How to grow up your business

Businesses often have a life cycle similar to people. In my last post I described this life cycle and gave some tips on how to know if it’s time for your business to grow up from high-growth but awkward teenager to more stable adult.

Some teenagers never grow up. Uncle Rico is stuck in 1984 (although I heard the Broncos may be giving him a second chance…). But due to biology and societal expectations, most teenagers find their way into adulthood.

Businesses don’t have the same outside influences. It’s up to you to intentionally grow it up. Growing up often means turning some attention to the boring stuff you neglected while focusing on sales growth.

You know it’s time to grow up, but how do you do it?

You shouldn’t try to do it all yourself. In fact, you shouldn’t try to do much of it. But you need to make sure it’s getting done.

Task someone on your team who is capable of taking the lead, or hire someone to help. An experienced, full-time person might be expensive, but you can hire a consultant to whip you into shape and inexpensively monitor your business going forward.

Not that I’m biased, but an experienced, part-time CFO would often be a good choice for this role.

Here are some areas to consider.

Legal

Are you legally structured correctly? Are there things you can do to increase liability protection?

Would it be better to move real estate to a separate legal entity? Similarly, do you have unrelated business units that can be spun out separately? Structuring like this can prevent lawsuits against one part of your business from affecting other parts.

Unfortunately, lawsuits are a part of doing business. I don’t think I’ve been involved in a business that hasn’t been involved in some kind of lawsuit.

Insurance

Have your auto, property, general/product liability, director/officer liability, workers compensation, and/or professional liability insurance policies kept up with your growth?

Are the limits and coverage adequate and correctly structured?

Tax 

Hopefully you’ve been handling taxes correctly from the beginning, but part of growing up is making sure. Have an accountant review income tax, sales tax, payroll tax, and property tax filings and processes to make sure its all being done correctly.

When you’re not making much money, tax penalties and interest caused by mistakes may be minor, and you’re less likely to be audited. This changes as you grow.

Believe me, you don’t want to be audited before you’ve grown up.

Accounting

Cleaning up your books is part of growing up. Can you rely on your books to make good, timely decisions?

If you don’t choose to clean up, you’ll eventually be forced to clean up by government agencies or capital sources like banks or investors.

Like many other messes in life, messy books are much less expensive to avoid than to clean up, so the earlier you grow up your accounting the better.

 HR

Startups usually hire based on desperation. Stuff to do is piling up, and they quickly throw bodies at the piles.

You need to be more intentional as you grow up, especially when you’ve grown past the point of being involved in every step of every hire. Those handling the hiring need to pay more attention to cultural fit, on-boarding, and a host of other HR and payroll issues.

This is not an exhaustive list, but it gives you an idea of things to think about as you try to grow up.

You or your person overseeing the growing up doesn’t need to be an expert in all of these areas, but they do need to know enough to communicate effectively with experts like outside attorneys, insurance brokers, tax accountants, etc.

Just a final thought. In this post I’m observing typical juvenile business behavior and giving advice on how to grow up. Typically, startups wait until after a period of high growth to start worry about these less exciting issues.

However, I’m not recommending they wait. As long as you don’t let it stifle your growth (and not have a business to grow up with), the sooner you grow up the smoother your growth will be. When it comes to legal, insurance, tax, accounting, and HR, an ounce of prevention is worth a pound of cure.

The trick is to prevent business-killing problems without preventing business-making growth.

Question: What other areas are involved in help a business grow up? 

W9 and 1099: Two Tax Forms Every US Entrepreneur Needs to Know About

In my last post I described the benefit of hiring contractors while bootstrapping a startup. I also explained the tax obligation that goes along with hiring contractors, which is to file a 1099-MISC form for contractors that meet certain requirements. I also mentioned severe penalties for not meeting this requirement. In this post, go into more detail about who to issue 1099-MISC forms to, how to file, and what the W9 form has to do with it.

Who do I send a 1099-MISC to (and what does the W9 form have to do with it)? 

There’s a long list of requirements for who businesses have to send 1099-MISC forms to, and I encourage you to familiar with the rules so you know what applies to your business. This post is focused on contractors.

