Year-end and Tax Preparation

A Simple Tax Compliance Method For The Self-Employed

By L.Kenway BComm CPB Retired

Revised June 11, 2024  |  Edited May 8, 2024  |  Updated April 29, 2024  |  Revised July 18, 2024  |  Originally Published  on Bookkeeping-Essentials.com in February 2009

How To Get Started | No-Tech Option | Low-Tech Option | Affordable Tech Option | Thinking Ahead | Simple Cash Management System | Owner's Pay |  Before You Spend Money Ask These Questions | Money Tips | Wrap-up

If you keep your books solely for year-end and tax preparation purposes, tax experts suggest you establish this simple method to meet this requirement.

It can be especially stressful when year-end and tax preparation comes around. Even more so if you developed the bad habit of ignoring your bookkeeping throughout the year. Here are the steps  to remove some of the stress from tax time:

1. Start organizing early in January to relieve your stress and your tax preparer's stress. It may cost less if you submit your information earlier in the tax season, say March 1st, rather than later (any time in April).
   
   More >> 2024 Tax Alert - Interest rates on unpaid balances
   
   
2. Organize your information using the simple year-end and tax preparation method outlined below.
   
   
3. Take your organized information to your tax preparer.  Another option only if you are relatively knowledgable about all aspects of your business's finances and CRA compliance rules is to do your taxes yourself using one of the online tax platforms.
   
   TAX ALERT: Go to your tax preparation interview ready to answer questions.
   
   
4. Make sure you understand how much the tax preparation service is going to cost prior to allowing the tax preparer to prepare your return. For clarity, get a quote prior to proceeding so you don't have sticker shock at the end.
   
   TAX ALERT: I would stay away from any tax preparer that charges a fee based on the size of your refund.
   
   
5. Understand that it is still your responsibility for what the tax return says even if a professional prepared it. That's why it is important to have the tax preparer review the finished return with you. Don't let them skip this step! Don't sign off until this has been done.
   
   TAX ALERT: Never sign a blank or incomplete return.
   
   More >> What It Means When You Sign Your Income Tax Return
   
   
6. If you receive a notice from CRA requiring action, make sure you let your tax preparer know. They will address CRA's concerns often at no charge as it may be included as part of the tax preparation service.
   
   
   
   

Three Year-End and Tax Preparation Options

Following are three year-end and tax preparation options; (1) old school no tech; (2) low tech, and (3) affordable tech. Choose the one you are most comfortable with.

What this method requires:

• Before you start, you will need a copy of your T2125 Schedule included in your prior year's T1 tax return for reference.
• A supply of file folders or 9 x 12 envelopes
• At year-end, access to an old-fashioned printing calculator with a paper tape.

Step One: At the beginning of each calendar year, refer to your prior year T2125 Schedule. Take a file folder (or envelope) and write on the front - the year, the tax line number from the T2125 Schedule, and the expense name. Do this for every line you used on last year's T2125 Schedule or expect to submit a tax claim on this year.

Step Two: Throughout the year, place all your corresponding business receipts in the appropriate file folder.

Step Three: At the end of the year, run a tape listing of every receipt for each file folder. Write the total expense for that line on the outside of the file folder. Insert or staple the paper tape listing to the inside of the file folder.

Step Four: Keep all file folders pertaining to one tax year together in a box. If you are audited, you've got everything you need to support your return.

Why It Works: It is a simple, low-tech way to keep and get your tax information ready for your tax preparer.

Drawback: It makes it onerous for your tax preparer to determine if all your deductions listed are allowable. You really need to be on top of knowing the rules.

It's also not the best way to implement good bookkeeping practices in your business. It does not provide information on whether you are making money or not. You could work around this if you are willing to use several bank accounts to manage your cash flow (see below).

Other Filing Options: Consider other low tech filing organization options if you want to use your records to help you run your business.

MORE >> Be Audit Ready If CRA Examines Transactions Between Family Members 

Here are some tips to reach your goal of getting all your ducks in a row:

1. Take an introductory bookkeeping course at your community college or online to learn the basics. You'll come away more confident you'll be on top of your business finances.
2. If you haven't already, open a separate bank account for your business. Don't mix your business finances with your personal finances.
   
   More >> Why you want a CRA audit trail?
   
