2 income taxes by Don Ferguson

ARE YOU PAYING TOO MUCH INCOME TAX?

PAY SMART INCOME TAX USE THE MONEY SAVED TO INCREASE YOUR WEALTH

“The trick is to stop thinking of it as ‘your’ money.” – IRS auditor

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2 - INCOME TAXES I_____________________________________________________________ NTRODUCTION

Are you paying too much income tax? There are two tax systems: one for the informed and one for the uninformed. Unfortunately, most of us fall into the un-informed group. We were taught by our parents and at school to get educated then find a good job. We were never taught about the tax benefits of owning our own business (sole proprietorship 10) - no matter how small that business might be. In this chapter, I discuss how much money you might be losing every year by not having a small, part-time, home-based business. You can increase your income tax refund each April by a few hundred dollars, perhaps as much as a few thousand dollars depending upon your income tax bracket. Our goal is to help you understand how to maximize the tax strategies of running a parttime, home-based business and how to accomplish it correctly while using very little of your own money or time. Although I talk about the Canadian tax system, the concepts work in most countries including the United States. I’ll show you an example of an app that can be used on your smartphone or computer to estimate the tax savings that can be realized in the American tax system. For Canada, I provide a paper “app” to calculate the potential tax savings.

10 http://en.wikipedia.org/wiki/Sole_proprietorship (Monday 26 August 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 9

Income Taxes

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D EFINITION _____________________________________________________________ Income Taxes

Income taxes in Canada constitute the majority of the annual revenues of the Government of Canada, and of the governments of the Provinces of Canada. In the last fiscal year, the government collected roughly three times more personal income taxes than it did corporate income taxes. Tax collection agreements enable different governments to levy taxes through a single administration and collection agency. The federal government collects personal income taxes on behalf of all provinces and territories except Quebec and collects corporate income taxes on behalf of all provinces and territories except Alberta and Quebec. Canada's federal income tax system is administered by the Canada Revenue Agency (CRA). Canadian federal income taxes, both personal and corporate, are levied under the provisions of the Income Tax Act. Provincial and territorial income taxes are levied under various provincial statutes. The Canadian income tax system is a self-assessment regime. Taxpayers assess their tax liability by filing a return with the CRA by the required filing deadline. CRA will then assess the return based on the return filed and on information it has obtained from employers and financial companies, correcting it for obvious errors.11

http://en.wikipedia.org/wiki/Income_taxes_in_Canada#cite_note-2 (Wednesday, 20 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 10

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Unlike the United Kingdom and the United States, Canada avoided charging an income tax prior to the First World War. The lack of income tax was seen as a key component in Canada's efforts to attract immigrants as Canada offered a lower tax regime compared to almost every other country. Prior to the war Canadian federal governments relied on tariffs and customs income under the auspices of the National Policy for most of their revenue, while the provincial governments sustained themselves primarily through their management of natural resources (the Prairie provinces being paid subsidies by the federal government as Ottawa retained control of their natural resources for the time being). The federal Liberal Party considered the probable need to introduce an income tax should their negotiation of a free trade agreement with the United States in the early 20th century succeed, but the Conservatives defeated the Liberals in 1911 over their support of free trade. The Conservatives opposed income tax as they wanted to attract immigrants primarily from the United Kingdom and the United States, and they wanted to give immigrants some incentive to come to Canada. Wartime expenses forced the Tories to re-consider their options and in 1917 the wartime government under Sir Robert Borden imposed a "temporary" income tax to cover expenses. Despite the new tax the Canadian government ran up considerable debts during the war and were unable to forego income tax revenue after the war ended. With the election of the Liberal government of Prime Minister William Lyon Mackenzie King, much of the National Policy _____________________________________________________________ Profitable Planning & Management Inc. Page 11

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H ISTORY _____________________________________________________________

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was dismantled and income tax has remained in place ever since.12