You must provide a 1099-MISC form to contractors if they meet the following criteria:

• they provided a service, not a product
• you paid them at least $600
• their business is not classified a corporation (C-Corp, S-Corp, or LLC filing as a C- or S-Corp)
• the corporation rule doesn’t apply to attorneys: you must provide a 1099-MISC form for all attorney fees
• you didn’t pay with a credit or debit card

To find out whether or not the business is a corporation and to get their business address and tax ID number, you should ask the contractor for a W9 form before making your first payment. An electronic copy is fine - you don’t need paper.

The W9 is a simple form that states the business or individual name, tax classification, address, Tax ID. Most contractors should already have the form on file, and if not, they should be able to quickly produce it. Here’s a link to the form.

You don’t need to request a W9 if the business has “Inc” or “Corp” at the end of their name. That tells you they are a corporation.

If a vendor refuses to provide a W9 form, you are required to withhold 28% of your payment and remit to the IRS (or better yet, don’t hire them!). If you don’t issue a 1099-MISC (you can’t without the information from the W9), you could be responsible for that 28% on top of the full payment already made to the contractor.

How do I file a 1099-MISC form and what is the deadline? 

Like filing your tax return, there are many ways to file a 1099-MISC. You can mail in paper forms, but I recommend using your accounting software or another online service.

For example, some versions of Quickbooks Desktop and Online allow you to flag vendors as 1099 vendors and save their address and tax ID. At the end of the year it’s very easy to file with information already in the system.

Even if your accounting software doesn’t issue 1099’s, other services may integrate with your accounting software so you don’t have to enter the address and Tax ID, and amount for each vendor. Tax1099.com is a service that integrates with most accounting software.

Other services include Intuit’s standalone 1099 filing service and expressirsforms.com.

These services are very inexpensive (around $3/form) and well worth the cost.

The deadlines are as follows:

 Jan 31 (or next business day): provide the 1099-MISC form to contractors

Feb 28: paper file forms with the IRS (not required if electronically filing)

Mar 31: electronically file the forms with the IRS (recommended)

It’s after the end of the year and I didn’t request W9’s. What do I do? 

1. Run a report in your accounting software to figure out how much you paid each vendor in the previous year.
2. Make a list of vendors who you paid more than $600 for services and aren’t obviously a corporation.
3. Request a W9 from each one (attach a blank form for convenience)
4. See above for filing options
5. Start a process now for collecting W9’s from each new contractor!

What if I haven’t filed 1099-MISC’s in the past? 

You have some risk of tax liability to the IRS. In an audit the IRS will identify vendors you paid for service. Each vendor you don’t have a W9 on file for and you didn’t send a 1099-MISC forms will have to prove they included your payment in their tax returns.

If they didn’t report your payments or can’t/won’t prove it, the IRS can bill you for 28% of what you paid to the vendor (good luck getting that amount back from the vendor).

If you haven’t filed 1099-MISC’s in the past, start now. Make collecting W9’s a standard part of your process for hiring consultants (don’t make a payment until you get one). Make the filing process easy each year.

Although this requirement is convenient, don’t get on the wrong side of the IRS by neglecting it.

Question: How do you make issuing 1099’s easy each year?

Do you hire contractors? You need to know about the W9 and 1099 tax forms.

Bootstrapping entrepreneurs hire employees only when absolutely necessary. They hire to alleviate significant pain, not because they might need the employee in the future. Building a team of great employees is key to building a successful business. Every leader knows that. However, taking on the cost and commitment of employees too early can hold back and even kill that success.

To lessen the risk of hiring too many, too soon, most entrepreneurs start with contractors. A startup entrepreneur wouldn’t hire a full-time accountant or an in-house lawyer.

Contractors can be anything from a freelancer with a specialized skill, such as a graphic designer, to a large businesses that provides certain services, such as a law firm.

Hiring contractors allows you to avoid many of the costs and complexities of hiring employees. You don’t have to follow labor laws intended for employees, register for payroll accounts with state tax agencies, or pay employer payroll taxes.

However, hiring contractors still comes with tax-related consequences. This post is for a United States audience, but other countries might have similar requirements.

First, you must be careful not to classify someone as a contractor when they should be an employee. The IRS doesn’t like that. They will charge you for the payroll tax you should have paid (plus penalties and interest). But that’s a subject for another post.

In this post, I want to make sure you are aware of another tax risk with contractors.

