Avoid these 9 expensive tax mistakes
Canadian entrepreneurs are some of the finest in the world when it comes to starting, managing and growing their small to medium-sized businesses. However, many of them have little or no accounting experience, particularly in the start-up years when their focus is on making their company a success.
Failing to double check claims and a lack of preparation during the year can lead to expensive tax mistakes.
Common Mistakes by small business owners :
1) Assuming that you don’t need to bother filing a tax return because you have no income.
Don’t make the unfortunate mistake of thinking that since you lost money, you will have no taxes to pay and don’t need to bother to complete a tax return. Ok, you had a bad year, and your business lost money. It happens. Even some of the biggest corporations lose money occasionally. Business losses are one of the most flexible personal income-splitting techniques because you can deduct the losses over any of the past three years or the next twenty years. Make sure you don’t compound your bad luck by not filing your tax return as this misunderstanding can cost thousands of dollars in tax refunds and even criminal penalties. Learn from the video story of Thomas.
2) Under-Reporting Cash Revenue
As a small business owner if you feel tempted that it’s “okay” to hide a little cash income here and there, beware that CRA agents are actively on the lookout for tax evasion. Many business owners tend to rationalise this cheating behaviour by complaining about the personal and corporate tax rates adding up to one of the highest in the world. They also tend to believe that failure to disclose cash income is just being negligent- a social transgression that can be cleared up with a simple apology and payment of whatever tax is owed. “I’ll just pay when they catch me …if they catch me!” is the typical response. Please be advised that tax evasion is a crime which attracts criminal charges.
Under reporting of cash income is one of the primary reason why CRA assumes that every taxpayer has something to hide. If your business operates with a significant percentage of cash transactions, you might not have correctly reported all the activity to your accounting. Most small business owners are already on the CRA’s radar, and if your expense/revenue ratios do not match those that your tax officials expect to see, you might invite the CRA’s wrath, thereby triggering a more detailed audit to identify additional specific details that may be incorrect. For more details read my article :
3) Not Separating business from personal expenses
If you operate an unincorporated business, start a distinct bank account for your business and run your expenses through that account. Make sure this mentality crosses over to credit cards as well. Make it a habit of utilising a business credit card for business expenses and a personal credit card for personal expenses, then pay each from their corresponding accounts. If this does not happen, funds can become co-mingled, and the legitimate tax deductions or tax credits you might qualify for may be disallowed because you did not maintain a clear and distinct business record for all financial transactions. Fines and penalties for this error vary, depending on the location of your business. Moreover, having separate bank accounts for your personal and business helps you visualise what’s what when you’re ready to file your taxes and save a raft of headaches, while also monitoring essential metrics such as cash flow.
“Income tax returns are the most imaginative fiction being written today.” ~ Herman Wouk
4) Claiming interest expense incorrectly.
Mainly, interest expenses can only be deducted if there is a direct link between the borrowed money and the present use of the money to gain or produce income from the property. A loan that is used to purchase investments directly will have deductible interest, whereas a mortgage that was used to buy a house instead of cashing in investments to buy the house does not have deductible interest as there is no longer a direct link to the income earning purpose.
In a recent April 20, 2018 case law – Van Steenis vs H.M.Q., 2017-3305(IT)I– The taxpayer used some proceeds from the sale of mutual funds, to reduce the loan principal, but the majority was used for personal purposes. The Court dismissed the appeal and upheld CRA’s denial of interest expense.
5) Claiming Home office Expenses incorrectly
One of the most common tax mistakes is wrongly claiming home office expenses.
To be eligible to deduct home office expenses from your home-based business, you must meet one of the following criteria :
1) Your home must be your principal place of business ; or
2) Alternatively, you use a designated area in your business income, and you use this space on a regular and ongoing basis to meet clients.
- If your home is not your principal place of business, designate an area in your home to be used solely for business purposes and conduct client meetings at home.
- If your home is your principal place of business, maximise your tax deductions by designating an area in your home to be used exclusively for your business.
- It’s vital to be realistic when claiming the size of your home office. Designate a precise area in your house for your office. You might want to maximise the home area used in your business or minimise the area of your home.
- Home office expenses can be deducted only from the business carried in the home and cannot be used to create a business loss. Eligible expenses which you are unable to use in the year can be carried forward to subsequent years and deducted from income generated by business at that time. If you are a GST/HST registrant, you can claim an input tax credit for GST/HST paid on home office expenses even if you are not able to deduct them in a given year because of limitation on creating or increasing losses.
- Maximise your tax savings by correctly classifying the business portion of home expenses from business expenses.
- Anything that could be connected to the operation of your business such as expenses for utilities maintenance(insurance electricity, heat and others), mortgage interest, property taxes, office supplies such as pens, pencils, pencils, paper clips, stationery and stamps can also be claimed. One often overlooked expense you can claim is cleaning services; if you have a cleaning service to tidy your home office, you can claim that as an expense, too.
