going to meetings, delivering goods, or seeing clients. The Canada Revenue Agency (CRA) enables business owners to subtract vehicle expenses from their taxable income, as long as specific limitations and conditions are met. Deductible costs include those associated with operating an automobile for business purposes. If you are part of a business partnership, you can claim expenses related to using your personal car for business tasks.
For vehicles serving both personal and business uses, only the proportion of expenses tied to earning business income can be deducted. However, parking charges and extra business insurance premiums for the car can be completely deducted. To verify your deduction claim, maintain a log of the total distance driven and the distance traveled for income-earning purposes.
Allowable expenses cover insurance, leasing costs, license and registration fees, maintenance and repairs, fuel expenses, interest on loans taken to acquire an automobile, and more.
9. Deduct meal and entertainment costs
Expenses incurred during the course of earning income from business or property are deductible. Nonetheless, there are limitations to how much can be deducted. Generally, the amount that a founder can deduct for beverages, food, and entertainment is 50% of the lesser of the following amounts: the actual amount you incurred for the expenses or the reasonable amount under the circumstances.
In some cases, 100% of meal and entertainment expenses may be deductible, including in the following situations:
- When provided as compensation to customers, and the business is in the food or entertainment industry;
- When billed to the customer and itemized on the invoice;
- When expenses relate to parties or events for all employees at a particular location (up to six times per year), even if clients are invited (tax implications may apply for employees);
- When meal expenses relate to employees housed at temporary work camps providing meals and accommodation at construction sites; and
- When meal and entertainment expenses related to fundraising events primarily benefiting registered charities.
It is crucial to keep detailed records and ensure that the expenses are reasonable and incurred to earn income.
10. Deduct business expenses
Startup founders may encounter two types of expenditures: current and capital. Current expenditures are part of daily operations and can be deducted in the year they occur, as long as they are reasonable and aimed at generating income. Founders must provide documentation to support these expenses, which may include advertising, utilities, accounting and legal fees, insurance, travel costs, and rent.
Capital expenditures relate to costs spent on improving an asset’s useful life beyond its original state. These expenses are distributed over the asset’s lifespan and offer long-term benefits that typically last for several years.
Founders should open a separate bank account for their business to monitor these expenses.
11. Use stock options
Canadian startups can offer stock options to employees as an alternative to traditional payment. A stock option grants an employee the right to purchase a specific number of company shares at a predetermined price, allowing the employee to benefit from the company’s growth over time.
Stock options can help retain top talent, especially when cash flow is limited. They offer tax benefits, since taxes aren’t due until the options are exercised. It’s important, however, to consult a tax professional or accountant for guidance.
12. Claim small business deduction
Canadian-controlled private corporations can take advantage of the small business deduction (SBD) for their first $500,000 of active business income, resulting in a lower tax rate. The SBD offers a 9% federal corporate tax rate on up to $500,000 of active business income, compared to the standard 15% rate. This allows small businesses to retain more after-tax earnings for growth and job creation. To benefit from the SBD, startups must follow the associated rules.
Startups qualifying for the SBD receive better tax rates and an “allowable business investment loss” that encourages investment in small businesses by reducing a founder’s potential loss if the business fails. It’s crucial to note that the $500,000 business limit must be shared among associated Canadian-controlled private corporations (CCPCs) and is gradually reduced when the prior year’s aggregate taxable capital exceeds $10 million. Consulting a tax professional is recommended.
13. Use investment tax credits (ITCs)
One potential approach to reducing your tax burden as an entrepreneur in Canada is to take advantage of the Investment Tax Credit (ITC). ITC is offered by both the federal and some provincial governments. This tax incentive encourages businesses to invest in certain capital expenses. By doing so, you can lower your overall tax liability, as the credit is a percentage of the qualifying investment’s cost.