Did you know that if you don’t handle payments to contractors correctly, you may have to send the IRS 28% of whatever you paid the contractor (on top of what you already paid them)? 

The IRS wants their (our) money 

Here’s the deal: the IRS has a harder time collecting tax from contractors than employees.

Employees have tax withheld from every paycheck. In most cases these withholdings are more than what the employee owes, which is why most people get a tax refund each year.

The IRS doesn’t have that luxury with contractors, so they came up with a system that increases the likelihood that contractors will report and pay taxes on their income.

What is the 1099-MISC form?

The system revolves around the 1099-MISC form and specifically Box 7 of that form, Non-employee compensation.

You must send to employees and file with the IRS W2 forms after the end of each year. Most business owners don’t need to think much about this because payroll service companies handle it all.

Similarly, you must send to certain contractors and file with the IRS the 1099-MISC form. Usually, this process is a little messier than payroll.

Not every contractor needs a 1099-MISC, and most businesses don’t pay all contractors in the same way. Some might be given checks, some might be paid through the payroll system, and some might be paid by credit card.

Issuing 1099-MISC should be an easy process if properly planned for, and the consequences for not doing so are severe. If the IRS finds that a contractor didn’t report and pay tax on your payments, you will be responsible for 28% of what you paid them (plus penalties and interest) to compensate for the lost tax revenue. Good luck collecting this from your contractor.

In my next post, I will go into more detail about who to issue 1099-MISC forms to, how to file, and what the W9 form has to do with it.

Use Hedging to Save your Business Bundles on Foreign Exchange

Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. In my last post I introduced some terminology, warned about the outrageous foreign exchange rates that banks charge, and recommended you set up a foreign exchange service for your business.

In this post, I’ll give one more transaction cost tip, and then I’ll move on to a practice that can save you much more than a few percent on transaction costs.

Where possible, use foreign currency bank accounts and debit/credit cards 

If you frequently travel to or make purchases from a foreign country, I recommend opening a bank account denominated in that currency. This allows you to minimize transaction costs by periodically buying the foreign currency to deposit into that account.

Having a debit card on that account, or a credit card linked to it, allows you to make routine purchases, such as meals while traveling, without paying transaction costs each time.

Using your local debit or card or credit card for foreign currency transactions comes with terrible exchange rates and sometimes additional fees for each transaction.

The bank in your country might offer accounts in different currencies. For example, most Canadian banks offer accounts in both CAD and USD. Some banks also allow foreign citizens to open accounts. For example, Wells Fargo in the US allows Canadian citizens to open accounts.

Rules and conditions vary across banks, currencies, and countries, so this may not be possible in all situations.

Hedging is not just for gamblers and big businesses

Having a foreign currency bank account is an example of a simple hedge.

Hedging is basically a way to protect yourself from changing values of foreign currencies by locking in the current rate for future transactions. While minimizing transaction costs can save you a few percentage points, hedging can save you much more than that.

Foreign currency values fluctuate wildly. The Canadian dollar has lost about 30% of its value against the US dollar in the last year (late 2014 to late 2015).

If you need to purchase $100,000 USD with CAD, it would cost you $30,000 CAD more now compared to a year ago.

Using the bank account example, if you had bought USD with CAD a year ago and kept it in a USD bank account, you would have saved yourself $30,000.

In hindsight that would have been a good idea, but there are two problems. First, you tied up $100,000 for a year. Second, the USD could have declined against the CAD instead of the other way around.

A better way to hedge is to purchase a hedging instrument.

I have been involved in small businesses with cross-border money movement for almost 10 years. I didn’t even consider hedging for the first few years because I thought the costs and complexity wouldn’t be worth the benefits.

However, our foreign exchange service showed me how inexpensive and simple foreign exchange hedging can be. They approved the company for a given credit limit and suggested I hedge about half of my expected needs over the next 90 days. I simply told them how much I wanted to hedge, and they created a contract allowing me to exchange funds at a given rate at any time over the next 90 days (called a forward contract).

The only cost was the exchange rate would be a fraction of a percentage higher than the spot rate. This is a small price to pay given the potentially huge swings in exchange rates.

Over the first few months the Canadian dollar weakened, and the hedge saved us several thousand dollars.

You can save your business bundles by being intentional about foreign exchange through minimizing transaction costs and hedging against future fluctuation.

Question: How have you used hedging to protect your business against foreign exchange fluctuation? 

