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Taxes for Canadian Small Businesses and Their Owners – Advice on How to Manage

For US persons, an irrevocable life insurance trust (ILIT) is arguably the most efficient structure for integrating tax-free investment growth, wealth transfer and asset protection. An ILIT comprises two main parts: (1) an irrevocable trust; and (2) a life insurance policy owned by the trust. An international (or offshore) ILIT is a trust governed by the law of a foreign jurisdiction that owns foreign-based life insurance. An offshore ILIT is better than a domestic ILIT because it is more flexible and less expensive. Regarding US tax laws, a properly designed international ILIT is treated virtually the same as a domestic ILIT. An ILIT becomes a dynasty trust (or GST trust) when the trust's settlor (or grantor, the person who establishes and funds the trust) applies his lifetime exemption for the generation skipping transfer tax (GSTT) to trust contributions. Once a dynasty trust is properly funded by applying the settlor's lifetime exemptions for gift, estate and GST taxes, all distributions to beneficiaries will be free of gift and estate taxes for the duration of the trust, even perpetually. The individual unified gift and estate tax exemption and the GSTT exemption are both $5 million ($10 million for a married couple) during 2011 and 2012, which are the highest amounts in decades. Under the US tax code, no income or capital gains taxes are due on life insurance investment growth, and no income tax is due when policy proceeds are paid to an insurance beneficiary upon death of the insured. When a dynasty trust purchases and owns the life insurance policy and is named as the insurance beneficiary, no estate tax or generation skipping transfer taxes are due. In other words, assets can grow and be enjoyed by trust beneficiaries completely tax-free forever. Depending on how a trust is designed, a portion of trust assets can be invested in a new life insurance policy each generation to continue the cycle.

Source Deductions - when you begin paying employees, this money is withheld by the business owners from their employee's wages for submission to the Government of Canada. GST - when you begin selling your products and services, you will need to charge this tax on each sale transaction. This is money that is collected from your customers for submission to the Government of Canada. Business Taxes - money submitted from the revenues of a business to the local municipal government. This is similar to property taxes on your home. Provincial Taxes - the tax that is charged by the provincial government based on the profit of a corporation. Federal Taxes - the tax that is charged by the federal government based on the profit of a corporation. Personal Taxes - the tax that is charged by the federal and provincial governments on the income of the business owners.

An offshore ILIT provides much greater protection of trust assets against creditors of both settlor and beneficiaries. Courts in the US have no jurisdiction outside of the US, and enforcement of US court judgments against offshore trust assets is virtually impossible. Although all offshore jurisdictions have laws against fraudulent transfers, they are more limited than in the United States. In any case, an offshore ILIT is necessary to purchase offshore life insurance because foreign life insurance companies are not allowed to market and sell policies directly to US residents. An international trust, however, is a non-resident and is eligible to purchase life insurance from an offshore insurance carrier. An international ILIT may be self-settled, that is, the settlor of the trust may be a beneficiary without exposing trust assets to the settlor's creditors. In contrast, in the United States, the general rule is that self-settled trusts are not honored for asset protection purposes. In Private Letter Ruling (PLR) 200944002, the IRS ruled that assets in a discretionary asset protection trust were not includable in the grantor's (settlor's) gross estate even though the grantor was a beneficiary of the trust. The trustee of a discretionary trust uses his discretion in making distributions to beneficiaries consistent with trust provisions. Previously, it was questionable whether a settlor could be beneficiary of an ILIT without jeopardizing favorable tax treatment upon his death. The new ruling gives some assurance to a US taxpayer who wants to be a beneficiary of a self-settled, irrevocable, discretionary asset-protection trust that is not subject to estate and GST tax. As a result, the trustee can (at the trustee's discretion) withdraw principal from the PPLI or take a tax-free loan from the policy's cash value and distribute it tax-free to the settlor, as well as to other beneficiaries. In other words, a settlor need not sacrifice all enjoyment of ILIT benefits in order to achieve preferred tax treatment.

The main rule to remember is this. Source Deductions and GST have to be paid first. In the case of these two taxes, the government considers the small business owner to be an agent for the government. The money that is collected is being held in trust by the business owner for the government. Ignoring this can lead to serious trouble.

To put it another way, consider how you would feel if you found out that the GST taxes collected by a business was being used to purchase a bigger car for the business owner. Or maybe the tax withheld on your salary was being used as a down payment on a summer home. It becomes pretty clear when one considers this that paying these amounts to the government is very important.

The home office, however, must be used exclusively for the business. Physically separating the area, such as using a specific room, is best for this. Also, if a personal vehicle is used for the business, the taxpayer must be sure to keep mileage records for the business use. Only the business miles can be deducted.

So in short, there are a lot of different levels of taxes that the Canadian small business owner has to deal with. Ignoring the payment of source deductions and GST is foolish. When faced with limited cash, try paying the taxes using post dated cheques.

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