An important opportunity for tax-saving, often overlooked, is careful timing of your income and expenses, and your personal deductions. This does not refer to when you actually receive cash (income), or disburse cash (expenses): income is taxed when it is earned, not when the cash is received, and expenses are deductible when incurred, not when the cash is paid out.
Therefore, how you time your work can produce very different tax results. For example, if work performed on December 30 was deferred till January 2, you would then report it as income for the following year, (assuming a December 31 fiscal year-end), and thus defer the related tax for a whole year. Therefore, many practitioners choose a fiscal year-end coinciding with their annual holiday. When they return from holiday, there is often a backlog of work to be done, and they will enjoy a one-year deferral on the tax paid on all that new work.
Timing your expenses is usually more within your control. For example, if your computer needs servicing, , have the work performed on December 30 so you can expense it in that year, since if you wait till January 2, you must wait twelve months for the tax savings. Note this does not allow you to “pre-pay” expenses and time your deductions accordingly: for example, if you pay rent for the next three months on December 30, that payment is treated as “prepaid expenses” as of December 31, and only expensed for tax purposes in the next year. This is important when making large outlays for new equipment. If you buy and begin using new equipment before December 31, you can make a full first-year depreciation claim for tax purposes; however, if you bought it on January 2, the tax savings from your first-year depreciation claim are delayed by a full year. Therefore, buy big ticket dental and computer equipment, and renovations, just before your fiscal year-end.
One common approach for deferring taxes is to accrue a salary bonus in your professional corporation’s (PC’s) year-end. For example, if your PC has a September 30, 2013 year-end, you can accrue a bonus to be paid to you within the next 179 days, and expense it as of September 30, 2013. An extra $60,000 bonus expense, at the 15.5% corporate tax rate, means PC saves tax of $9,300 for its 2013 tax year. The $60,000 bonus must be paid to you as salary within 179 days of September 30, 2013, i.e. PC must remit the related personal tax withholdings on this $60,000 to the CRA (generally due by April 15, 2014). If your standard monthly salary is $10,000, then by March 28, 2014 (179 days after PC year-end) you will have received the full bonus, and the necessary tax remittances will have been made. Note that this will not reduce your over-all corporate income tax, but in this example, it defers $9,300 of corporate tax for a full year. Likewise, while not reducing your personal tax, it defers the tax remittance on the $60,000 salary, which you were going to receive anyhow, for up to six months. While the same amount of corporate and personal tax will be paid, this helps your cash flow, assuming you intended to take the $60,000 salary anyhow, since it allows you to defer the personal tax/payroll remittances for six months. This can also be useful if you expect to be in a lower bracket in the following year (for example, you will only be working for a few months before taking an extended leave): the $60,000 which would have been taxed at high rates in 2013 is now taxed at low-bracket rates in 2014. Because it results in lower PC income in 2013, your PC will also have lower tax instalments for the 2014 tax year.
If you already have a PC, careful timing can save significant tax. For example, adding low-bracket family members as shareholders before December 31 means dividends can be paid to them for that calendar year, giving them a whole extra year of low-tax dividends. How you time the purchase or sale of your practice can also mean large savings. For example, if you already have a PC with a May 31 year-end and are buying practice assets, then closing the deal in late May gives you the first year’s depreciation almost at once, rather than waiting for a full year if the deal closes in early June. Likewise, delaying a share sale till the next calendar year defers the capital gains tax on the sale for 12 months, and if you are retiring, may allow you to declare the sale in a lower tax-bracket year.
How you time deductions on your personal return can also save tax. For example, there is no requirement to claim an RRSP deduction in the same year you make the RRSP contribution. So a large RRSP contribution made in a low-income year (when you are in a low tax bracket and would therefore lose most of the potential benefit of the deduction), should be claimed in a later year. For example, in year 1, you make a $20,000 RRSP contribution; but if due to low income or large tuition tax credit carry-forwards, you are in a low tax bracket, the $20,000 deduction will save little or no tax. However, if your income in the following year will be $160,000, and you claim the $20,000 in the following year, the same deduction could yield up to $9,200 of tax savings, at the high 46% tax rate.
Therefore, carefully timing your business decisions, income inclusions and tax deductions can postpone or even save tax.
This article was prepared by David Chong Yen, CPA, CA, CFP and Louise Wong, CPA, CA, TEP of DCY Professional Corporation Chartered Accountants who are tax specialists and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org / email@example.com. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.