# Entrepreneurs pay less taxes



## heffer (Feb 21, 2010)

I tried posting this last week in the Taxation forums but for some reason it never appeared so I'll try General this time.

A co-worker told me you can save big on taxes just by starting your own business. But this almost sounds like a huge loop-hole that's too good to be true. Here is the story he outlined for me.

Laura is a highschool science *teacher, *working full-time at Point Grey Secondary in Vancouver BC, with a salary of *$50,000/yr*. Her favorite pastimes include *cooking, reading, and hiking*.

Laura decides to start a small, self employed business selling *cookies* to supplement her income. She registers her business and completes all necessary legal papers accordingly, and calls her company *"Weekend Delights."* Her plan is simple, customers order cookies from her website. Laura then takes the orders, bakes the cookies in *her own kitchen* and delivers them to her customers. Laura only bakes and delivers on weekends, so as to not affect her main job *teaching*. Over the course of the year she bought a used Honda Fit, a new computer, web design/management services, kitchen renovation contract, cooking supplies/ingredients, etc totaling *$20,000* which she paid in full *using money out of her own pocket*. Since her business operates at home, she plans to use 40% of the money she pays for her mortgage, phone bill, utility bills, auto insurance, etc as deductible income totaling *$5,000*. At the end of the year her *realized income* has been reduced *to* only *$25,000.* Laura decides that her cookie business is not at all profitable so she decides to close down her business. She doesn't file for bankruptcy because Weekend Delights doesn't owe anyone money. She posts a final message on her website, apologetically informing all visitors that Weekend Delights will no longer be in business. She goes to the local business bureau and *shuts down her company. 
*
The following year Laura decides to venture into another start up. This time, her business model is to buy and sell used books. She starts a company called "*Weekend Reading.*" Within just *2 years* of operation however, she closes her business again due to heavy losses. But not before lowering her taxable income by *$20,000* for *each* of those 2 years. 

Laura continues this trend year after year and her realized annual income never exceeded $30,000 again. 

End of story

Hm, it just seems like there has to be some kind of drawback to this tax saving strategy because it sounds so simple that *anyone with a regular day job can pull this off*, yet MOST people are not self employed. Does Laura's credit score suffer when she closes a business with negative equity? Where does all that negative net worth go? Does it just disappear and the government forgets about it? Won't the CRA accuse her of gaming the system? But then again, how can they prove that she's using her car, computer, and other "*company property*" for personal enjoyment. My friend assures me that this kind of business strategy is perfectly *legal* and it's why you always read things like *4 out of 5 small companies close within the first 3 years of operation*. It's not because startups are as detrimental as people think. It's because a lot of companies are created with the* very intention of losing money* and closing in the near future to ultimately, *save money*, through paying less taxes. Maybe he has a point, but I just feel really unethical even thinking about doing something like this. Any Lauras out there? What are the *disadvantages* of entrepreneurship. 

heffer


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## Four Pillars (Apr 5, 2009)

So she spends a lot of time on these businesses, suffers "heavy losses" and gets a tax writeoff?

I'm not really seeing the upside of this plan. 

Plus, I suspect she is being too aggressive with the deductions (but I'm no expert!)


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## MoneyGal (Apr 24, 2009)

I! don't! think! so! 

Believe me. CRA sees through these. You might get away with one or two, but then you face the threat of a "lifestyle audit." I've worked with one client once who was on the receiving end of a lifestyle audit and believe me, _never again_. 

Read this circular on "tax avoidance."


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## Cal (Jun 17, 2009)

If she cannot prove a 'reasonable expectation for a profit', she would be paying some $ when audited.


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## bean438 (Jul 18, 2009)

All I can say is it is Audit time!
Moneygal's CRA link says it all.

More importantly CRA says it is not the actual law that matters, nor is it the spirit, or intent of the law, it is CRA's interpretation of the intent/spirit of the law.

If CRA wants something shut down, then it shall be so! 

Personally I stick with the RSP, which really is the only tax break a T4 taxpayer gets these days.
I can deduct my RSP contribution and not lose a minutes sleep that I will get audited over it 5 years later. Even if i did it would be a simple matter of producing receipts, but I believe CRA gets a copy of these anyway.


Personally i would like to see jail time for anyone caught trying to not pay their own share.


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## MoneyGal (Apr 24, 2009)

And the thing with an audit: once you've been audited, your file is (apparently) red-flagged_ for the rest of your life_. Why? because you have a higher propensity to evade taxes. 

Also: if you do this, you essentially have to never tell anyone. Or live in fear that a disgruntled ex-partner or neighbour will call that handy tip line and turn you in. I have heard (but never verified) that the main source of tips for CRA is people turning their friends and family members in directly.


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## specialk (Jul 14, 2009)

Maybe I am not understanding completely...but it seems like the biggest flaw in this plan is:
So what if you pay less taxes on a bunch of money you blew for no reason. This is like saying you should get 6 cans of pepsi (that you don't need anyway) instead of 1 so that you can get more back at the bottle depot.


