Charities 101

A registered charity is an organization established and operated for charitable purposes, and must devote its resources to charitable activities. The charity must be resident in Canada, and cannot use its income to benefit its members. Charities are usually registered as Corporations, or are governed by a trust or a constitution. They may be under a covering of a parent Organization.

The main advantages of charities are:

Ø  Charities are able to receive gifts tax free.

Ø  Charities provide receipts to donors for tax savings.

Ø  Charities are tax exempt

Ø  Charities make a great impact in our communities, provinces and our country!

The main disadvantages of charities are:

Ø  Charities take time to set up.

Ø  It is a large undertaking to set up a Charity, and there are ongoing requirements.

Ø  Charities must meet a public benefit test.

Ø  You cannot keep profit of the charity.

Ø  If you lose charitable status, all assets are taxed, or if break any of the various charitable rules you could face various consequences.

Many people have asked what the difference is between a charity and foundation in Canada.  The main difference is that charities are public and foundations are private.  Foundations in Canada are charities and mostly operate by the same rules.  Foundations are typically used to raise funds privately to distribute to other charities.

Charities should not be confused with non profits.  Non profits have much less regulation than charities, however they are treated similarly in that they are typically tax exempt and cannot distribute profit to benefit ownership.  The biggest difference between charities and non profits is that non profits are not allowed to issue tax receipts for donations to receive tax credits!

Maximizing the use of your corporation Part 3

In the last couple blogs we’ve been discussing some of the ways you can maximize the use of your corporation.  At this time I’d like to remind you that although we’ve covered a lot of information on corporations in this large blog series, we cannot cover it all via blog.  If you have questions on what I am covering or anything I am not covering do not hesitate to contact me.  Also remember that educational articles, such as this one, should be used in conjunction with good planning!

The next thing to discuss in maximizing the use of your corporation is further lesson on dividends.  We have been discussing dividends in this blog series, as well as other blogs, and you can see by now how beneficial it can be to use dividends to save tax.  Remember that corporations can issue dividends to shareholders as long as the corporation has positive retained earnings (sum of profits less dividends declared since the corporation’s inception).  One of the main concepts in tax is to get the lowest overall tax paid between all family members and entities owned and controlled by the family.  So now if we combine that concept with dividends you are looking at big tax savings.  The ideas combined here are to keep all family members at the lowest tax brackets possible using tax favorable types of income. (dividends in this case).  Some of the main options to look at in this maximization of tax savings are to add other family members as shareholders of the corporation(s) or to ensure all your family members are beneficiaries of the family trust if you have one.  Either way you are now able to split dividends amongst family members giving you more options for income splitting and tax savings, with no additional liability.  In the case of the trust you can also split capital gains among beneficiaries. 

Another thing to talk about in looking at dividends from your corporation is Capital Dividends.  Capital Dividends are issued tax free by the corporation and received tax free by the shareholders.  Capital dividends arise out of Capital Gains in a corporation.  When a corporation has a capital gain it only pays tax on 50% of the gain, which is the same as when an individual has a capital gain.  So in essence Capital Dividends are issued out of the 50% non taxable profit arising out of a capital gain in a corporation.  Again, Capital Dividends are non taxable!

When to Incorporate? Part 1

In my last blog we discussed Why Incorporate?  This completely ties into when to incorporate as you will see from this blog.  There is no absolute answer to “When to Incorporate?” as everyone’s situation is different, however these are some general guidelines to help you know when it’s right for you to incorporate.  Let’s look at the 3 reasons that people incorporate and how they tie into when to incorporate.

The first is tax savings as incorporations that earn active income receive what’s called the Small Business Deduction which allows Corporate Income taxes (Federal & Provincial combined) to be as low as 14% in Alberta (currently). This low tax rate on active income earned in a corporation is static up to $500,000 active net business income.  Once you make over $500,000 in a corporation you pay a significantly higher tax rate, but most corporations will never need to go over $500,000 in net income (after expenses).  If you see in your projections that your corporation will exceed $500,000 it is essential that you plan in advance to look for ways to avoid this.  For example you may structure 2 separate, non-related, corporations to provide 2 separate products or services your one corporation may have provided so each could stay under the $500,000 Small Business Deduction Limit.

Individuals, on the other hand, have what’s called a Graduated Tax system, which means there are tax brackets that make individuals earning more income pay higher rates of tax.  There are various levels that trigger the higher rates of tax, and there are even personal tax exemptions that allow you to pay no tax if you have very low income.  This is why a lot of people start as sole proprietors because they will pay less personal tax as sole proprietor that earns up to about $30,000 of net income (not including income splitting in Alberta).  Once you make about $30,000 in your corporation it changes and you can now save more tax using a corporation.  This is because shareholders of the corporation can receive about $30,000 in tax free dividends from a private corporation before paying tax if this is there only source of income.  Not only is there no personal tax on the dividends, but also no EI or CPP.  This means at around $30,000 you typically only pay the corporate taxes at a lower rate, even if you (the shareholder) has pulled out all of the $30,000 made in profit.  There is one more factor to consider: Accounting Costs!  Accounting Costs for a corporation are much more than individual costs as there both Federal and Provincial Tax returns that must be done for a corporation and they are much more complex than personal tax returns.   Not to mention full accounting must be done for corporations, including assets and liabilities, and financial statements are prepared, along with schedules and minutes for the corporation’s minute book.  Although you are saving tax at $30,000 net, if you include the accounting fees against the savings you are looking at incorporating around $35,000 net to save taxes (including accounting fees).  This way you will be saving more than you pay the accountant! At Kustom Design our goal is to always save you more than you pay!