   
3. Schedule your bookkeeping tasks so they don't pile up. Think of it as "cleaning as you go". It's much easier to clean the fridge if you wipe any spills as they occur rather than weeks later when they harden. Bookkeeping is the same. Keeping on top of it makes it less of a chore. Daily is best but weekly works too.
4. Nowadays, technology is available and affordable for small businesses. Digitize all your bills, receipts, and of course invoices. Switch to digital receipts where possible. It is easier to keep them organized and gets rid of the problem of faded, lost, or damaged receipts.
   
   More >> Can you shred your scanned receipts?
   
   
5. Take advantage of one of the many small business accounting software out there such as QuickBooks Online, Xero, or Sage. It really does make everything easier and reduces bookkeeping errors because it's programmed to know the rules. You will need to take some initial training to ensure you are using the various modules correctly and not making a mess of things. 
6. Once your data is entered into your accounting program, review the financial statements for issues you can get resolved before they become a problem.
   
   More >> How to mine your business reports to run your business better
   
   
7. If you are not a do-it-yourselfer, hire a certified professional bookkeeper to handle this task for you. It's important to not get behind on government reporting and have information you can use to run your business not from the seat of your pants.

Self-employed business owners who only do their bookkeeping sporadically or for year-end and tax preparation need a method to manage their cash flow. Cash is what keeps your business going. This system helps with that. It gives you a clear picture of your cash position at the start of each day allowing you to get a feel for your cash flow trends and whether you need to change your plans.

How does it work?

By prioritizing profit generation, not generating sales; by setting predetermined allocations for the cash coming into your business. Mike Michalowicz's book Profit First outlines a system for managing your cash flow to prioritize profits ensuring you are not living in entrepreneurial poverty. To implement this financial management system based on human behaviour (which is why it works), you need to create your TAP.

This system lets you see your cash flow just by signing into your bank(s). You can quickly see how much cash came in, how much you've set aside for operating expenses, payroll, taxes, etc by setting up recurring transfers.

Who is this system for?

• If you are an entrepreneur living in poverty, this system will help you achieve a living "wage".
• If you just want to put your cash management on auto pilot
• Any business person who looks at their bank balance or credit card balance to make spending decisions.

What is TAP?

TAP stands for targeted allocation percentages. They are predetermined percentages of your incoming cash flow allocated to different bank accounts. It puts many of your cash management decisions on autopilot alleviating some stress from daily business routine.

Why is TAP important?

TAP helps you prioritize profit and is a way to achieve financial stability for your business. It allows you to allocate your hard-earned revenue in an effective, efficient, not wasteful manner. If you want to emphasize growth over profits, then tweak your TAP to achieve that goal.

Basic steps:

Step 1: Determine your TAP (target allocation percentages).

While every business is different, service-based businesses usually have higher profit margins than product-based businesses. You may need to review your financial statements (or last year's T2125 Schedule) to determine where your business currently sits. Here is a good starting point that you can then tinker with until you get something that fits.

• GST HST 5% to 15% - depends on your location in Canada; if you use the Quick Method Rate of reporting, set aside your Quick Rate; these funds are held in trust so are not included in your TAP allocations
  
  
• Profit 2-5% of revenue before tax - sets funds aside for future business growth or quarterly bonuses;  Goal is 10%
  
  
• Owner's Pay (Draw) 30% of revenue before tax - set aside funds to pay yourself a living salary; Goal is 50%
  

• Tax 15-20% of revenue before tax - set aside funds for your quarterly tax installments or annual income tax payable
  
  
• Operating Expenses are allocated the remaining percentage of revenue: 45 - 53% of revenue before tax. This is the cash you run the business on if you want a paycheque and want your business to be profitable. If this amount doesn't cover your expenses, you need to reduce business expenses and/or increase sales. You need to find ways to optimize your business. I.E. run a tighter ship. 

As your business grows or you become more comfortable managing your cash, you can add other target accounts, such as a capital expenditure account, a debt repayment account, a marketing account, or a rainy day account.

Step 2: Open six bank accounts. 

