For people who start, run, or work in a small business taxes play a big role in your day to day life. It can be one of the biggest expenses a company faces. In part 1 of 2 in this series of understanding tax policy, we'll dive into why it's important to understand tax policy; how to maximize profits by optimizing taxes; tools for getting organized, and then review sales, use and value-added taxes focusing on Canada. We've seen questions come in about the recent Federal government's implementation of Canada wide Carbon Tax. See our latest blog here for more details on that.
The tips we've highlighted are based on Author Jane Barratt's Lynda.com video series entitled Taxes for Small Business
In the following, we'll look at what's important for small business owners and managers to understand about tax. As always, we suggest following up with your accountant if you have any questions about taxes.
Why should you understand tax policy?
Why is it important to understand tax policy? It helps you plan your business, prepare for the future, and explore loopholes. Even if you're not an accountant, it's important to understand accounting so you can set clear expectations and collaborate with your accountant on grey areas. A tax hike or cut can make a huge difference to your bottom-line and the revenues of the Government. Federal, state, and local Governments can impose taxes and levies. Taxes are one of the few strategies that the Government has to win favor by promising to either lower taxes or increase their income (in order to provide more services) by raising taxes.
Note: Governments can also use monetary policy to move the economy. In other words... interest rates. The higher the interest rate, the more expensive it will be to borrow money to grow your business. Keep your ears to the ground for monetary policy changes. Implementing good financial health practices when times are good can help a lot if the economy is in a down turn.
How can you maximize profits by optimizing taxes
For anyone running a small business or earning money through contracting or freelancing, it's important to know how your country's tax policy will affect you. Understand what the brackets are for your earnings and look beyond the numbers to see how your business in particular is taxed. Passive income, for example, or earnings from subscriptions may be taxed at a very different rate compared to labor-based businesses such as for a contractor.
Adjusting elements of your business can sometimes make huge savings. Make sure your legal structure minimizes your tax exposure. Also, if you're not already involved in a small business industry group, it might make sense to join. Most industries have powerful lobby groups. Think about the preferences given to banking and pharmaceutical companies.
What are some tools you can use to get organized?
It's important to benchmark where you are now with your taxes. Do some scenario planning for years where there could be higher or lower tax burdens on your business. Plan for a worst case scenario when you may need to cut expenses and a best case scenario where you'll have additional money to deploy in growing your business, or keeping for yourself.
Whether you're a freelancer, someone with a side hustle, or the owner or employee of a small business, these tips can set a baseline for the financial health of your business.
Sales, use, and value-added taxes:
One of the most annoying taxes from a personal perspective is sales tax, especially in places where the sales tax is added at the point of sale. So all of a sudden, your $99 purchase is now $110.88 if you are located in Vancouver, BC. This is called a Goods and Services Tax. Collectively, sales taxes are known as consumption taxes. Now there are benefits to governments raising revenue through sales tax. Consumption taxes, however, tend to hit lower income people the hardest.
But what about a small business owner or manager? You may not be paying the taxes, but you're 100% responsible for collecting, reporting, and passing them on to the appropriate authority. You're also responsible for charging the right people the right amount of sales tax. Here there can be a lot of variation depending on what you're selling. Luxury items, for example, may command a higher sales tax. And to add to the complexity, different locations may require different payment schedules, monthly or quarterly, for example. One thing that is safe to assume, is that sales tax does not run on the same timetable as personal taxes. Not paying on time could result in penalties, further cutting into your profits.
If you're starting a business, check if you're required to have a sales tax permit. Your local board of trade or other industry bodies like the Small Business Association, the SBA in the US, have a great resource that shows exactly what you need to do based on your location. Now there are some exceptions that are applicable in many countries. Sales made to nonprofits can be sales tax exempt as are secondhand goods, wholesale goods, or raw materials, for example.
But what's good news for nonprofits or wholesalers is often not great news for you, as you may need to see and record proof of the buyer's tax exempt status, in short, more paperwork.
And if all of this isn't complicated enough, if you're selling online you have to consider the location of the customer. The good news is that most payment platforms will calculate the sales tax in accordance with local regulations. Bottom line, sales taxes are complicated and a big responsibility to get right. You can be penalized if you get it wrong.
The variances in sales taxes are yet another reason to pay attention to what's going on in the world of tax.
Thanks for reading!
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