How To Save your Business Bundles on Foreign Exchange

Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. If you are not intentional about minimizing the cost of exchanging foreign currency, you are probably paying 2-5% more than necessary on every transaction.

If you spend $5000 on a foreign conference, that’s $100-250 more out of your pocket than necessary. That may not sound like a lot, and maybe it’s not a big deal if your only foreign experience is once a year. But these extra costs add up quickly.

If you pay a million dollars to a foreign supplier, you’re paying $20,000-$50,000 more than you need to. That’s significant.

First, some terminology 

For me to write concisely about foreign exchange, we need to understand some terminology. I’m not a foreign exchange expert, so my explanations might sound elementary to an exchange trader, but it works for the purposes of this post.

The actual exchange rate between two currencies is not an exact science. The published exchange rate between two currencies can be called the spot rate. However, when you actually exchange currencies, you never pay exactly the spot rate.

Those who trade currencies, such as banks, make money on a spread, which is the difference between what they are willing to buy the currency for and what they sell it for. The larger the spread, the more the trader makes (buy low, sell high).

For example, if a spot rate between Canadian dollars (CAD) and US dollars (USD) is 0.80 USD/CAD, is a bank might be willing to buy a $1 CAD for 75 cents USD and sell it for 85 cents. Their spread is 10 cents.

If you exchange foreign currency, you want the rate you exchange at to be as close as possible to the spot rate. As a benchmark to keep in mind while reading this post, you should never exchange foreign currency for more than about 0.5% from the spot rate (unless it’s such a small amount the convenience outweighs the cost).

For example, if you are buying CAD with USD and the spot rate is $0.800, you should not pay more than $0.804 USD for the $1 CAD.  If the amount exchanged is in the thousands of dollars or more, you could pay as little as 0.1-0.2%.

With the technicalities out of the way, here are some tips for saving money on foreign exchange. These actions aren’t reserved for big businesses. Even the smallest of businesses can easily take these steps.

NEVER let your bank exchange foreign currency (at least at their published rate)

Okay, “never" might be too a strong a word. If you need $100 worth of foreign currency, $2-5 may be worth the convenience of a local bank.

As I write this, Wells Fargo’s online rates say they will sell you $1 CAD for $0.7703 USD. The spot rate is $0.7337. This means their rate is 5% more than the spot rate (remember the benchmark is 0.5%, 1/10 of what they are charging). If you buy $10,000 CAD with USD at this rate, you are spending at least $450 more than you should be.

Like any good business, most banks are willing to negotiate their rates, especially for large amounts. Their published rate is just a starting point and what they will charge if you don’t ask.

Every bank is different, but they should be willing to go down to 2-2.5% above spot for small transactions or under 1% for large transactions.

Banks may be okay if you exchange foreign currency infrequently and in small amounts, but to avoid banks, let’s move on the next tip.

Get an account with a foreign exchange service

Many foreign exchange services offer rates at a fraction of the price of banks. This is where I get the benchmark of a maximum of 0.5% above the spot rate.

There are many services out there, but I am most familiar with GPS Capital Markets in the US and Western Union and Citizens Bank in Canada. Some banks have in-house foreign exchange services that provide better rates than their retail branches, but I’m not very familiar with those options.

Here is the actual exchange rate schedule for a foreign exchange service I recently set up for one of the businesses I work with.

$0 -$5,000                          0.50%

$5,000-$10,000                  0.40%

$10,000-$20,000                0.30%

$20,000-50,000                  0.20%

$50,000 +                           0.15%

They have no minimum transaction amount or minimum volume over time. It was easier to set up than a bank account.

Unless you have a physical location near you, these services doesn’t work if you need a small amount of foreign cash for a trip. But they work great for paying foreign suppliers, receiving funds from foreign customers, or moving money between your own banks accounts in different currencies.

The process varies, but in general you deposit or wire funds to their account in one currency, and they wire or deposit the funds to their final destination in the foreign currency.

I work with a company that has locations in Canada and the US. Most of the revenue comes in Canada and most of the expenses are in the US. The foreign exchange service I use has an account at the same bank we use in Canada.

Any time I need to move funds from Canada to the US, I fax a request to the bank to transfer Canadian funds from our account to exchange service account, the service exchanges the CAD to USD at a great rate, and they wire the USD to our US bank account. It takes me about 30 seconds to send the fax and notify the exchange service, and a few hours later the funds appear in the US account.