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H OME-BASED BUSINESS _____________________________________________________________ Definition

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A home business is a small business that operates from the business owner's home office. In addition to location, home businesses are usually defined by having a very small number of employees, usually all immediate family of the business owner, in which case it is also a family business. Home businesses generally lack shop frontage, customer parking and street advertising signs. These businesses are sometimes prohibited by residential zoning regulations. The prospect of working from home has gained credibility over the years. Home offices can now compete with small commercial businesses and save on rent in the process. Faxes, high speed internet connections, dedicated home telephone lines, and cell phones help to make a home-based business a reality. 13 _____________________________________________________________

Examples

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Numerous businesses, initially started as home based, have expanded to become significantly larger operations. These include such businesses and people as: â&#x20AC;˘ Apple Inc., started by Steve Jobs and Steve Wozniak from Steve's garage

http://en.wikipedia.org/wiki/Income_taxes_in_Canada (Wednesday, 20 March 2013) 13 http://en.wikipedia.org/wiki/Home_business (Wednesday, 20 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 12

• Hewlett-Packard, whose original location is now a museum, the HP Garage • Hurricane Electric, California based ISP backbone provider • Southwest Technical Products Corporation, founded by Daniel Meyer • James Avery Craftsman, Christian themed jewelry maker • Genuine Scooters, Chicago motorscooter manufacturer • Amigo Mobility International Inc, Michigan based mobility scooter manufacturer, founded by Allan R. Thieme • Lindos Electronics, British audio quality measurement equipment manufacturer • Rembrandt Group, South African tobacco conglomerate founded by Anton Rupert • Koorong, Australian Christian bookstore chain • Joel L. Malter, coin and antiquities dealer • Real Goods, California solar energy installation company and green business retailer • Endress+Hauser, instrumentation company based in Switzerland • Press-A-Print, US printing company • Robert A. Kleist and Gordon Barrus, inventors of the Line matrix printer • Borland Software, California software company founded by Philippe Kahn • John B. Moon, engineer working with magnetic materials • iiNet, Australian internet service provider • J. C. Bamford, UK digging equipment manufacturer started from a rented garage • FLEXcon, Massachusetts Pressure-sensitive adhesive film manufacturer • Holiday Magic, multi level marketer started from the purchase of another home-based business • Amazon.com, internet retailer founded by Jeff Bezos14

14 http://en.wikipedia.org/wiki/Home_business (Wednesday, 20 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 13

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G OVERNMENT ENCOURAGEMENT _____________________________________________________________ Income Taxes

Our governments actually encourage us to set up new businesses. As can be seen in the examples on the previous pages, a small business started in one’s home can become a big business that pays big taxes. Plus, there’s the income taxes paid by all those employees! Governments do very well financially by encouraging us to become owners of businesses - even small home-based businesses. _____________________________________________________________

Allowable Expenses

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This list of “Allowable Expenses” is taken directly from the income tax forms15 that we submit at the end of the year: • Advertising • Meals and entertainment (allowable part only) • Bad debts • Insurance • Interest • Business tax, fees, licences, dues, memberships, and subscriptions • Office expenses • Supplies • Legal, accounting, and other professional fees • Management and administration fees • Rent • Maintenance and repairs • Salaries, wages, and benefits (including employer's contributions) • Property taxes 15

Page 2 of CRA Form T2125 Statement of Business or Professional Activities http://www.cra-arc.gc.ca/E/pbg/tf/t2125/t2125-12e.pdf (Wednesday, 20 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 14

• Travel (including transportation fees, accommodations, and allowable part of meals) • Telephone and utilities • Fuel costs (except for motor vehicles) • Delivery, freight, and express • Motor vehicle expenses (not including CCA) • Allowance on eligible capital property • Capital cost allowance (CCA) • Other expenses (specify) For more information about the list above, see Chapter 9, “How To Use A Line of Credit”. _____________________________________________________________