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## bean438 (Jul 18, 2009)

Moneygal a coworker's wife works for Canada Robbery Agency.
According to her, the number one source of "tips":

Ex spouses

Second highest source of tips are neighbours who get upset at their neighbour who makes roughly the same amount of salary, same number of kids, but somehow manages to have new cars all the time, 5 plasma tvs, taking lots of trips, etc.

If CRA was smart they would offer a percentage of the recovered taxes as a reward. I believe the IRS does this.

CRA is not stupid, and are pretty good at digging up crooks. As useless as this government is they are, and always will be extremely efficient at collecting money.


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## MoneyGal (Apr 24, 2009)

SpecialK: the "trick" is that you get to write off the costs of a bunch of personal-use items (part of your utility bills, car, and in the example given, kitchen renos), plus you declare losses to recoup some of the taxes you've already paid on your salary. 

So you aren't "out" any money - instead, you've recouped some tax $$ and bought yourself a few nice things on the taxpayer's dime.


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## swoop_ds (Mar 2, 2010)

I actually wanted to do this in a more legitimate way with a photography business. I would have realistic expectation of some sort of income (maybe 2 or 3 weddings a year at 1000$ish a pop). Then I figured that I could write off all kinds of crazy stuff. . . Although, the main drawbacks are: 

-i think your file at cra gets flagged or something and you're more likely to get audited if you have this sort of micro business 
-a lot of extra paperwork (keeping receipts for seven plus years)
-extra expense at tax time unless you're a whiz (although I think you can write off tax prep expenses on next years return)
-i don't believe you can write off things like computers, only their depreciation, and only against "actual profit" from the business, but I may be wrong, and I think you can carry it forward until you have profit. 

I think this can work, and can save you a lot of tax money but I think its better if you're actually trying to make your micro business work and not just looking for free taxpayer money. 

-Dave


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## MoneyGal (Apr 24, 2009)

1. yes to increased risk of review/audit. 

2. yes to increased paperwork, but you have to keep your tax stuff for 7 years in any case - you aren't "off the hook" if you do not have self-employment income.

3. you must capitalize expenses over a certain threshold. However, computers depreciate very quickly. Workspace in the home expenses do not create a loss but can be carried forward indefinitely to claim against income. Other expenses, including depreciation, may be claimed against tax paid on earned income - which is what makes the "scheme" outlined in the first post attractive.


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## OhGreatGuru (May 24, 2009)

_Laura decides to start a small, self employed business selling cookies to supplement her income. She registers her business and completes all necessary legal papers accordingly, and calls her company "Weekend Delights." Her plan is simple, customers order cookies from her website. Laura then takes the orders, bakes the cookies in her own kitchen and delivers them to her customers. Laura only bakes and delivers on weekends, so as to not affect her main job teaching. Over the course of the year she bought a used Honda Fit, a new computer, web design/management services, kitchen renovation contract, cooking supplies/ingredients, etc totaling $20,000 which she paid in full using money out of her own pocket. Since her business operates at home, she plans to use 40% of the money she pays for her mortgage, phone bill, utility bills, auto insurance, etc as deductible income totaling $5,000. At the end of the year her realized income has been reduced to only $25,000._ 

She will get caught by CRA in time. The annoying part is that all of us have probably heard of acquaintances claiming they have successfully pulled similar stunts. But there are major flaws in the scenario described.

- I'm pretty sure you can't write off mortgage costs on your principal residence for business-in-the home costs. 
- The percentage of your home's annual "operating costs" that you can write off have to be in proportion to the amount of space used by tthe business. As soon as she tries to claim 40% CRA is going to look closer.
- Renovating the kitchen is a capital improvement. Even if CRA allowed her to claim part of it (since it is not exclusively used for her business) she would not be able to claim the full amount in one year. But offhand I don't think they would even go that far, since the improvement is to her principal residence. She might be able to claim the cost of some equipment & appliances.
- Likewise, she cannot write off the cost of a car in one year. 
- If the business owns the car, at the end of the year she has to pay the business for her portion of annual operating costs such as gas, insurance, repairs. And the business cannot claim "expenses" for which it was reimbursed. If she owns the car, then the business has to pay her for the proportion the car is used on business, and can't claim any more. This is where people find it easy to cheat, but if CRA investigate they will want to see logbooks as evidence of how she arrived at cost allocation. And certainly anyone who tries to claim 100% business use is inviting an audit.
- Showing consistent net business losses is another fine way to invite an audit.
"declaring bankruptcy" isn't as easy as it sounds. CRA will want to see statements for closing out the business and will want to know how our teacher acquired the assets of the business at no cost.

PS. In the anecdote given, Laura is proposing to deduct $25,000 in costs. Even supposing those were permissible deductions (which they aren't) she can only deduct Net Business Losses. She is obliged to report her business's gross income and it's net income/loss. If she claimed $25K loss, it would mean she had zero gross income. Don't you think this would raise a red flag? If she hasn't sold a single cookie, she doesn't exactly have a business.


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## cardhu (May 26, 2009)

Further to what everyone else has said ... 