That’s enough foreign exchange fun for now. I’ll save more tips for my next post.

As you can see, even the smallest businesses can save a lot of money on foreign exchange by taking some simple steps.

Question: How do you save your business on foreign exchange?

Two Common Accounting Mistakes Business Owners Make

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Most business owners would rather focus on building their business than dealing with accounting. They know it’s important to have good numbers to base decisions on. They know they need to file and pay their taxes accurately and on time. But many struggle to make it happen without getting bogged down in the details themselves.

In a perfect world, companies' accounting should be accurate and up to date without requiring the business owners to think about it. They should be able to review the key metrics as needed and be confident that all other details are being taken care of.

However, many business owners operate far from this ideal. In several years of helping small businesses with accounting, I’ve seen two common mistakes that business owners make.

At one extreme, business owners pay too little attention to their accounting.

One mistake I see at this extreme is turning over accounting to inexperienced bookkeepers.

They may not realize there’s a problem until they have serious issues. They may have tax agencies coming after them for inaccurate or unpaid taxes. They may get in a cash crunch because they don’t understand their numbers.

For example, a business may take prepayments from customers, which makes their bank balance look good at times. If the customers aren’t profitable, the cost of providing the product or service will eventually drain the cash from taking prepayments.

I worked with a company that had grown rapidly to several million dollars per year in sales. As they grew, they didn’t invest in their accounting. They had hired and lost a series of low-cost bookkeepers and paid little attention to what the bookkeepers were doing. Taxes weren’t filed accurately. The books didn’t accurately show their profitability. It took a lot of work (and a high cost) to clean up the mess and put proper procedures and people in place.

Small business accounting doesn’t have to be complicated and expensive. Most business don’t even need a full-time, experienced accountant. However, it takes someone experienced to set up the systems and monitor less experienced staff.

At the other extreme, business owners try to do the accounting themselves.

Even if business owners can do their own accounting, it doesn’t mean they should. They have much more important things to do, like build the business. They shouldn’t get bogged down in the accounting details.

I saw this with another business that had grown to several million per year in revenue. The owner knew accounting basics, and as the business grew he continued to handle all the accounting. He was spending almost half of his time entering bills, sending checks, reconciling bank accounts, etc. The accounting was being done well, but it was taking the owner away from more important activities.

I helped him set up a system in which a part-time experienced accountant trained and supervised a low-cost, part-time bookkeeper. Now he hardly has to think about accounting, and half of his valuable time is freed to build his business.

A better way

There is no right way to find the balance between these extremes. It depends on the nature and size of the business.

At the small and simple end, the company’s tax accountant may be able to advise a team member who spends some of their time taking care of the day-to-day bookkeeping.

At the large and complicated end, some businesses may need one or more full-time experienced accountants led by a full or part-time CFO.

Most small business are somewhere in the middle.

A structure I’ve seen work well is to contract with a part-time, experienced accountant. This accountant could help the business’ own staff, such as an office manager, handle the accounting. Alternatively, the accountant could completely take over the accounting function, typically with his own bookkeepers.

I'm biased because I provide these part-time services, but it works well in the companies I’m involved with.

Accounting is important, and business owners need to make sure their accounting is handled properly while not spending much of their time thinking about it.

Question: How do you handle your small business accounting? 

Selling Your Home and Other Assets When Moving from Canada to the US

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including

1. Various topics, tax agencies, impact of moving, filing status, and income tax rates
2. Deductions and credits
3. Payroll tax
4. Health care and other insurance
5. Capital gains
6. Small business tax 
7. The year of the move

In this post I’ll talk about the tax implications of owning and selling your assets in Canada (either in reality or as deemed by the CRA).

Selling your personal residence 

If you sell your house before you move, or if you move from the US to Canada, you don’t need to worry about this.

If you are selling your personal residence after moving from Canada, there are a couple of gotchas to watch out for.

Non-resident withholding: If non-residents sell certain assets in Canada, the buyer is required to withhold a portion of the purchase price until the CRA issues a Certificate of Compliance. This certificate basically says the non-resident seller has complied with tax requirements and the buyer can give the rest of the money to the seller.