An ITC of at least 15% can be claimed on non-capital expenses related to scientific research and experimental development (SR&ED). SR&ED is a systematic investigation or exploration in science or technology fields conducted through experiments or analysis. The eligible types of research include:
- Basic research: The pursuit of expanding scientific knowledge;
- Applied research: The pursuit of expanding scientific knowledge for practical application;
- Experimental development: Achieving technological advancements for the improvement or creation of new devices, materials, products, or processes; and
- Work performed on behalf of the taxpayer, such as design, engineering, computer programming, data collection, operations research, testing, and psychological research that is directly supporting basic research, applied research, or experimental development.
Eligible costs encompass SR&ED activities you undertake and 80% of the expenses paid to an arm’s length third party conducting SR&ED activities on your behalf. As an entrepreneur, your ITC ranges from a minimum of 15% to a maximum of 35% of your qualified SR&ED expenditures. It’s advisable to consult a tax professional to fully understand and take advantage of these credits.
14. Use accelerated depreciation
Entrepreneurs can claim a deduction known as Capital Cost Allowance (CCA) for depreciating capital assets that generate income for their startup. The Accelerated Investment Incentive (AII), a temporary measure, allows entrepreneurs to triple the usual first-year tax write-offs when they acquire assets between November 20, 2018, and December 31, 2023. The AII encourages investment in capital assets by offering additional benefits for eligible depreciable assets, such as a larger CCA deduction in the first year of acquisition, ultimately leading to tax reductions. The AII is temporary and will be phased out by 2028.
15. Use a Registered Retirement Savings Plan
Business owners can minimize their tax burden by investing in a Registered Retirement Savings Plan (RRSP), a retirement savings option that enables Canadian residents to prepare for their golden years while decreasing their taxable earnings. By consistently making RRSP contributions, founders can enhance their tax savings and enjoy tax-deferred growth. The RRSP contribution limits stand at 18% of the person’s previous year’s earned income, subject to a yearly cap. It is advisable to seek guidance from a financial advisor or accountant to establish the suitable contribution sum based on individual earnings.
16. Use a tax-free savings account
Under the direction of Finance Minister Jim Flaherty, the Canadian government launched a new registered account known as the tax-free savings account (TFSA) in 2008. This account allows Canadian citizens aged 18 and above to deposit savings that grow tax-free. The current yearly contribution maximum is $6,500, with a cumulative limit of $88,000. (as of 2023). While $6,500 each year may appear to be a little sum, the long-term compounding impact may help businesses accumulate a substantial retirement nest egg. TFSAs, despite their name, provide a wide range of investment options, including equities, mutual funds, segregated funds, and GICs.
TFSA contributions don’t come with tax deductions like RRSPs. However, investments made within a TFSA grow tax-free, which can lead to considerable tax-free gains for founders over time.
17. Split income with family members
A valuable tax planning approach for founders involves income splitting with family members. This strategy entails distributing income to relatives in lower tax brackets, potentially decreasing the family’s total tax burden. For instance, a startup founder might compensate their partner or child for their contributions to the business, shifting some earnings from the founder’s higher tax bracket to the relative’s lower one.
When combined with RRSPs, income splitting could enable founders with part-time earnings from their startups to enjoy tax-free income, thanks to RRSP deductions. Lowering income through income splitting might lead to additional refundable tax credits for the founder. Consequently, they can invest more tax-free funds in a TFSA and boost their cash flow for debt repayment.
18. Use tax deferral strategies
One method founders can use for tax planning is postponing their compensation. By putting off receiving a salary or taking dividends from their business, entrepreneurs can lessen their taxable income and delay their tax obligation to a future year. This approach can be especially beneficial for startups that reinvest earnings and don’t require immediate cash flow for personal use.
When founders defer their compensation, they can channel the company’s earnings back into the business or retain profits in the form of cash or other assets. In doing so, the profits remain undistributed to the founders, becoming subject to personal income tax only upon withdrawal. Moreover, delaying compensation can offer additional advantages, like enabling faster business growth and fostering greater financial stability.
