How to be gainfully self-employed
[an error occurred while processing this directive]
How to be gainfully self-employed
The trick is to make enough money
to take advantage of tax, planning benefits.
Tuesday, February 23, 1999
Special to The Globe and Mail
Rob Kerr knows the benefits and perils of running your own business.
"You can work 24 hours a day, seven days a week if you want to," says the chartered accountant, who founded Kerr Financial Corp. in Montreal 20 years ago. Today, Kerr Financial, a fee-only financial-planning firm, employs 26 people in Montreal, Toronto and Ottawa and has partners in Calgary and Vancouver.
Among the employees are his daughter, Krista, in Toronto, who is also a chartered accountant; his wife, Gitta, who is vice-president and treasurer at the Montreal head office; and his daughter, Leslie, in Ottawa, who manages the company's division dealing with financial-education seminars for government and business.
Although employees enviously eye the tax advantages of being self-employed, "the intangibles are really what people need and want," Mr. Kerr says, "the feeling that you control your time and destiny."
Having said that, he acknowledges there can be substantial tax and financial advantages to having your own business, as well as planning opportunities not available to salaried workers. The trick -- one that Mr. Kerr, at age 54, has mastered -- is to make enough money to take advantage of them.
"The system still works on the premise that you have to be making money," says Alan Vale, partner at KPMG.
Ideally, tax-planning strategies will evolve with your business, advisers say. When you're just starting out, perhaps as a sole proprietor, you probably will spend more than you make, resulting in a loss.
If you are still working as an employee, you can deduct this loss from your employment income, or any other income you may be earning, says Irene Jacob, principal at Deloitte & Touche in Vancouver. This is a "good reason not to incorporate at the beginning."
Mind you, Revenue Canada could challenge the deduction if it suspects you did not have a reasonable expectation of profit; hobby farmers and owners of rental property are often hauled up for reassessment. "It's the hottest area of litigation in the tax courts," Mr. Vale says.
If you do not have other income, or if you are in a business where you need to limit your legal liability, you may want to incorporate right away because you can carry losses forward for seven years to deduct against future profits, says Lou Pagnutti, partner in entrepreneurial services at Ernst & Young.
Generally, though, accountants advise against incorporating until you are making enough money to leave most of it in the corporation, where it will be taxed at a lower rate, Ms. Jacobs says. Companies that qualify for the small-business deduction pay about 22 per cent in Ontario on the first $200,000 of income, Mr. Pagnutti notes.
If you set up an office in your house and it is your main place of business, you can deduct a portion (based on square footage) of your rent or mortgage payments, taxes, utilities, telephone and other expenses. But you cannot use home-office expenses to create a loss, Ms. Jacobs points out. Starting in 1998, self-employed people also have been able to deduct private-health-insurance premiums for themselves and their family.
Even after you are making enough money to incorporate, cash still may be tight, Mr. Kerr notes. That's where another advantage of having your own business comes in. During the first two years, you can delay paying tax by taking an advance or loan without it being taxable -- provided you pay it back. Otherwise, Revenue Canada will consider it to have been paid to you the year in which you borrowed it.
"That little bit of flexibility is nice because you probably need it in getting the company going," Mr. Kerr says.
Whether you incorporate or not, you can hire your spouse and children, provided they actually work in the business and you pay them a reasonable salary.
This also could give rise to some tax-planning opportunities. Suppose, for example, that you have been laid off and were paid a lump sum large enough to put you in the top marginal tax bracket. You may not want any more income that year. But if your spouse is working in the business, you could pay him or her up to $29,600, and it would be taxed at a much lower rate than if you had paid it to yourself, Mr. Kerr says.
When RRSP season rolls around, you can arrange to have your company pay money directly into an RRSP on your behalf rather than having to contribute with after-tax dollars, he adds.
If your company is profitable and has been structured properly, you can make other family members shareholders and pay them dividends, further diffusing income. Or you can set up trusts for your children and pay dividends to the trusts to pay for their education. Your company also can pay you dividends rather than salary.
As well, you may be able to work holidays in with your business trips to advantage. Say you attend a conference in California (businesses are allowed to deduct the cost of two conferences a year) and you take a side trip to Las Vegas. You will have to pay your personal costs for the Las Vegas trip, but the airfare to and from the conference destination usually will be fully deductible, Mr. Vale says.
As your business grows still more profitable, you may decide to sell it and either retire or start another one. "If you can create a business that can be sold, the first $500,000 of capital gains will be tax free," he says. "All it takes is a lot of work and a little bit of luck."
Alternatively, you may wish to do what is called an estate freeze, whereby the value of your shares is frozen and future growth is passed on to your children, Mr. Pagnutti says.
Cars, houses, golf-club memberships -- all are potential advantages that can flow to entrepreneurs who own their own business. But Mr. Kerr and others caution against "getting piggy."
You may be able to sneak things by Revenue Canada for a while, but you run the risk of "getting hammered" with a retroactive tax assessment, he says. "There are pitfalls when one gets greedy."
Another pitfall common to entrepreneurs is to invest everything in the business without stopping to think about what could happen if it falters or runs into legal trouble.
"One day they find the business failing and their entire net worth going down with it," Mr. Kerr says.