Self-Employed & Corporate Income Taxes: Installments, Penalties, and Planning Ahead
Yes, it’s that time of year again. Your accountant, the tax software companies, and that place down the block have all been sending you endless lists of deductions, paperwork, and requests for information. It can feel a little daunting.
If you’re self-employed, a contractor, or a corporation owner, it’s even more stress-inducing. You want to pay as little tax as possible and back when you were an employee (if that was ever a thing), your taxes, CPP contributions, and EI premiums were automatically deducted from your paycheque. Now, you have to sort that stuff out yourself, and given that you may be scrambling to grow your operations, your time and money may be more than a little tight.
Not having the money put aside is one of the many reasons a tax filing can be late – or avoided altogether – resulting in interest and penalties. If you owe tax from last year and you file your return after the due date, the late filing penalty is 5% of the balance owing. On top of that you’ll be paying an additional 1% for each month your return is late for up to 12 months.
If you’ve failed to report income of $500 or more, you’re going to be charged 10% of the amount you failed to report for your most recent return plus 50% of the difference between the understated tax (or overstated credits) related to the amount you failed to report. (Try to get these penalties waived through the Voluntary Disclosures Program).
Interest & Payment Plans
If you cannot pay the full amount of your taxes, don’t hide under the covers. Contact CRA right away to find out if you qualify for payment arrangements or even tax relief. Do not put this off – it’ll only result in a bigger mess. Avoiding CRA can result in a demand letter, asking for the full balance immediately. You’re better off to get ahead of it and start that payment plan. You’re still going to be charged interest at the current rate, but at least it’ll be managed.
Even employees often end up with installment payments. If you owe more than $3,000 in taxes, CRA may decide that you should make quarterly payments for the current tax year. Don’t ignore these either. Yes, they are annoying, but they’re a requirement, and not making them will result in further penalties. Save yourself some money by avoiding these penalties, and incorporate these payments into your regular cash flow plan.
Now for the planning…
First, start with the past years’ debts and get the plan for those squared away. Second, start thinking about the future. Rather than ending up in a debt situation – with the requisite interest and charges – each year, you’re better off to start saving NOW for current year taxes. If you were an employee, these would be deducted off of every pay anyway – why not treat your business/self-employment income the same way?
Open Up at Least Two Savings Accounts
Account 1: Income Tax
Some people call this ‘TAX – DO NOT TOUCH THIS ACCOUNT EVER’ just to ensure that the message is hammered home. Take a percentage of every dollar you earn and allocate it to this savings account.
If you’ve created a business cash flow projection (highly, highly recommend), you’ll have a rough idea of your expenses – deductions – how much you can pay yourself, and your estimated tax for the year ahead. This can also be a useful tool if you’re not sure what you should be charging. The stark realities of your time and your expenses may encourage you to force your charge-out rates up (if they’re under your control). Use your business cash flow projection to calculate how much you should be placing into this account on a regular basis.
From time to time throughout the year, especially when cash is tight, you may look longingly at this account. You may think it’ll be okay, just this once. It won’t be. That account does not belong to you. You’re just holding it for CRA.
Account 2: GST/HST
It’s a little easier to determine the GST/HST that you’ll be owing, whether quarterly or annually. You’re collecting this with every single invoice you send out. Of course, you’ll be able to deduct the GST/HST you pay on business expenses. If you have a good accounting system where these amounts are updated regularly, you can allocate these funds with each payment you receive.
If you have a corporation, it makes sense to open up both a corporate income tax savings account and a personal income tax savings account, as you’ll be saving two sets of taxes at different rates. Your personal cash flow projection will help you estimate your personal taxes in the year ahead as well.
Not sure how to get started? Talk to your accountant, and get in touch with Kathryn, our Director of Cash Flow Strategies for a consultation.