Understand small business taxes
As a lawyer in Ontario, I often receive inquiries from small business owners about the intricacies of small business taxes in Canada. Navigating the tax landscape can be challenging, but understanding your obligations and opportunities can significantly benefit your business. This article aims to provide a comprehensive guide on small business taxes in Ontario, covering tax rates, payment schedules, registration requirements, consequences of non-payment, potential deductions, and more. We'll also explore what constitutes a small business, how it differs from a large business, and how taxes vary based on business structure. If you are a complete noob in taxes, then this guide is for you. Enjoy, my friend.
What is Considered a Small Business?
In Canada, a small business is typically defined as a corporation with active business income eligible for the small business deduction, which is up to $500,000 of active business income. However, definitions can vary based on context:
For tax purposes: The Canada Revenue Agency (CRA) considers a small business to be a Canadian-controlled private corporation (CCPC) that can claim the small business deduction.
For employment: A small business might be defined as having up to 99 employees.
For revenue: Small businesses often have lower revenue thresholds compared to large corporations, though specific thresholds can vary by industry.
How Does a Large Business Differ?
Large businesses exceed the thresholds set for small businesses ($500,000 of active business income and 99 employees). They generally have more employees, higher revenue, and may not qualify for the small business deduction. For tax purposes, a large business is a corporation with more than $500,000 in active business income.
Small Business Tax Rates and the Small Business Deduction
The Small Business Deduction
The small business deduction (SBD) is a tax benefit that allows Canadian-controlled private corporations (CCPCs) to pay a reduced tax rate on the first $500,000 of active business income. This deduction significantly lowers the effective tax rate for qualifying small businesses.
Federal Tax Rate: The federal small business tax rate is 9% on the first $500,000 of active business income.
Provincial Tax Rate: In Ontario, the provincial small business tax rate is 3.2%, resulting in a combined rate of 12.2%.
General Corporate Tax Rate
For income exceeding $500,000, or for large businesses, the general federal corporate tax rate is 15%, and the provincial rate in Ontario is 11.5%, making the combined rate 26.5%.
Comparing Small Business Tax Rates with Personal Income Tax Rates
Operating as a small business can be more profitable than operating as a sole proprietorship or partnership, where income is taxed at personal income tax rates. In Ontario, personal income tax rates are progressive and can be significantly higher:
Personal Income Tax Rates: For individuals, the top marginal tax rate in Ontario can be over 53% for income exceeding certain thresholds.
Small Business Tax Rates: In contrast, small businesses benefit from a combined tax rate of just 12.2% on the first $500,000 of active business income.
Why It’s More Profitable to Operate as a Small Business
By operating as a small business, you can take advantage of the lower corporate tax rates, which means more after-tax income to reinvest in your business or distribute to shareholders. Additionally, incorporating can provide liability protection and access to other tax planning opportunities.
Let's compare how much you would pay in taxes and end up taking home if you earn $500,000 as a corporation and as an individual in Ontario.
As a Corporation:
Federal small business tax rate: 9%. Ontario small business tax rate: 3.2%.Combined small business tax rate: 12.2%
Calculation: Total tax on $500,000: $500,000 * 12.2% = $61,000. Therefore, a corporation earning $500,000 would pay $61,000 in taxes.
As an Individual:
For simplicity, let's assume the individual falls into the top marginal tax bracket, which is over 53% for high-income earners in Ontario.
Calculation (yes, it’s that complex):
Federal Tax Rates: 15% on the first $53,359 = $8,003.85; 20.5% on the next $53,359 (up to $106,717) = $10,935.60; 26% on the next $58,157 (up to $164,874) = $15,121.82; 29% on the next $55,016 (up to $219,390) = $15,954.64; 33% on income over $219,390 = ($500,000 - $219,390) * 33% = $92,801.70.
Total Federal Tax: $8,003.85 + $10,935.60 + $15,121.82 + $15,954.64 + $92,801.70 = $142,817.61
Provincial Tax Rates: 5.05% on the first $49,231 = $2,485.16; 9.15% on the next $49,231 (up to $98,463) = $4,504.61; 11.16% on the next $12,405 (up to $110,869) = $1,383.86; 12.16% on the next $43,993 (up to $154,862) = $5,348.82; 13.16% on the next $65,128 (up to $220,000) = $8,569.85; 13.16% on income over $220,000 = ($500,000 - $220,000) * 13.16% = $36,248.00.
