Low Tax or No Tax?

As a self-employed individual, you have more flexibility in managing your taxes compared to traditional employees. With smart planning and strategic deductions, you can significantly reduce—or even eliminate—your tax liability while staying fully compliant with the law. Here’s how:

1. Choose the Right Business Structure

Your business structure determines how you’re taxed. In Canada, sole proprietors pay taxes on personal income, while incorporating allows you to retain earnings within the corporation at a lower tax rate. Consider these options:

• Sole Proprietorship: Simple setup but fully taxed at personal income rates.
• Corporation: Pay yourself dividends instead of a salary to lower personal tax obligations.
• Limited Partnership: Can offer tax advantages, especially when combined with other strategies.

2. Maximize Business Deductions

Many expenses related to your business are tax-deductible. Keep track of the following:

• Home Office Deduction: If you work from home, a portion of your rent/mortgage, utilities, and internet can be deducted.
• Vehicle Expenses: If you use a car for business, claim mileage, fuel, insurance, and maintenance.
• Business Supplies & Equipment: Laptops, software, office furniture, and tools are deductible.
• Professional Fees: Accountant, lawyer, and consultant fees reduce taxable income.
• Meals & Entertainment: Up to 50% of business-related meals and events can be written off.
• Advertising & Marketing: Website hosting, paid ads, and social media marketing expenses are deductible.

3. Use Tax-Advantaged Accounts

• RRSP (Registered Retirement Savings Plan): Contributions are tax-deductible, lowering your taxable income.
• TFSA (Tax-Free Savings Account): Investment gains grow tax-free, reducing capital gains tax.
• IPPs (Individual Pension Plans): A great option for incorporated professionals to shelter more income.

4. Income Splitting with Family Members

If your spouse or children help in your business, pay them a reasonable salary. This moves income to a lower tax bracket and allows them to contribute to RRSPs or TFSAs.

5. Defer Income to Lower Tax Years

If you expect lower income in the following year, defer invoicing clients until after December 31 to push income into the next tax period, reducing your current liability.

6. Claim Capital Cost Allowance (CCA)

Instead of deducting large asset purchases in one year, you can spread deductions over multiple years to minimize taxable income over time.

7. Take Advantage of Government Grants and Credits

Look into tax credits for small businesses, including:

• Scientific Research & Experimental Development (SR&ED) Credit
• Small Business Deduction (for corporations earning under $500,000)
• GST/HST Input Tax Credits (recover GST/HST paid on business expenses)

8. Advanced Tax Strategies

Reducing Tax to $0 with Share Loans

Example: Consultant Earning $200,000 a Year

Let’s say you run a consulting business and generate $200,000 in annual revenue. If you withdraw all earnings as salary, you will be taxed at a high personal rate. Instead, here’s how you can reduce your taxable income to nearly $0 legally:

1. Incorporate Your Business – Instead of operating as a sole proprietor, set up a corporation to retain earnings at a lower tax rate (around 12-15% in Canada, depending on the province).
2. Retain Earnings in the Corporation – Instead of paying yourself a salary or dividend, leave most of the earnings in the corporation to avoid personal tax.
3. Borrow Against Company Shares – Instead of taking income directly, take a loan from a financial institution using your company’s shares or retained earnings as collateral.
4. No Tax on Loan Proceeds – The borrowed funds are not taxable because they are considered a loan, not income.
5. Repay the Loan Strategically – Repay the loan using dividends in low-income years or after retirement when you fall into a lower tax bracket.

Family Dividend Strategy (Previously Used by High-Income Earners)

One of the strategies used by high-income professionals, such as dentists and consultants, was income splitting through family dividends. Here’s how it worked:

1. Incorporate and Issue Shares to Family Members – The corporation would issue shares to children or a spouse in lower tax brackets.
2. Pay Dividends Instead of Salary – Instead of withdrawing a salary, the professional would pay dividends to their children or spouse, who had little to no other income.
3. Low or No Tax on Dividends – Since the recipients had low income, the dividend payments were taxed at a much lower rate (sometimes zero, depending on tax brackets and deductions).
4. Gifting the Money Back to Parents – After receiving dividends, children or spouses would often “gift” the money back to the original earner (the parent or professional), allowing the high-income earner to access tax-free money while reducing taxable income.

This strategy significantly lowered tax liabilities, but the Canadian government introduced Tax on Split Income (TOSI) rules in 2018 to limit its effectiveness. Now, dividends paid to family members who don’t contribute meaningfully to the business are taxed at the highest marginal rate. However, income splitting is still possible under certain conditions, such as when family members are actively involved in the business.

9. Hire an Expert

A tax professional can ensure you’re taking full advantage of legal deductions while keeping you compliant. The cost of a good accountant is often outweighed by the tax savings they help you achieve.

Final Thoughts

Legally reducing taxes when self-employed is all about using the right deductions, structuring your income wisely, and leveraging tax-efficient investment options. The key is to stay informed and proactive so you can maximize your earnings while minimizing your tax burden.

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Disclaimer: This blog article is for informational purposes only and should not be considered financial advice. Everyone’s financial situation is unique. Always consult with a qualified financial advisor or planner to assess your individual circumstances before making financial decisions.