Personal Expenses vs Business Expenses

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If we set up a home-based business, some everyday expenses that we are already paying can become business expenses that are paid with “before-tax dollars” as opposed to “after-tax dollars”. For example: • Commutes to our place of employment can become business trips if we also have business meetings or buy office supplies on our way to or from work. • Our cell phones become our business phones and a portion of the expenses are business expenses. • The interest paid on a Line of Credit set up to cover business expenses is deductible. Use the new Line of Credit and/or a separate credit card to pay for all business expenses. • Convert personal assets (desk, chair, computer, keyboard, mouse, trackpad, printer, filing cabinets, stapler, paper supplies, calculators, etc.) to business assets16 17 by taking money equal to their fair market value from the new Line of Credit and putting it

http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/rprtng/cptl/prsnl-eng.html (Monday, 15 April 2013) 17 http://www.cra-arc.gc.ca/E/pbg/tf/t2125/t2125-12e.pdf _____________________________________________________________ Profitable Planning & Management Inc. Page 15

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Income Taxes

into your personal bank account. Use that money to pay down personal debt. â&#x20AC;˘ The costs of meals or refreshments that you share with people in your business or with whom you discuss your business become business expenses. So, discuss your business often - even if for only a few minutes. Note: Office space in the home has to be dedicated for business use only and CRA expects that you will be meeting there with clients. Telephones, computers, internet, etc. either have to be dedicated to the business or fairly pro-rated between business and private use. _____________________________________________________________

Business-Use-Of-Home Expenses

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When your home-based business is making a profit, you can write off some of the expenses required to operate your home. This list of expenses is taken directly from the income tax forms18 we submit at the end of the year. The numbers below are fictitious and are used as an example only. Heat Electricity Insurance Maintenance Mortgage interest Property taxes Other expenses (specify) Total Expenses

1,000 1,000 500 1,500 15,000 4,000 0 23,000

Minus: personal-use part

20,700

Business-Use-Of-Home Expense 18

2,300

Page 3 of CRA Form T2125 Statement of Business or Professional Activities http://www.cra-arc.gc.ca/E/pbg/tf/t2125/t2125-12e.pdf (Wednesday, 20 March 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 16

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The “Business-Use-Of-Home Expense” cannot be used to create a loss against your employment income 19. However, it can be used to decrease taxable profits from your home-based business thus decreasing the income tax you have to pay on your business profits. In the example on the previous page, you could write off $2,300 of your expenses for operating your home. What that means is you are paying $2,300 of your home-operating expenses with pre-tax dollars from your business as opposed to after-tax dollars from your employment. If you are in the 33.77% tax bracket, you would have to earn $3,473 gross income from your employment to pay $2,300 from your takehome pay.

With a home-based business, you have to earn only $2,300 in your business to pay $2,300 of your home-operating expenses.

http://www.cra-arc.gc.ca/E/pub/tp/it514/it514-e.pdf (Tuesday, 16 April 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 17

Income Taxes

Calculate the total annual expenses for your home in the categories listed above. Then subtract the “personal-use part” - the percentage of the total area of your home that is not your office (typically 90%).

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And, you’ve freed up $2,300 of your take-home pay from your employment for other personal expenses.

Income Taxes

Understanding the significance of the previous three short paragraphs is critical to understanding the benefits of having a home-based business, even a part-time business, and being able to convert some of your current personal expenses to business expenses. _____________________________________________________________

S UMMARY - CANADA _____________________________________________________________ Being properly informed about the income tax rules that apply to a home-based business, we can convert some personal expenses to business expenses and increase our income tax refund by a few hundred dollars, perhaps as much as a few thousand dollars, depending upon your tax bracket. Once our home-based business has become profitable, we can start paying some of our home expenses with pre-tax dollars from the business as opposed to after-tax dollars from our employment takehome pay. The tax savings that can be created by setting up a part-time, homebased business help pay ongoing personal expenses. For more information, see Chapter 9, “How To Use A Line of Credit”. Contact the person who gave you this book and ask them for more information about setting up a part-time, home-based business. _____________________________________________________________