Please check back for the next installment of the “When to incorporate” blog series.

Why Incorporate?

There are many reasons to incorporate, which really break down into 3 areas.  The 1^st area is tax savings.  Corporations can save taxes in many ways and we will go deeper into the area of tax savings throughout this series of blogs.  Corporations can pay as little as 14% total federal and provincial tax on active income up to $500,000 in Alberta.  All provinces and territories across Canada have attractive tax savings at different levels using corporations.  You can also avoid payroll remittances and extra costs such as EI and CPP with the utilization of dividends.  Shareholder loans are a very powerful tool of a corporation and are tax free.  You can sell assets to the Corporation at Fair Market Value and receive the amount now or in the future from the corporation tax free.  As you will see throughout this series there are many ways to save and defer taxes through a corporation.  In the next series we will discuss when to incorporate and part of this will include the timing of incorporation for tax purposes, which in Alberta is about$30,000 - $35,000 net income if this is your only source of income.  If you have other sources of income or if you corporation will grow quickly, then you may want to incorporate right from the start.  We will discuss this in my next blog.

The 2^nd area of reasons to incorporate has to do with liability protection.  When you incorporate you set yourself up for limited liability. Unlike partnerships where partners are usually personally liable for the business acts of their partners, corporate shareholders are typically not personally liable for the acts of the directors, officers or other shareholders of the corporation.  The director takes the liability and that is typically only liability for anything that is personally guaranteed by the director, government agency debts or debts that arise from environmental damage.  For further liability protection your corporation can be owned by trusts and holding companies.  For more on trusts see my blog series on the family trust.

The 3^rd area of reasons to incorporate has to do the fact that incorporation makes your business more attractive.  Many businesses seek to do business with corporations over sole proprietorships.  If you need capital from investors or the bank you will have much more of a chance of receiving it as a corporation.  Also some corporations will not hire sole proprietors for the job as CRA could deem sole proprietors as employees in some situations, which creates a huge CRA payroll debt!  Overall corporations are more attractive to do business with.

In my next blogs we will get into the timing of setting up a corporation and structuring your corporation.

BC talking about scrapping the HST

On the surface, or so it might appear from Premier Campbell’s televised speech to the province last week, the government is comfortable letting the public decide whether to scrap the HST.  This is quite rare as most governments don’t allow the general public to vote on tax policies, never mind the option of scrapping the HST! 

However at the same time BC is looking at a 15% personal income tax cut, which could make BC have one of the lowest, if not the lowest personal tax rate in the country.  Many people are complaining about the HST and there is a referendum on it next fall.  It looks as if the government is hoping that the personal tax savings will help people forget about the HST. 

The main issue with scrapping the HST is that BC may have to pay back over $1 Billion to the Federal Government.  This would mean that the tax cuts that they are proposing would be offset in the future by tax increases to pay the debt to the Federal Government.

In my opinion taxation in Canada should be one or the other: a consumption tax (such as the GST or HST) or income tax.  I don’t think we should have both.  Even though we at Kustom Design make our income off reporting peoples’ and corporations’ tax returns, I would suggest that the consumption tax would be the better method, thus simplifying everything for everyone! 

Using your Personal Exemptions

Every tax paying Canadian has a Personal Exemption, called the Basic Personal Amount on the Tax Return. The Federal Personal Exemption for 2009 is $10,320 and the Provincial Personal Exemption for 2009 is $16,775. This means you can make up to $10,320 without paying any Federal Tax and $16,775 without paying any Provincial Tax. If one spouse makes less than either personal exemption then the higher income earning spouse can claim the other spouses’ unused portions of the exemptions. In the case where one spouse has no income, the other spouse may claim the full exemptions of the other spouse. Also for single parents, you may claim your child as an “equivalent to spouse” and claim double exemptions both provincially and federally. Using the Personal Exemption is key in tax savings, and if the couple has a corporation that is the main source of income then there is flexibility on how much income and what type of income each spouse is given.

Ways to Save on Tax for Self-employed and Business Owners

Here are more ways for the self-employed people and business owners to save on their taxes:

• Deducting Business Expenses: You can deduct any and all expenses that you incur for your business. These expenses can be in the life of the corporation, or before the incorporation.
• Use Dividends: Dividends are very tax effective. Dividends come out of the retained earnings, which is after the Corporation has already paid tax.
• Make spouses and dependents over 18 shareholders of the corporation: This makes it easy to split income in the form of dividends.
• Utilize Private Health Service Plans (PHSPs). These plans allow you to deduct 100% of your medical expenses through your company. You can also use PHSPs to pay for family members and employee’s medical expenses.

These are just some of the ways you as a self-employed individual or business owner can save tax. There are so many other ways to be able to maximize your tax deductions and credits. Remember, it is always best to see a tax professional to help you with your tax planning. Best, Michael Lepitre