Family file: self-employed

On Their Own

The pressures of being self-employed while raising two children is getting to the Youngs. How can they ensure their family has enough money for the future?

Financial Post Magazine November 06, 2007

Last year, Kyle and Ashleigh Young made a $20,000 mistake. They both run profitable small businesses from their home in Markham, Ont., but they’re quick to admit that neither has mastered the paperwork side of things. So, muddled by a slew of bi-monthly and tri-monthly tax payments – GST, PST and income tax, all at different dates for each business – the Youngs forgot to put aside cash for Kyle’s income tax. This amounted to a nasty surprise come tax time: a $20,000 bill. Because the Youngs had no emergency fund, they had to refinance their mortgage to pay the tax bill. Now, as their businesses continue to grow – and with their hands full raising two young children – the Youngs are worried something like this will happen again. “We are feeling more and more vulnerable being self-employed,” says Ashleigh. “What if something happened to me or Kyle? Will our family be protected?”

Kyle, 37, a tradesman who decided he’d had enough of working for other people, launched his own business three years ago. He earns $61,000 a year. Ashleigh, 39, works as a consultant exclusively for one client – a former employer – four days a week and brings in $94,000 a year. While their combined income of $155,000 a year is enough to cover their $127,800 in annual expenses for car payments, mortgage, daycare, vacations, bills, food and clothing, stresses about their financial health are mounting.

One concern is life insurance: While Ashleigh and Kyle both have policies that would provide $300,000 in case of death and $1,500 a month for disability, they aren’t sure if it’s enough. Medical and dental benefits is another big issue. While Ashleigh pays into a plan to receive “horrible and skimpy” benefits from her client, she is considering going back to the cubicle life so she can get full benefits. “My kids have flat feet,” she jokes, “and they’re going to need orthodontics.” On top of that, the family will face the cost of two university degrees when the kids head off to school in a decade. “We’ll still be paying the mortgage,” Ashleigh says, wondering, “Will we have enough money to do it considering the mess we got into last year?”

Throughout their self-employment, the Youngs have saved money. They refer to their yearly $5,000 RRSP and $2,000 RESP contributions as “untouchables,” and are slowly paying down their $250,000 mortgage. (After last year’s refinancing, they borrowed more against their house and increased their monthly payments instead of extending the amortization.)

At this point, however, the couple’s main concern is building enough security into their businesses so they can protect their family, beginning by getting a grip on their monthly finances. “We’re not in big enough businesses to actually hire someone to manage our books,” Ashleigh says. “But I’m starting to think we should.”

What the experts say

The Youngs’ anxieties about their future are well-founded, according to Jason Heath, CFP, a consultant for E.E.S. Financial Services. In fact, the couple might even be facing another nasty tax surprise in the near future. “Working from home doesn’t necessarily mean the Canada Revenue Agency (CRA) will consider Ashleigh self-employed,” Heath warns. “She’s paying into a benefits plan, which is typically the sort of thing an employee would do.” Being labelled an employee could impact what she is able to claim as business expenses and force her to pay for Employment

Insurance. Sandy Page, CFP and co-founder of Page & Associates, agrees. “The CRA usually likes to see you have three clients,” she says. The best possible solution?

“Incorporate.” Despite the fact that the businesses aren’t related, Page says the Youngs can “merge their talents” and go into business together. This tactic could help Ashleigh defend her self-employed status if the CRA investigates. Incorporating will also make it easier to do income splitting, which spreads the profits evenly between husband and wife to keep them both in lower tax brackets.

A tax expert will help them sort out the situation and, if Ashleigh can clearly establish her self-employed status, will help them take advantage of the tax benefits. “The Youngs are definitely missing out on a lot of tax deductions,” says Heath. They will be eligible to claim expenses for things like car lease payments, car insurance, repairs and maintenance. They can even write off the parts of their home used for office work. They just need someone to get them organized. “The Youngs are better off paying someone to do it for them,” Heath says, “so they can focus on running their businesses.” Reduced taxes will free up cash flow so the Youngs can boost their insurance: Both Page and Heath see a major shortfall with their current coverage.

The advisers also recommend that the Youngs maximize their RRSP contributions, which will increase their savings for the future and lower their tax bill. “The highest income earner should do this every year,” Page says, “at least equal to the principal payments on their mortgage.”

The couple should also boost their RESP contributions. Currently, they have $13,000 saved in their RESP, yet in ten years, the bill for two kids for four years of tuition and residence will be $120,000. If they don’t raise their contributions, both advisers warn that they won’t have enough cash to cover their children’s education.

Once the couple gets its finances in order, there will be no need for Ashleigh to return to a staff job for financial reasons. Their first step should be hiring a financial planner with tax expertise and handing over control of their finances to someone who can create a concrete strategy and plan for the future. The Youngs need more than an accountant, Page says. “They only account for the past. The Youngs need someone to look at the big picture, someone to hold their hand through the whole process. I don’t think their situation is as complicated as they think.” With expert advice, they’ll be protected from any more nasty surprises from the tax man.

Tip of the Month: Determine if you are self-employed

Self-employed workers can claim some sweet tax deductions and avoid paying for Employment Insurance. But just because you work at home doesn?t mean the Canada Revenue Agency will consider you self-employed. If your main client closely supervises your work and provides equipment, training and benefits, you might be considered an employee. If you?re not sure what category you fall in, you can request a CRA ruling.

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