1. For all cash coming into the business. Now you will know how much money comes in each day, week or month just by looking at your bank balance.
2. For your net CRA sales taxes; for self-employed, preferably this account is at an online bank that pays higher interest than brick and mortar banks. This money is held in trust.
3. For your quarterly profit sharing or business growth; for self-employed, preferably this account is at an online bank that pays higher interest than brick and mortar banks.
4. For systematic owner's pay; for self-employed, preferably this account is at an online bank that pays higher interest than brick and mortar banks.
5. For your income taxes; for self-employed, preferably this account is at an online bank that pays higher interest than brick and mortar banks.
6. For business operating expenses; the bank account will preferably be tailored to withdrawals (cash, cheques, or online bill payments and transfers) with little to no bank fees such as RBC's Digital Choice Business Account. It features unlimited deposits including Moneris, unlimited cheque deposits, unlimited electronic debit and credit transactions, limited Interac transactions for $6 per month. Additional fees apply for in branch transactions, cash deposits, paper transactions as this is marketed for digital transactions. Most of the other brick and mortar banks have service charges starting at $10+.

Think of the bank accounts as similar to the old envelope personal budgeting system, which used an envelope for each saving/spending bucket. Here, you will be using bank accounts instead of paper envelopes.

Step 3: Twice a month allocate your TAPs.

Twice a month, you will allocate your TAPs from the incoming cash bank account to the other five bank accounts. One suggestion is the 10th and 25th of each month, or you could do this weekly - whatever lets you feel in control of your cash.

Move your GST HST funds collected first before calculating your TAP. This money is held in trust for the government and should not be used to fund business purchases or personal lifestyle expenses.

Don't pay attention to the amount being transferred at the start, even if it's just 25 cents. Don't tell yourself it's not enough to make a difference so I'll just skip it. Just make the transfer. You are establishing habits. The amounts being transferred will grow. Consistency and discipline is what makes this system work.

Step 4: Pay yourself on a regular basis.

Pay yourself on a regular basis. It could be weekly, bi-weekly, or semi-monthly. I suggest semi-monthly on the 13th and 28th of the month.

Here's how it would work:

Options:

One method (shown above) is to forgo a pay cheque if there are not enough funds to cover the entire pay due. The remedy for this is fine-tune your business by finding ways to reduce expenses or increase sales. The theory is not receiving a pay cheque will motivate you to work at making your business more efficient to ensure you always receive a pay cheque. This wouldn't work for me personally.

Another method would be to seed the bank account for your first pay cheque at the start before you begin applying TAP. It gives you a head start to funding the account properly. If you set your TAP properly, you shouldn't have any shortfalls. Remember you can tweak your TAP quarterly, so maybe you get paid less during your slow season initially until you have built up a reserve. In the example above, if the account had been seeded, no pay cheques would have been missed.

Step 5: Take care of your quarterly transactions and review.

At least once a quarter, in addition to making quarterly payouts, you will review your TAP and decide if you need to make any adjustments. You will also adjust your TAP immediately if there is a significant event. 

Things to keep in mind when you review and tinker with your TAP:

• In the beginning, you may need to pay yourself less so all your business financial obligations are met to ensure your bills are paid, late fees are kept to a minimum, and your credit rating is kept intact. Your goals are (1) to get your business expenses under control and purposeful, and (2) earn a salary equal to or better than if you were not self-employed.
• Don't skimp on your income tax allocation, as it will just move your financial problems twelve to eighteen months down the road.
• Stay off CRA's radar by reporting, filing, and paying your GST HST on time. Missing these deadlines creates a whole host of issues and pressure you really could do without.
• It's important to pay yourself at least twice a month so you can meet your personal lifestyle obligations and don't dip arbitrarily into the business's cash drawer. When you start managing your cash using this system, you might need to reduce your lifestyle expenses initially (but not for too long) until you get your business expenses under control by making hard decisions to ensure you get paid. I like to think of a business as a spoiled child always throwing temper tantrums to get what it wants, not needs. If you want a paycheque, you need to be in control of what the business needs. You call the shots which means some of the "extras" or "nice to haves" may have to wait for a bit.
• Your profit account is where you plan for business growth, "the child's" wants, building a reserve, or rewarding yourself. Being business savvy ensures you earn a quarterly bonus for all your hard work and cash management skill set. It is suggested you distribute 50% of the balance in your profit account each quarter as a bonus to yourself.

What's Great About This System:

It effortlessly manages your cash, so you are always in control of your finances, even if you are behind in your bookkeeping. It will likely make your year-end and tax preparation easier. Putting your money decisions on auto-pilot actually reduces some of the stress in your day as you don't have to think about it, you just do it. It lets you exhale so you can just breathe.

If your personal finances are in a mess too, you can setup this system for your personal finances as well.

