Yep...it's tax season! I know this isn't what you want to hear. Some of you would much rather talk about the start of Spring or March Madness. Actually, madness isn't a bad way to describe this time of year in my world. Unfortunately, even if you don't do this for a living, you need to start thinking about your tax return.
For some of you, this is going to be the first return since you started your own business. If that's the case you really need to keep reading. Even if this isn't your first time around, consider this a small refresher course.
Disclaimer: Since I'm in Canada, some of this might not be specific to your area, but I'll try to keep it as generic as possible. You don't have to read this with a Canadian accent to fully appreciate the advice either.
What's different?
Up until now you've had a "job" that earned you a paycheque. Every couple weeks you'd get money, and your boss would handle all the taxes for you. Sure, the cheque seemed small after all those deductions, but if you played your cards right you got a nice refund in April.
For better or for worse, those days are now behind you.
Here are some points to think about when completing your return this year, and from this point forward.
1. Say goodbye to refunds
For the mostpart, you need to forget about the glory days of getting fat refund cheques in May. The reason you got those refunds is because the amount of taxes your employer deducted from your paycheque and sent to the government was more than what you ended up owing. If you have a family, and you're the only income earner in the house, you could get quite a lot of those taxes back each year.
Now that you're on your own, nobody is sending money to the government on your behalf. The money you received from your clients last year is all pre-tax money. Since nothing was already sent, you don't have an overpayment that can be refunded.(1) The best scenario is that you have so many claims and deductions that you don't owe anything.
(1) - In Canada, there is something called a Working Income Tax Benefit. Basically, if you worked, but didn't earn a lot of money, you can get a credit on your return. If your eligible benefit is larger than what you owe, that will result in a refund.
2. If I'm not getting a refund, then...
Yes, that means you will most likely owe money. For some people, this will be the first time you've had to send the government a payment at tax time. It's not pleasant, and if you had a really good first year of business, it might be a large bill.
I know March is a bit late to start planning ahead for a big payment, but I want you to go into the process with your eyes open. If this is just dawning on you now and you're freaking out, stop and take a deep breath. If you wake up tomorrow and find out you owe the government more than you can come up with before April 30th you still have options.
3. Remember that it could be much worse
Some guy you've never met telling you that a $5,000 tax bill isn't a big deal is annoying, right? I know, but stop for a second to think about the big picture. Let's say you generated $100,000 of revenue last year. I don't mean take home pay, but that's how many sales you made in 2013.
As an employee, you would have been taxed on $100,000. Yes, it would have been taken off your cheque is small(ish) chunks, but by the end of the year your T4 would show tax deductions based on the full $100,000.
As a sole proprietor, you will be taxed on your net income. If you spent $50,000 on your business in 2013 in order to generate that $100,000, you're going to be taxed on $50,000...not $100,000. That's a really simplistic look, so let's not get too literal. Some of that $50,000 could have been personal use, or not 100% deductible, but you get the idea. The point is that, although it might be a huge tax bill when you owe it all at once, it's much less than what you would have sent the government as an employee.
4. With that in mind, make sure you know what to claim
If you know that there might be a large tax bill in your future, you really owe it to yourself to try to reduce it by as much as is legally possible. If you're handing your return to a professional, they will (if they're any good) go through a huge list of possible expenses with you. Ask questions if you're unsure, but don't just assume that you can't claim something.
If you're doing it yourself, familiarize yourself with this section of your return. It's the self employment section, and will list all of the revenue and expenses you can enter. Go through that list to see if there's anything you hadn't thought of, and ask someone if anything is confusing.
5. Make a better plan for next year
This, sadly, isn't reserved for newbies. We all have that one thing that we never prepare for properly. Whether it's doing your taxes or packing for a trip, we make a mess of it and then promise ourselves we'll improve next time.
My best advice here is to start paying yourself an after-tax income every month. If you brought in $5,000 last month, don't pay yourself $5,000. Instead, set aside a % of your earnings each month into a savings account. That money is going to pay your tax bill, as though your boss was taking it off your cheque. Obviously it will depend on your tax bracket, but if you can set aside 25% each month it will really help. The lowest federal tax rate is 15% in Canada, but you also have to factor in provincial taxes and CPP. Yes, the government is going to expect you to contribute to your CPP even if you're self-employed, so you're going to need to account for that too.
If you need some advice, please let me know. I'm always happy to help. You can also share some tips of your own in the comments.