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Going it alone: A tax primer on going into business for yourself

Now that tax season is over and you're possibly mourning the amount of tax you paid last year (just check out line 435 on page four of your tax return if you can't recall that figure), how can you improve things for 2012? I'm going to suggest that you think about full- or part-time self-employment.

You can be as creative as you want to be (provided it's legal) when it comes to a product or service to offer. Here's a primer on why to consider self-employment and how to go about setting up your business.

Tax breaks

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When you run a business you'll be entitled to claim a deduction for any expenses incurred to earn income from the business provided the amount is reasonable. The types of expenses can vary by the type of business, but there are some common expenses that are often claimed, and some of these are things you're paying for anyway.

Here's a list to consider: Advertising and promotion, meals and entertainment (generally 50 per cent of these costs), memberships, subscriptions, licences, office supplies, salaries and wages (including those paid to family members), telephone, home office expenses (where your home is your principal place of business: A portion of mortgage interest, rent, property taxes, utilities, maintenance and repairs, landscaping costs), vehicle expenses (a portion of gas and oil, insurance, registration, repairs, loan interest, lease costs, automobile club dues, car washes), among other costs.

Tax structure

When you set up your business there are three common structures to consider: Proprietorship, partnership or a corporation:

1. Proprietorship

This is an arrangement where it's you, in business by yourself, for yourself. This is the simplest structure to use because it's as easy as letting others know you're in business (by hanging the proverbial "shingle on the door"). There is little government regulation, and it's low-cost to set up. The drawbacks of a proprietorship include unlimited liability for the obligations of the business. That is, you are really inseparable from the business from a liability perspective. If the business is something that you hope will last beyond your lifetime, then succession planning becomes more difficult in the case of a proprietorship. From a tax perspective, any income earned from the business is reported on your personal tax return (Form T2125). There are generally fewer opportunities for creative or sophisticated tax planning in the case of a proprietorship.

2. Partnership

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A partnership arrangement is simply two or more partners carrying on business together with a view to creating profit. The benefit of partnerships can include a pooling of the skills of different individuals and perhaps access to more capital to start and grow a business. The partners are often jointly and severally liable for the obligations of the partnership (which means you could be liable for mistakes made by your partners), unless you structure it as a limited partnership. From a tax perspective, the profits or losses of the partnership are allocated to the partners to be reported on their personal tax returns. Choosing your partners carefully is critical (do you have the same vision and can you work together?), and a written partnership agreement is a must.

3. Corporation

A corporation is a separate legal entity and is treated as a separate person for tax purposes. In addition to offering limited liability a corporation can provide additional tax planning opportunities. A small business corporation is often entitled to a "small business deduction" which results in the first $500,000 of active business income being taxed at just 11 per cent federally, plus provincial taxes, putting the average tax rate at about 15 per cent. This is generally less than you'd pay personally on that same income. As a general rule, if you expect to incur losses in your first years of business, you may be better off operating as a proprietorship so that those losses can be applied against other income you might have. Incorporating generally makes more sense once you've grown in size and profitability.

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About the Author
Author and founder of WaterStreet Family Offices

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices. More

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