Discipline Required:

• Only works if you run all income and expenses through your bank accounts.
• Only works if you consistently make the transfers regardless of the amount being transferred.
• Only works if you are disciplined enough to stick to your TAPs.

Joey Ragona has an excellent YouTube video on how to implement this system.

Before You Spend Money Ask These Questions

Small business owners often get into cash flow problems because they don't make decisions about their business strategically. Before spending money on or in your business, consider all your options so you stay within your allocated TAP. Consider the following:

• Does the business really need to buy "that item"? If yes, does the business need to buy that item now?
• What other things could the business spend that money on?
• How much money does the business have available after all necessary expenses have been paid? (You setup automatic payment of your "pay cheque", utility bills, credit card, automated TAP transfers, etc. right?)
• Could the business buy the item later at a better price?
• Does continually monitoring the online environment which bombards you with constant news and online consumption opportunities unconsciously impact your ability to make smart money spending business decisions? For example does it trigger a "need" to spend money on the latest thing out there for your business which brings an initial feeling of relief in the short-term but will likely lead to long-term pain? Go back to the first question, does the business really need to buy "that item" now?
• Can the business afford to do this? Do a reality check by acknowledging how much money the business has available for expenditures.

Before spending funds on unplanned purchases for your business, think of the business's long-term goals. Following your allocated TAPs may not be sexy or flashy, but it isn't supposed to be. Staying the course by being steady and deliberate automatically contributes to your future success. Now that's way more sexy than flash any day ... any day.

"We" all know if you aren't getting the results you want in any area of your life, the only way to get a different result is to do something different to change it up ... and hopefully you'll get different results ... the ones you were hoping for.

An excellent article in the Financial Post Business Insider titled "15 money tips to make you rich in 2015" lists 15 action items to help you do things a bit differently in any year. I've summarized them here but follow the link above to read the entire article. It's worth your time.

1. Become you own CFO - Become aware of where your money is going.
2. Go on a diet - Cut out one expense for 30 days that isn't helping you achieve your goals.
3. Be selfish - Take care of yourself financially so you have move flexibility to help others.
4. Be selfless - Nurture an attitude of selflessness that focuses on helping others.
5. Improve your credit score - get your free credit report and address any items hurting your score.
6. Define what true wealth means for you - It is more than just a certain amount money. For many, it includes freedom, family, health, purpose, experiences, etc. Knowing your definition will help you stay on track and arrive at your dream life sooner. (Editor - anything written by Brian Tracy will help you figure out your definition of wealth.)
7. Automate your money - When the money comes in, automatically send it to other accounts so you won't be tempted to waste it. (Editor - Profit First discussed earlier in this article  explains how to put this system in play. It will also help with item 3 above.)
8. Add another income stream - Never put all your eggs in one basket.
9. Focus on passive and residual income - Build wealth by putting your business or money to work for you instead of trading your time for money.
10. Get a library card - Invest in yourself by reading to increase your knowledge and inspire you. (P.S. the library card thing doesn't work for me ... They rarely have the books I want want when I want them (so I get like five all at once) which means I never get the books back on time so it costs me a frick'en fortune in late fees! Amazon eBooks work much better for me.)
11. Make your investments boring - Investing should be more like watching paint dry. Learn to take the emotion out of it. Running your own business is high risk. Your other investments should be low risk for a "balanced" portfolio.
12. Track your progress - Think big picture and monitor your net worth I.E. track how much of your money / wealth you keep.
13. Cut 10% -  And invest it ... in yourself ... or pay down debt ... (or invest it in items 8, 9 or 11 above). "Go through your expenses line by line and see what you can cancel or reduce. I do this practice at least twice per year to keep things in line, and I find hundreds in savings each time."
14. Hang out with rich people - "You become the average of the five people you spend the most time with."
15. Reduce your goals - Create a single challenge at any given time. (How about working on this list?)

• If you keep your books solely for year-end and tax preparation purposes, tax experts suggest you establish the simple method outlined above to meet this requirement.
• I laid out three options to implement this system: no tech, low tech, and affordable tech.
• The Profit First cash management system works well for self-employed business owners who don't do their books during the year. It puts you in control of your cash flow instead of flying by the seat of your pants.
• Consider other options available before you make unplanned expenditures in or on the business. Year-end and tax preparation will go so much more smoothly.

Disclaimer: I am not a certified Profit First Professional or associated with Mike Michalowich. I just like the system and introduced some of my client's to it. Get Mike's book to learn more about the system.

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