Any time an anecdote begins with the words ... _“A co-worker told me”_... red flags start fluttering in the breeze. You are right to be skeptical, heffer, there are a lot of myths and misconceptions floating about, and for some reason, whenever these sorts of tales are described, there’s always a “co-worker” lurking in the background .... take his/her assurances with an appropriate dose of salt ... most proponents of these kinds of schemes have trouble distinguishing between _“getting away with it”_, and “_legitimacy”_. 



> _how can [CRA] prove that she's using her car, computer, and other "company property" for personal enjoyment._


 They don’t have to ... the burden of proof is on Laura, not CRA. 



swoop ds said:


> I would have realistic expectation of some sort of income (maybe 2 or 3 weddings a year at 1000$ish a pop)


Swoop ... a reasonable expectation of income isn’t enough ... you must have a reasonable expectation of *profit* ... they are different animals ... without a REOP, there is no “business” and you are asking for trouble.


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## swoop_ds (Mar 2, 2010)

Thanks for clearing up the income vs profit aspect. What would CRA want to see my counting as expenses to go against my income in the photography scenario described? I assume income can only be called profit after expenses but I'm not sure what I'd have for expenses.

What I can think of:
equipment/depreciation
% of vehicle costs used for business (likely no more than 5%ish)
stationary
% of residence for studio/office

I think with a few weddings and whatnot here and there, there would indeed be profit. Can all the income/expenses/profit be logged by year in a receipt box (including vehicle log book) and kept track of in excel? Our must I be more deligent than this?

-Dave


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## cardhu (May 26, 2009)

OK, that's different ... if you're running a profit, and only have minimal expenses, then you're less likely to be targeted for an audit ... I had the impression, based on the quoted passages below, that you were proposing a scheme similar to what the OP described ... 

_



Then I figured that I could write off all kinds of crazy stuff ......
I think this can work, and can save you a lot of tax money

Click to expand...

_Note that profits do not save you any tax money ... they increase your tax bill.


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## ghostryder (Apr 5, 2009)

heffer said:


> Since her business operates at home, she plans to use 40% of the money she pays for her mortgage, phone bill, utility bills, auto insurance, etc as deductible income totaling *$5,000*.



How exactly is Laura going to justify 40% business use of home? She will have to show that she is using 40% of her house for business purposes ONLY. Since it is unlikely that she has two kitchens, there will obviously be some personal use of the kitchen. She would then have to pro-rate the 40% by the number of hours the kitchen is actually used for business purposes.

Only the mortage interest would be an expense, pro-rated of course.

Phone bill would only be allowed if the line was dedicated to the business. If it is being used at all for anything other than business use, it will be disallowed.

Utilities also would be pro-rated.

Auto insurance would be a vehicle expense. Which has to be pro-rated based on the number of Km's the vehicle is actually used for business.




heffer said:


> But then again, how can they prove that she's using her car, computer, and other "*company property*" for personal enjoyment.


CRA doesn't have to. If they can demonstrate (ultimately to a judge) that her claim is unreasonable, the expense will be disallowed. If she only has one car, then obviously there will be some personal use of the vehicle. Same with any other assets like the computer.



Plus, since she is preparing food in her own kitchen, there may be interest from municipal and provincial authorities. Municipal business licence, does the zoning in your neighbourhood allow home based businesses (some types of businesses may not be permitted), provincial public health authorities etc....


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## swoop_ds (Mar 2, 2010)

So ultimately, will it just be easy and probably more profitable to simply not claim any photography income and do it "under the table"?
-Dave


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## cardhu (May 26, 2009)

Dave, that’d be tax evasion.


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## bean438 (Jul 18, 2009)

cardhu said:


> Further to what everyone else has said ...
> 
> Any time an anecdote begins with the words ... _“A co-worker told me”_... red flags start fluttering in the breeze. You are right to be skeptical, heffer, there are a lot of myths and misconceptions floating about, and for some reason, whenever these sorts of tales are described, there’s always a “co-worker” lurking in the background .... take his/her assurances with an appropriate dose of salt ... most proponents of these kinds of schemes have trouble distinguishing between _“getting away with it”_, and “_legitimacy”_.
> 
> ...



Cardu did CRA change things again? Reasonable expectation of profit used to be the criteria, but wasnt that overturned in court? I thought that the criteria now a days was you have to differentiate between hobby and business? People can't be penalized for running a poor business.


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## swoop_ds (Mar 2, 2010)

Yeah I realize that it's tax evasion! I think what I'll do is start claiming my income (and expenses!) once I get to the point where I get 2000 or 3000 a year from it. Anything under that just seems like extra work that CRA wouldnt notice anyways.

I guess I'll just see how things go. Also, sorry about derailing the thread!

-Dave


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## wealthyboomer (Feb 1, 2010)

MoneyGal said:


> And the thing with an audit: once you've been audited, your file is (apparently) red-flagged_ for the rest of your life_. Why? because you have a higher propensity to evade taxes.
> 
> Also: if you do this, you essentially have to never tell anyone. Or live in fear that a disgruntled ex-partner or neighbour will call that handy tip line and turn you in. I have heard (but never verified) that the main source of tips for CRA is people turning their friends and family members in directly.


I do know of 2 high profile Realtors who this happened to. One disliked the other, and so reported her to CRA. She got audited....but in do so, she also reported the other guy. He then got an audit.


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