Total Provincial Tax: $2,485.16 + $4,504.61 + $1,383.86 + $5,348.82 + $8,569.85 + $36,248.00 = $58,540.30
Total Tax: $142,817.61 + $58,540.30 Total Tax: $201,357.91
Summary
Corporation After-Tax Income: $500,000 - $61,000 = $439,000
Individual After-Tax Income: $500,000 - $201,358 = $298,642
As you can see, operating as a corporation allows you to retain significantly more of your income after taxes compared to earning the same amount as an individual. This substantial difference highlights the financial advantages of incorporating your business and utilizing the small business deduction. Omulique Legal Services (that’s us, my friend) is specialized on incorporating businesses in Ontario and Canada. Shoot us an email for a free consultation to discuss at info@omulique.ca
Impact of Business Structure on Taxes
The structure of your business significantly impacts how you are taxed. Each type of business structure—sole proprietorship, partnership, corporation, and professional corporation—has its own tax implications. Here’s a detailed look at how each structure affects your taxes:
1. Sole Proprietorship
Tax Filing:
Income from a sole proprietorship is reported on your personal tax return. It is included in your total personal income and taxed at personal income tax rates.
Personal Tax Rates (2023):
15% on the first $53,359
20.5% on the next $53,359
26% on the next $58,157
29% on the next $55,016
33% on income over $219,390
Tax Deductions:
You can claim business expenses directly related to earning your business income, such as office supplies, rent, utilities, and vehicle expenses.
Business deductions reduce your taxable income, which in turn lowers your tax liability.
Liability:
Personal liability is unlimited. You are personally responsible for all business debts and obligations.
2. Partnership
Tax Filing:
A partnership itself does not pay taxes. Instead, each partner reports their share of the partnership’s income on their personal tax return.
The income is divided according to the partnership agreement and taxed at the individual partner’s personal income tax rates.
Tax Deductions:
Similar to a sole proprietorship, partners can claim business expenses against their share of the partnership’s income.
Common deductions include operating expenses, professional fees, and travel costs.
Liability:
In a general partnership, all partners have unlimited personal liability for the partnership’s debts and obligations. Limited partnerships have both general partners (with unlimited liability) and limited partners (with liability limited to their investment).
3. Corporation
Tax Filing:
Corporations are separate legal entities and must file their own tax returns (T2 Corporation Income Tax Return).
They benefit from different tax rates based on their income level. Small businesses benefit from the Small Business Deduction (SBD) on the first $500,000 of active business income.
Small Business Rate:
Federal: 9%
Ontario: 3.2%
Combined: 12.2%
General Corporate Rate (Income above $500,000):
Federal: 15%
Ontario: 11.5%
Combined: 26.5%
Tax Deductions:
Corporations can claim a wide range of business expenses, including salaries, rent, utilities, and capital cost allowances (depreciation of assets).
The SBD allows for a reduced tax rate on the first $500,000 of active business income, making it advantageous for many small businesses.
Liability:
Limited liability. Shareholders are not personally liable for the corporation’s debts or obligations, beyond their investment in the company.
4. Professional Corporation
Tax Filing:
Professional corporations must also file a T2 Corporation Income Tax Return.
They are eligible for the same Small Business Deduction as other Canadian-controlled private corporations, reducing their tax rate on the first $500,000 of active business income.
Small Business Rate:
Federal: 9%
Ontario: 3.2%
Combined: 12.2%
General Corporate Rate (Income above $500,000):
Federal: 15%
Ontario: 11.5%
Combined: 26.5%
Tax Deductions:
Similar to other corporations, professional corporations can claim a broad range of business expenses, including those specific to their profession, such as professional development and regulatory compliance costs.
Liability:
Professional corporations offer limited liability protection for their shareholders. However, professionals may still be personally liable for their own negligent acts or omissions.
How to Pay Your Taxes
Paying your taxes involves several steps:
Register for a Business Number (BN): If you haven't already, you need to register for a BN with the CRA. This number is used for all your tax-related accounts.
File Your Corporate Tax Return (T2): Every corporation in Canada must file a T2 return annually, regardless of whether it has taxable income. This return must be filed within six months of the end of your fiscal year. You can file your T2 return electronically using CRA’s My Business Account portal or by mailing it to the CRA.
Remit Installment Payments: If your estimated federal tax payable exceeds $3,000 in the current or previous two tax years, you are required to pay your taxes in quarterly installments. You can make these payments online through your financial institution, by mail, or through CRA’s My Business Account portal.