Q UESTIONS _____________________________________________________________ Are you paying too much income tax? Would you like to pay less income tax? _____________________________________________________________ Profitable Planning & Management Inc. Page 18

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P OTENTIAL SAVINGS - INCOME TAX - CANADA _____________________________________________________________ Canadian Income Tax Rates are set by both Federal and Provincial/ Territorial governments with each entity setting their own Taxable Income Brackets and Tax Rates.20 Rather than doing calculations for each province/territory, I’ve created an “average” chart of tax brackets and taxation rates.21 In a very arbitrary manner, I’m using the following tax brackets and rates as “averages” for all of Canada: • 23.48% on the first $40,577 of taxable income, plus • 33.77% from $40,578 to $82,896 of taxable income, plus • 39.42% from $82,897 to $138,771 of taxable income, plus • 44.80% of taxable income over $138,771. _____________________________________________________________

Income Tax Estimator - Canada

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Use the Income Tax Estimator on the following two pages to calculate your income tax savings if you were to start a small, parttime, home-based business. I’ve suggested a few numbers for the calculations. Feel free to change those to something you think is reasonable for you. When calculating the “Estimated Annual Deductions” on the second page, where you see the “????” in the formula, use the percentage from the appropriate tax bracket above.

http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html#federal (Wednesday, 20 March 2013) 21 See Appendix B _____________________________________________________________ Profitable Planning & Management Inc. Page 19

Income Taxes

Would you like to increase your income tax refund next April by a few hundred dollars, perhaps as much as a few thousand dollars, (depending upon your tax bracket)?

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TAX SAVINGS ESTIMATOR - CANADA

Income Taxes

Using these two pages, follow the instructions to calculate your income tax savings if you start a part-time, home-based business. Home Office Deduction

Home based deductions are available when any dwelling unit of yours is used on a regular basis for your business. Monthly total of any of the following: heat, electricity, insurance, maintenance, mortgage interest, property taxes. $_________ / mth x 12 = $_________ / yr x 10% = $_________ / yr.

Business Vehicle Deduction

Business Vehicle Deduction - use of any vehicle in the course of operating your home-based business may be deductible as a business expense. Use calendar-year Kms and expenses (fuel, oil, maintenance, parts, insurance, licence & registration fees, interest on car loan or lease expenses22 ). Business Kms _________ / Total Kms _________ x Total $_________ spent = $_________ / yr.

Business Travel Deduction

Business Travel Deduction - travel expenses incurred when business activity requires you to stay away from the principal place of business can be deductible. Estimated annual cost of: Airfare, Hotel, Parking, and other related business travel expenses: 2,000 $_________ / yr x 100% = $_________ / yr.

22 http://www.cra-arc.gc.ca/E/pub/tg/t4002/ (Saturday 03 August 2013 _____________________________________________________________ Profitable Planning & Management Inc. Page 20

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Meals & Entertainment Deduction

Income Taxes

Meals & Entertainment Deduction - expenses incurred for meals and entertainment can be deductible if related or associated with your business. Estimated cost of business meals each month: 100 $_________ / mth x 12 = $_________ / yr x 50% = $_________ / yr.

General Office Deduction General Office Expense Deduction - general business expenses such as telephone & internet use, supplies and marketing materials may be deductible. Estimated monthly cost of the following: Telephone & Cell Phone, Internet, Business cards, General Office supplies, Marketing and Advertising. $________ / mth x 12 = $_________ / yr x 100% = $_________ / yr. Add the five annual costs indicated above to calculate your Estimated Total Annual Deductions = $

/ yr.

Based on a Tax Rate of ????%*, your Estimated Annual Refund =

x ????% = $

/ yr.

