Having filed their personal income tax returns, many people believe that the tax season for 2021 has drawn to a close. Well, that is if you do not run a business. In Canada, you can run a business by owning a corporation, or by being self-employed, each of which has its unique perks and flaws.
While incorporation has many tax advantages, it is more complicated than sole proprietorship when it comes to accounting. The reason being that unlike sole proprietorship where all business expenses are deductible in a single-entry system, corporations use a double-entry system that provides a more holistic view of their finance. Whether a business receives tax refunds or is subject to tax duty hinges on the numbers that come out of the double-entry system.
So, what is a double-entry system?
In a nutshell, a double-entry system sets the milestone for modern bookkeeping and accounting. It reinstates that every financial transaction has equal and opposing effects in at least two different accounts. That is, an expense is never as simple as money going out but appears in a different form and stays in the company.
How does it work?
In the double-entry system, transactions are recorded as debits and credits. Debits in one account offsets credits in another, tallying a balanced sum. For example, Mike Inc. spent 4k on equipment. The 4k, therefore, changed from debits in expenses to credit in assets after the transaction. It cannot be deducted because it still has stayed in Mike Inc.
Types of Accounts
When a business transaction is recorded for accounting and/or bookkeeping purposes, it communicates and refers to the financial information of a corporation that can be classified into different accounts. There are all together seven different types of accounts that classify all business transactions:
Why is it important for business owners to tax plan?
Business owners who generate large expenses often believe that with their expenses, they can deduct taxes. The conviction that they are not subject to tax duty often accounts for their late payments and the penalties their late payments ensue. This is why we urge business owners to consult tax professionals at their convenience to find out how much tax they actually owe, other than making assumptions.
The same advice also applies to self-employed individuals. While the double-entry system is not required, early tax planning has helped many of our clients save up big on taxes. The earlier you come to us, the more likely for us to go through the details of your finances with you and make adjustments tailored to your needs. Take one of our clients as an example. He and his family run a sole proprietorship and file taxes as self-employed. In the past, they used home-office expenses to deduct their business incomes. However, their business suffered in 2020 due to lurgy, slashing half of their incomes. Because they came to us in late April, leaving us plenty of time to review, we applied more OTB for them with their home-office expenses and helped them claim an extra of over two thousands dollars.
That said, the finances of every individual vary from one another and change as time elapses. What applies to our client this time may have little value to you and definitely cannot be duplicated for perpetuity. If you own a business either by being self-employed or owning a corporation, please consult a tax expert at your earliest convenience.