Each seller (i.e. both spouses) needs to file forms T2062E, T2091(IND), T2091(IND)-WS, and T1159 within 10 days of the sale at the latest to request the certificate. You can request it as you know there is going to be a sale. I’d recommend filing as soon as possible because the certificate can take a while to get. I think it took about two months to get mine, and I understand it can take a lot longer.

This one got me. I didn’t know about the withholding requirement, so 25% of the purchase price of my house was held by the buyer’s attorney for two months.

After the end of the year you have to file a Section 116 tax return to report the non-resident disposition.

There are lots of hoops to jump through if you sell your personal residence after become a non-resident.

Reduced personal residence deduction: Like the US, the gain earned on selling your personal residence in Canada is tax-free with certain restrictions and limits. However, the house is no longer your personal residence after you move, and the personal residence deduction only applies to the time it was your personal residence.

You may take a while to find a buyer, or you may rent it out before selling.

The CRA does provide some grace. The formula that calculates the personal residence portion uses full years and adds a year. This means that you have the year you move plus an extra year before you start having to pay tax on a portion of the gain.

For example, if you buy a house in 2010, move before the end of 2015, and sell the house by the end of 2016, you won’t pay any capital gains tax.

Form T2091(IND) is the form used to calculate any taxable capital gains on a personal residence.

Without thinking about this rule, we entered a lease to own arrangement that ended towards the end of the year after we moved. We barely escaped capital gains tax.

Deemed disposition 

Canada only taxes residents, while the US taxes all residents plus all US citizens wherever they live in the world.

The only way for US citizens to escape US tax is to move out and renounce citizenship. US citizens who move to Canada (or any other country) have to file a tax return in both countries. The IRS provides a credit for the tax paid to the country of residence (which is hopefully at least what would be owed to the US, otherwise, Uncle Sam will bill for the difference)

Those who leave Canada can drop their Canadian residency and voila, no more Canadian tax. However, there’s a catch. Canada won’t let anyone escape gains they haven’t paid tax on yet. The CRA treats most assets as if they are sold at market value on the moving day (“deemed disposition”), and tax is owed on any gains.

For example, you paid $1 each for shares in a private company, and they are worth $5 when you move. You have to pay capital gains tax on the $4 gain, even though it’s not a real gain. This can be a shocker if you don’t plan for it, so I recommend carefully reviewing your situation with a tax advisor experienced in this area.

Moving cross-border involves a lot of preparation, work, and stress. It’s easy to forget about the tax implications until the tax deadlines in the year after you move, but you’ll save yourself a lot of headache and probably a lot of money if you plan ahead.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Don’t Forget about Tax Before Moving Between Canada and the US!

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including

1. Various topics, tax agencies, impact of moving, filing status, and income tax rates
2. Deductions and credits
3. Payroll tax
4. Health care and other insurance
5. Capital gains
6. Small business tax 

In this post I’ll talk about the year of the move. Taxes in the year you move can be complicated and are affected by decisions you make before you move. In this post I’ll give you some things to think about, but I encourage you to get with your tax advisor as long as possible before you move. 

When moving to the US, you pick a point in time when you drop Canadian residency and become a US resident. You only file Canada tax returns for the portion of the year you were in Canada, and you file US tax returns for the portion of the year you were in the US. The exception is if you are deemed to be a resident for the entire year, which I talk about below.

When US citizens move to Canada, they still have to file US returns for the entire year (and all future years), and they file in Canada for the portion of the year they were Canadian residents.

The following are things to watch out for:

Residency rules

Normally you are considered to be a resident of the one country to which you have the closest ties. In the simplest situation, on the day you move you cease to be a resident of one country and become a resident of the other.

Of course, real situations are not usually that simple.

One rule that almost got me was the US substantial presence test. You are deemed to be a resident of the US (and are required to file US tax returns for the entire year) if you are in the US a certain number of days over the last three years according to a formula.

I moved in August, so I assumed I would only be a US resident for the part of the year I lived there. However, I spent a lot of time in the US before I moved. As I counted my days for this formula, I realized I would be considered a US resident for the entire year. That was a problem because of the way my Canadian income from a corporation was treated favorably by Canada but treated differently in the US. I had to leave the US for a couple of weeks after I moved to avoid a large tax bill. I would have been in trouble if I didn’t find out until I went to file taxes after the end of the year.