However, postponing compensation isn’t a long-lasting tax planning strategy. Eventually, founders will have to receive a salary or take dividends, and the deferred tax obligation will come due. As a result, founders need to carefully consider the timing of their compensation, ideally with guidance from a tax expert.
19. Use of life insurance policies
Life insurance not only offers tax-free benefits to beneficiaries but can also serve as a tax-smart way for startup founders to borrow against their policy’s cash surrender value. This value represents the amount the policyholder would obtain if they were to cancel or give up their life insurance policy. By taking a loan against this value, founders can access funds without generating a taxable event since the loan isn’t considered income. This approach can be especially valuable for those needing capital for business expenses without incurring tax liabilities.
Repayment of the loan against the cash surrender value can be scheduled according to the founder’s preference, and the interest paid on the loan may be tax-deductible. If the loan remains unpaid during the policyholder’s lifetime, the outstanding balance will be subtracted from the death benefit given to the policy’s beneficiaries.
It’s crucial to recognize that leveraging the cash surrender value of a life insurance policy is a complicated tactic requiring thorough consideration and planning. The particular tax consequences will vary based on the founder’s individual situation, and compliance with rules and regulations is necessary to avoid triggering a taxable event. Consequently, founders should consult a financial advisor well-versed in the Canadian tax system to ensure they utilize life insurance in a manner that is advantageous to them.
20. Take advantage of tax treaties
Founders conducting business internationally might face taxes in Canada as well as in other countries. To circumvent double taxation, they can leverage tax treaties established between Canada and foreign nations. These agreements, made between two or more countries, aim to prevent double taxation and foster trade and investment. Depending on the terms, tax treaties can offer tax relief in one or both participating countries.
For instance, certain tax treaties might reduce the withholding tax rate on dividends, interest, or royalties received by a Canadian startup founder operating in another country. This reduction can lower the tax liability for the founder in the foreign nation and Canada. Moreover, some treaties may grant a foreign tax credit, enabling the founder to counterbalance taxes paid abroad against their Canadian tax obligation. This approach can alleviate the startup founder’s total tax burden, simplifying international business operations. It’s important to acknowledge that tax treaties can be intricate, and their specific provisions depend on the founder’s unique situation and the foreign country involved.
As a result, founders should seek advice from a tax expert or financial consultant familiar with international tax regulations and the Canadian tax system to ensure compliance with Canadian tax laws while utilizing tax treaties. Additionally, staying updated on modifications to tax treaties or global tax laws is crucial to adapt their tax planning strategy accordingly.
21. Bonus: review your tax plan regularly
Startup owners must consistently evaluate their tax strategies and modify them as needed to capitalize on emerging tax-saving prospects. Tax regulations and laws continually evolve, presenting new incentives or deductions that could benefit your enterprise. Moreover, your tax planning approach may require updates as your business undergoes changes and growth.
Collaborating with a tax expert or financial consultant well-versed in the Canadian tax landscape can help ensure your tax strategy remains current. These professionals can pinpoint new tax-saving opportunities and advise on how to exploit them. They can also keep you informed about adjustments to tax laws and regulations that could affect your tax planning approach.
Periodically assessing your tax strategy is crucial for making the most of all available deductions and credits for your business. This process may include examining your company’s expenses and identifying areas where tax liability can be reduced. Potential deductions might cover home office expenses, travel costs, or equipment purchases.
Lastly, maintaining precise records of your business operations and expenses is essential for optimizing tax-saving opportunities. Employing accounting software or enlisting an accountant’s services can help you effectively manage your financial records.
About the author
Anthony Gordon is a certified financial planner based in Toronto who helps business owners simplify their financial future through strategies focused on financial planning, tax planning, exit planning, and estate planning. Anthony enables his clients to prioritize their families, businesses, and lifestyles by providing this expertise.
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