- Do not deduct chairs, desks and filing cabinets because these are capital expenses.
- It is not recommended that you claim depreciation on the percentage of your home used for business purposes as there may be adverse tax implications once you decide to sell your home. If you do not claim depreciation, your complete house may be eligible as your principal residence. This way, any gain realised on the subsequent sale of your home may be tax-free.
- It’s important to keep a well-organised file of all receipts and a record of payments and go over them with your CPA to see if they are eligible deductions for your at home business. Please keep in mind, and it is your principal residence, so you wouldn’t want the CRA to make you lose part of your exemption.
6) Claiming Vehicle Expenses incorrectly
- Driving from home to your office is not considered a business expense.
- If you are deducting vehicle expenses from your business income, keep a log of where you’re driving, as well as your daily mileage.
- As a bare minimum standard, the CRA needs you to provide them with a log for a minimum of 3 months in a year as evidence of business vehicle usage.
Record your odometer readings at the beginning and end of each year
- Mobile apps such as Concur, Expensify and Mileage Expense Log digitise the task and make it even easier.
- Schedule client meetings on the way to an from work so that all of your mileage for that day would be considered for business use thereby increasing business kilometres and saving taxes.
- Keep all automotive receipts to support your deduction.
- If two or more vehicles are used in your business, keep track of business kilometres on each vehicle to maximise your tax deductions.
- Maximise tax savings by using the vehicle with higher operating costs.
After military service, the most patriotic thing you can do as a wealthy person is pay your taxes ~ Mark Cuban
7) Not knowing whether individuals working for you should be categorised as independent contractors or employees of the company.
If you assume, your workforce is contracted, and the Canada Revenue Agency (CRA) decides that it is not, you could be liable for both yours and the employee’s share of CPP and EI and withholding taxes. Moreover, you will be subject to the levy of penalties and interest on the under-remittance of those payments. The key in this regard is to understand the specific regulations and reporting requirements in your area to know when someone can be treated as an independent contractor, and when they must be treated as an employee of the company. For more details read my article :
8) Failing to have sufficient proof to write-off business expenses
If you are a business owner, the CRA will let you claim reasonable business expenses which include costs incurred to earn business expenses such as interest paid on business loans and bonds; business fees, memberships or subscriptions; payroll and benefits; accounting, legal and other professional services; and telephone lines and utilities. You can claim 50 per cent of meal and entertainment expenses (includes gift certificates to restaurants or places of entertainment) incurred to expand your business or for travelling for work. However, you can use these business expenses only if you can track and record these expenses on a timely basis. You must be able to prove to the CRA that these expenses were necessary for your business.
If you are like most small business owners, you might not like to spend the time to record your business transactions as you might feel it distracts you from what makes you money, i.e. your business.
The most overlooked opportunity to save taxes is keeping adequate business records.
Record keeping doesn’t have to consume your time; you can outsource this function to your CPA and submit expenses through free cloud accounting smartphone apps such as QBO, which help make it easy to record expenses as they occur. Watch this to see how Tom benefited from cloud accounting by CPAs.
Always remember that accurate records can help you prove your case to Canada Revenue Agency.
If you are curious about the decision to outsource to a CPA , please read the undermentioned article :
9)Improper classification of Capital vs Expense items
One of the most critical distinctions in tax, one that can result in significant tax savings if you get it right, is the distinction between a capital item and an expense item.
If you make a mistake in this area and treat something as a capital expenditure instead of as an expense, you may find it will take five, ten, twenty years to fully deduct the cost of that purchase. On the other hand, being too aggressive and deducting capital expenditures as an expense could open you to scrutiny from CRA. Finding the balance between capital and expense can be difficult, but the tax savings make it worthwhile to gain some knowledge on how to distinguish between these.
The primary rule is whether or not the expenditure provides a lasting benefit to the business over many years, if the answer is yes, this points towards the classification as capital, e.g. purchase of furniture offers an advantage to the company over many years; hence the outflow of money is capitalised. The secondary rule is whether or not the expenditure is considered maintenance or improvement, e.g. replacing the roof to bring the building back to its original condition is an expense whereas replacing the old roof with a new, better quality, more durable roof would be seen as an improvement and be treated as capital expenditure. There are other additional rules to determine expensing vs capitalization, but are beyond the scope of this article. If you are still curious, consult with your CPA to gain a deeper understanding.
Tax issues present an ever-changing, ongoing challenge to small businesses, particularly start-ups. They require consistent, competent attention and compliance. Avoid making the most common business tax mistakes by finding a CPA to help you set up and maintain everything related to taxes. With proper tax planning, reporting and paying, you can rest assured that your business will be in excellent shape in the event the tax authorities raise any questions.
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