The flip side is that until you meet the substantial presence test, you are considered a nonresident. Nonresidents don’t quality for some tax deductions, such as the standard deduction and child tax credit. However, you can file back to the day you moved as a resident once you meet the test. If the tax return deadline is before you become a resident, you have to file a nonresident alien tax return and then amend it once you become a resident.

I was able to wait until I met the substantial presence test before filing a resident tax return. When I did file, I was called a dual-status alien filing a dual-status return (so you know the terminology for doing your own research).

Residency rules are complicated, and it’s important for your to do your own research on your situation.

Canadian corporations and residency 

I mentioned this in my small business tax post, corporation owners who move out of Canada need to be careful. If more than 50% of the ownership becomes non-residents of Canada, the corporation ceases to be a Canadian Controlled Private Corporation (CCPC) and will lose the associated tax benefits.

If you are closing your business as part of your move, it may be wise to dispose of all of the corporation's assets before you move. If your business generates income after you move, such as capital gains from selling assets, it will not qualify for CCPC tax advantages.

Further, as a US resident you are taxed on your worldwide income using US tax laws, including salary or dividends you take from the corporation.

Pro-rated items

Some items on tax returns are based on a full year, such as the standard deduction and personal exemption. When you are filing as a resident for only part of the year, some deductions are prorated and some aren’t. Deductions that aren’t prorated give you an advantage in that year because you get a full year of deductions/credits against a partial year of income. The US personal exemption and child tax credit are examples.

You can be strategic about deductions that are timing based. For example, if you give regular donations to organizations with presence in both Canada and the US, you can maximize your yearly donation in Canada. Canada provides more tax savings on charitable donations.

Health care

I wrote about the differences in health care systems in a previous post. I’ll mention a couple of important points related to when you move.

If you are moving from Canada, the provincial health care system will allow you to keep your coverage for a certain period after your move.

In our case, we were able to keep our Alberta Health coverage for two full months after the month we moved. We purchased inexpensive travel insurance for this period. This saved us three months of US health insurance premiums.

If you are moving to Canada, enjoy universal health care! But make sure you plan ahead because the provincial health care system may require a waiting period before you qualify for coverage.

Moving cross-border involves a lot of preparation, work, and stress. It’s easy to forget about the tax implications until the tax deadlines in the year after you move. You’ll save yourself a lot of headache and probably a lot of money if you plan ahead.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

Key Differences Between Canada and US Tax - Small Business Tax

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including various topics, tax agencies, impact of moving, filing status, and income tax rates, deductions and credits, payroll tax, health care and other insurance, and capital gains.

In this post I’ll compare small business tax.

Small business owners will find business tax to be one of the most significant differences between the two countries. As you will see, the difference is more in the structure than the total tax burden.

Sole proprietorships are the most simple business structure, and they are treated roughly the same in both Canada and the US. Beyond that, business tax structure is quite different between the countries.

Canada: Corporations are king

In Canada, most small businesses operate a C Corporations. This is surprising to Americans who are double taxed at at very high rates when using C Corps.

There are two reasons C Corps work in Canada:

1. The federal corporate tax rate is much lower (15% in Canada vs 34-35% in the US - yes, only 15% - you American read that correctly)
2. The small business deduction reduces the federal corporate tax rate to 11% on the first $500,000 in taxable income

Provinces also have a regular rate and small business deduction rate. In Alberta, for example, the rate is 3% on the first $500,000 (14% combined federal and provincial) and 12% above that (27% combined federal and provincial). Provincial rates in Canada are higher than state rates in the US, but the combined rates are still much lower in Canada.

Important caveat: the small business deduction is subject to some restrictions, including the requirement that the corporation be a Canadian-controlled private corporation (CCPC). To be a CCPC, Canadian residents must own a controlling interest in the corporation. If you and/or your spouse control the corporation, and it continues to do business in Canada after you move to the US, it will lose CCPC status.

Aside from tax rates, corporations allow income splitting between spouses. Even if one spouse does all the work for the corporation, both spouses can own the corporation and take dividends in proportion to their ownership. This isn’t an issue in the US where spouses file together, but in Canada spouses file separately.

Income splitting of regular income under certain conditions was recently added to Canadian tax law, but the newly elected Liberal government would like to repeal it. Until this change was made, corporations were one of the only ways for spouses to split income. They may soon return to that status.

