You’re likely asking yourself, what is the dilemma that self-employed workers face? Well, with more and more Canadians joining the ranks of the self-employment every year, one has to ask themselves how they are going to tackle the age old question, how much does one write off vs how much income does one claim on their taxes. We all want to earn as much money as possible and pay as little income tax as required.

This was my train of thought until the topic of ‘paying taxes’ was brought to my attention by a friend that’s an accountant. As he said, paying income tax isn’t such a horrible thing, in fact it’s a necessity which provides for our infrastructure and without it the ‘world’ we know would be drastically different. Here was the response from him after I re-posted a reference to INCOME TAX RELIEF DAY that I saw on social media.

“I would actually look at it more positively and say that I/we spent this money to live in a great country, province and municipality and it’s worth every penny in taxes spent. I will guarantee you there are billions of people on this planet that would switch positions with us in a second and remember this so called date (INCOME TAX RELIEF DAY) is based on the average Canadian family income of $45,000 and is based on all taxes including not just income taxes, but property tax, sales taxes, health taxes, fuel taxes and much more. So technically not all of it is going to Canada Revenue Agency (CRA). Some of it is going to municipal and Metro Vancouver. For more information go to the Fraser Institute website https://www.fraserinstitute.org/research-news/display.aspx?id=22954. ”

After reading over this message, it got me thinking about how some self-employed people report their taxes and the effect that it has on their chances of qualifying for a mortgage. Besides the duty to provide to our country, we all have a personal desire to provide as much as possible for our family. It’s a so-called ‘tug-of-war’ of who gets your money and how much of it. Here’s where the dilemma gets complicated if you want to borrow money from a lender to purchase residential real estate.

The federal Government of Canada regulates the CRA as well as the lending criteria and policies followed by ALL the ‘A’ lenders. ‘A’ lenders are our chartered banks and non-bank or monoline/investment lender. We also have credit unions that are provincially regulated but follow the CMHC lending criteria, which is federal. Having more ‘cash’ in your pocket actually allows you to borrow less. Showing more income claimed, which requires you to pay more tax allows you to borrow more money if desired. ‘A’ Lenders assess their risk management for lending money to borrowers on historical earning and in this case, if one is self-employed then they require a 2 year average based on T1 Generals or in some cases Notice of Assessments (NOA).

It’s a CATCH 22 and you (and your qualified accountant) need to decide which path you’re going to follow; write off maximum expenses and claim ‘little’ income or claim a ‘healthy’ income and pay more income. Neither is right or wrong.

Upon getting the urge to buy residential real estate a detailed conversation on how ‘your income’ is structured should be had with their Mortgage Expert and Certified General Accountant. Once you have chosen which style of accounting your business will adopt, you just have to be prepared to follow the lending guidelines. Plus, it’s really not that bad either way.

Let’s face it, everyone wants the lowest rate possible when it comes to their mortgage. As a Mortgage Expert, it’s something that I seek for every client. But not all clients are eligible for the lowest rate for a number of different reasons. Two main reasons are because of credit blemishes and, of course, lack of income reported.

Business Case

The following is a fictitious scenario that represents a self-employed person that writes down expenses in order to minimize CRA income tax.

Jane is a business owner in Vancouver. She has a modest business that is experiencing growth year after year. Jane enjoys the many perks of being a business owner, especially the tax breaks that come along with it!  Since Jane is able to work with her certified accountant, and considerably write down her income, she often saves thousands of dollars a year on taxes.

Jane would like to purchase a new home. She has a 20% down payment to place on a home, and knows that she grosses more than $100,000 per year in her business. However, since she currently writes down her income to $20,000 per year, her Mortgage Expert has just informed her that she will need to state her  income with a ‘Non-Prime’ or ‘B’ lender for approval.

Now if Jane claimed $100,000 per year for the last 2 years, she may qualify for the best rate out there from an ‘A’ lender. However, let’s look at what that really means:

Jane has saved $23,299 per year because of the tax laws the government has legislated for self-employed business owners. Now let’s compare the interest on a ‘typical’ verified-income loan, and a ‘non-prime’ stated-income loan.

** For ease of comparison to BC yearly tax rate– 1 year term has been used. Rates are approximations for example purposes.**
Jane is paying $3,545 more in interest per year, but her income tax savings are $23,299 per year.  She is actually saving $19,754 per year more than the typical ‘verified-income’ employee that was able to receive a mortgage interest rate of 2.69%.

With all entrepreneurs there is one thing in common – they are all savvy and driven to succeed, or fail, on their own terms.

It takes an extreme amount of hard work to get a business from the infancy stage to a self-sufficient entity that produces a constant and steady flow of revenue. Business owners all want to save money while at the same time earning and establishing a presence in their chosen space. Business financials are all structured differently and, depending on how one chooses to operate, will dictate how they can proceed once it’s time to seek residential real estate financing.

If you are self-employed, make sure to consult with us at Dominion Lending Centres to find out how your mortgage can be tailored. Every mortgage scenario is completely different from the next, so make sure yours fits correctly and you are informed before you start the financing process.

Michael Hallett

Dominion Lending Centres – Accredited Mortgage Professional