What Small Business Owners Need to Know About Income Tax Instalments

One of the more difficult aspects of the transition from employment to small business ownership is having to be more disciplined.  You can no longer rely on your employer to take care of business functions that do not relate to your job ,and must take a much more active role in ensuring that you remain on top of your obligations whether it is collecting payments from customers, paying bills or ensuring that you do not run afoul of Revenue Canada.  One of these obligations requires that you remit your own income taxes, which is done via the mechanism of instalment payments.

What is an Instalment Payment?

When you are an employee, your employer is responsible for deducting and remitting deductions from your paycheque to the revenue agencies.  Small business owners, who are unincorporated, are required to take on this responsibility.  Since unincorporated small businesses are only taxed on the profits of the business which are inconsistent from month to month, it can be difficult to estimate taxes payable (unless of course you have a crack accounting system).  As such Revenue Canada requires that you pay “instalments” of taxes payable based on an estimate.

What are the different types of Instalment Payments?

Small business owners are require to make periodic payments towards:

  • Income taxes
  • GST/HST/QST Payable 

How are they calculated?

Given the virtual impossibility of estimating your income taxes exactly, until you have completed your bookkeeping for the year, there are different methods by which you can pay instalments.  The first method is to base payments on your prior year taxes payable.  Eg if you owed $10,000 in income taxes for 2011, you would be required to pay $2,500 per quarter in 2012.  This gets a little more complicated as, since you don’t know your income taxes payable until later in the year, the first two instalments due March 15th and June 15th are based on your 2010 income.

Alternatively, given the fluctuations between profit earned in one year vs. another, you can estimate your taxes for the current year and remit based on these amounts.  For example, if your average tax rate was 35% in 2011 and you estimate that after expenses you will earn $75,000 in the current year, you can remit $26,250 over four instalments equaling $6,562.  Note that if you think that your profit will be higher or lower, your tax bracket might change thereby resulting in a different average tax rate.

What happens if I don’t make instalments?

Revenue Canada charges interest on unpaid instalments at prescribed rates which are currently around 5%.

Revenue Quebec similary charges interest at the normal published rate as long as Instalment payments exceed 75% of the amount payable.  If not:

If your instalment payment is less than 75% of the payment required, interest of 10% per year, capitalized daily, is applicable. 

What else do I need to know?

You are not required to pay instalments in your first year of business as there is no history upon which to make the calculation.

Revenue Canada does not require you to pay instalments if your taxes payable are estimated to be $3,000 or less.  If you live in Quebec, this amount is reduced to $1,800.

Quebeckers similarly have to pay instalments if estimated taxes payable are $1,800 or less.

You are only required to make GST-QST instalments if the amount payable for the year exceeds $3,000.  In this case, payments must be made within one month of the fiscal quarter.

Both Revenue Canada and Revenue Quebec require that you pay instalments quarterly on March 15th, June 15th, September 15th and December 15th.   They will send you a notice once they have assessed your prior year tax return informing you of the amount payable along with a remittance slip.  Payment can be made via cheque or online banking.

By remitting instalments on a timely basis you reduce the amount of potential interest costs (which sare also not tax deductible to your business) and more importantly mitigate the temptation to spend money that technically belongs to the government.