Pay the Final Balance: Any remaining tax balance must be paid within two months after the end of your fiscal year. However, if your corporation is a CCPC eligible for the small business deduction, you have three months to pay the balance.
When to Pay Your Taxes
It's crucial to adhere to the following deadlines:
Installment Payments: Quarterly installments are due on March 15, June 15, September 15, and December 15.
Corporate Tax Return (T2): Due six months after the end of your fiscal year. For example, if your fiscal year ends on December 31, your T2 return is due by June 30 of the following year.
Final Balance Payment: Due two months after the end of your fiscal year, or three months if your corporation qualifies as a CCPC. For instance, if your fiscal year ends on December 31, your final balance payment is due by February 28 (or March 31 for CCPCs).
Business Number and Other Registrations
Apart from the BN, depending on your business activities, you might need to register for:
Goods and Services Tax/Harmonized Sales Tax (GST/HST): If your business generates more than $30,000 in revenue annually, you must register for and collect GST/HST.
Payroll Deductions: If you have employees, you need to register for a payroll account to remit payroll deductions such as income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums.
Consequences of Not Paying Your Taxes
Failing to pay your taxes can lead to serious consequences, including:
Interest and Penalties: The CRA charges interest on any overdue amounts, including unpaid taxes, interest, and penalties. The interest rate is determined quarterly and can compound daily. For example, if you owe $10,000 in taxes and are charged 5% interest annually, you will owe approximately $500 in interest if you don’t pay for a year.
Legal Action: The CRA has the authority to take legal action to collect outstanding taxes. This can include garnishing your bank accounts or wages and placing liens on your property. In severe cases, they may seize assets or initiate court proceedings.
Damaged Credit Rating: Non-payment of taxes can negatively impact your credit rating, making it difficult to secure financing for your business in the future. For instance, if you apply for a business loan, lenders may view unpaid taxes as a red flag.
Business Deductions You Can Claim
Business deductions are expenses that businesses incur in the course of earning income. These expenses can be subtracted from the total revenue to determine the taxable income, thereby reducing the overall tax liability. The Canada Revenue Agency (CRA) allows businesses to claim various deductions, provided they are reasonable and necessary for the operation of the business.
Operating Expenses: Costs such as rent, utilities, office supplies, and salaries are deductible.
Vehicle Expenses: If you use your vehicle for business purposes, you can deduct a portion of your vehicle expenses, including fuel, maintenance, insurance, and depreciation.
Home Office Expenses: If you operate your business from home, you can claim a portion of your home expenses, such as mortgage interest, property taxes, utilities, and maintenance.
Capital Cost Allowance (CCA): You can claim depreciation on capital assets, such as machinery, equipment, and buildings, over several years.
Advertising and Promotion: Expenses for advertising and promotion, including website development and social media marketing, are deductible.
Professional Fees: Legal and accounting fees related to your business operations are deductible.
How to Claim Business Deductions
To claim these deductions, you must:
Keep Detailed Records: Maintain accurate records of all your business expenses, including receipts, invoices, and bank statements.
Categorize Expenses: Organize your expenses into appropriate categories to make it easier to complete your tax return.
Use Accounting Software: Consider using accounting software to track your expenses and generate financial reports.
Complete the T2 Return: On your T2 return, report your business income and deduct the eligible expenses to calculate your net taxable income.
Submit Supporting Documents: While you don't need to submit all your receipts with your tax return, you should retain them in case the CRA requests supporting documents during an audit.
Where to Send Your Tax Documents
For electronic filing, you can use the CRA’s My Business Account portal. If you choose to file by mail, send your completed T2 return and any accompanying schedules to the designated tax center for your region. You can find the appropriate mailing address on the CRA website.
Conclusion
Understanding and managing your small business taxes is essential for the financial health and legal compliance of your business. By staying informed about tax rates, payment schedules, and potential deductions, you can minimize your tax liability and avoid penalties. The distinction between small and large businesses, as well as the impact of your business structure, plays a significant role in how you manage your taxes. If you're ever in doubt, consulting with a tax professional or a lawyer can provide personalized advice tailored to your business needs.
Feel free to reach out if you have any questions or need assistance with your business taxes in Ontario. Stay compliant, stay informed, and keep your business thriving!
For more information, visit the Canada Revenue Agency's website.