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* Disclaimer: This estimator is to be used to obtain a rough estimate of the type of annual tax savings you could have with your part-time, home-based business. Consult with a qualified tax professional.

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P OTENTIAL SAVINGS - INCOME TAX - UNITED STATES _____________________________________________________________ Income Taxes

How much can you expect to save on your income taxes by starting a small, part-time, home-based business? Below are screenshots from an app 23 we can use on a computer or smartphone to estimate your savings. Assumptions: • Business Vehicle Deduction is calculated by totaling miles driven for business and multiplying the sum by $0.55; • Business Travel Deduction is 100% of the actual travel expenses incurred for the part-time, home-based business; • Meals & Entertainment Deduction is calculated by multiplying the sum of the yearly cost of business meals and entertainment by 50%; • Office Supply Deduction is 100% of the actual cost of any office supplies used for the home-based business.

23 http://www.donferg.moremoneylowertax.com _____________________________________________________________ Profitable Planning & Management Inc. Page 22

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Income Taxes

This screenshot from the app 24 shows one example of potential savings.

24 http://www.donferg.moremoneylowertax.com _____________________________________________________________ Profitable Planning & Management Inc. Page 23

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S UMMARY - USA _____________________________________________________________ Income Taxes

Being properly informed about the income tax rules that apply to a home-based business, we can convert some personal expenses to business expenses and decrease the amount of income tax we pay each month from our employment income. You can "give yourself a raise" of a few hundred dollars per month - depending upon your tax bracket. The tax savings that can be created by setting up a part-time, homebased business help pay ongoing business expenses. For more information, see Chapter 9, â&#x20AC;&#x153;How To Use A Line of Creditâ&#x20AC;?.

_____________________________________________________________ Profitable Planning & Management Inc. Page 24

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Income Tax Estimator - USA

Contact the person who gave you this book and ask them to use their Tax Savings Estimator app to show you the estimated tax savings for your personal situation. On the other hand, you can use the Income Tax Estimator on the following two pages to calculate your income tax savings if you start a part-time, home-based business. If youâ&#x20AC;&#x2122;re not sure what numbers to enter into a formula, insert the appropriate numbers used on the screenshot on the previous page.

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TAX SAVINGS ESTIMATOR - USA

Income Taxes

Using these two pages, follow the instructions to calculate your income tax savings if you start a part-time, home-based business. Home Office Deduction

Home based deductions are available when any dwelling unit of yours is used on a regular basis for your business. Monthly total of any of the following: Rent, Real Estate Taxes, Utilities and Services, Mortgage Interest, Insurance, Casualty Losses: $_________ / mth x 12 = $_________ / yr x 10% = $_________ / yr.

Business Vehicle Deduction

Business Vehicle Deduction - use of any vehicle in the course of operating your home-based business, may be deductible as a business expense. Estimated number of business miles driven annually: Business Related Miles _________ / yr x $0.55 = $_________ / yr.

Business Travel Deduction

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Meals & Entertainment Deduction

Income Taxes

Meals & Entertainment Deduction - expenses incurred for meals and entertainment can be deductible if related or associated with your business. Estimated cost of business meals each month: $_________ / mth x 12 = $_________ / yr x 50% = $_________ / yr.

/ yr.

Estimated Annual Savings = $____________ x 28% = $

/ yr.

Estimated Monthly Savings = $

/ yr รท 12 = $____________ / mth.

_____________________________________________________________ * Disclaimer: This estimator is to be used to obtain a rough estimate of the type of annual tax savings you could have with your part-time, home-based business. Consult with a qualified tax professional before making any changes to your W-425. If you do not have a qualified tax professional, please go this web site and they will refer one for you: www.AccountableSolutions.biz.

25 http://www.irs.gov/pub/irs-pdf/fw4.pdf (Saturday, 20 April 2013) _____________________________________________________________ Profitable Planning & Management Inc. Page 27