Of course, money taken out of a corporation by the owner is included in the owner’s personal income. Personal income tax can be deferred indefinitely by leaving money earned by the corporation in the corporation. That money can then be invested in assets unrelated to the main corporate activity.

Many owners use corporations to build wealth with minimal taxes. For example, an attorney who earns fee income through a corporation can take just enough out of the corporation to live on and invest the rest in assets like rental properties, mutual funds, etc. This is the single biggest advantage of using the C Corp structure.

Finally, money taken out of a Canadian corporation is not double taxed. Money taken as a salary or bonus is deducted from the corporation’s taxable income, preventing double tax.

Unlike the US, even income taken as dividends is not double taxed. The ingenious Canadian tax code writers devised a way, in theory, to make owners indifferent to taking income from a corporation as salary or dividends. It’s too complicated to get into here, but income taken as a dividend can be partially credited against personal income tax. As a result, there really isn’t much difference either way in the amount of total tax paid.

Corporate tax in Canada can be complicated. Like the small business deduction, some tax rates and other benefits are subject to restriction. However, if your Canada corporation is complicated enough to worry about these restrictions, you probably wouldn’t be reading this post for tax information anyway.

US: LLC’s rule

US small business tax is much simpler. The C Corp structure is only used by businesses that are either large or have a large number of shareholders.

Many small businesses in the US operate as LLC’s. LLC are much easier to set up and maintain than corporations. LLC’s provide personal liability protection, and the tax structure is like a sole proprietorship or partnership. The LLC itself is not taxed. The LLC’s net income flows through to the owners’ personal tax return and is taxed as ordinary income.

I wrote a post here about the different types of LLC’s.

Are you American business owners ready to move to Canada yet? Are you wondering why I moved to the US?

Well, before you get too depressed, realize that corporations in Canada are not a huge advantage. Rather, Canadian tax law has simply removed the disadvantage of using a C Corp for small business. Since small business don’t use C Corps in the US anyway, nothing is lost.

If anything, Canadians should be disappointed LLC’s are not available in Canada.

Even though the structure is much different, most small business owners wouldn’t notice much of a difference in their overall tax burden.

I mentioned in previous posts that my tax bill went up slightly when I moved to the US, but it was only because I was able to use a corporation to split my income with my wife. Without this benefit, my Canada tax bill would have been slightly higher.

The biggest advantage in Canada for small business is the ability to keep money in the corporation and avoid the personal tax component. However, most people need most of their business income to live on, negating this benefit.

The bottom line: most small business owners won’t see much of a difference in their total tax bill between Canada and the US, but it is important to understand the difference in structure.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Tax - Capital Gains

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.

I’ve been writing a series of posts on the topic, including tax agencies, impact of moving, filing status, and income tax rates; deductions and credits, payroll tax; and health care and other insurance.

In this post I’ll compare capital gains.

Put simply, capital gains occur when you sell certain property for more than you paid for it. This type of property is usually purchased for the intent of selling for a profit and/or generating income. For example, a rental property.

Capital gains are taxable. Both countries tax capital gains more favorably than regular income, but each countries handles it quite differently.

In Canada, you only include half of your capital gain in your taxable income. For example, if you earn a $100,000 salary and sell a rental property for $20,000 more than you paid for it, your tax is calculated on $110,000 of taxable income (only $10,000 of the capital gain is included). This means the tax rate on capital gains in Canada is half of your marginal tax rate (the rate top rate bracket your income falls into).

It doesn’t matter how long you owned the property for. It’s treated the same whether you sold it 1 day or 50 years after you bought it.

In the US, capital gains tax is more complicated.

The full amount of a short-term capital gain (property held for less than 1 year) is taxed as regular income. Long-term capital gains are taxed at a lower rate than regular income, but the amount depends on your tax bracket. Long-term capital gains in the 10% and 15% tax bracket aren’t taxed at all, those in the highest tax bracket are taxed at 20%, and everything in between is 15%.

Capital losses, obviously, are the opposite of capital gains. A capital loss is when you sell property for less than you paid for it.

In Canada, capital losses can only be used to reduce capital gains. If capital losses in one year are more than capital gains, you can use it to reduce capital gains in up to three previous years or any future year.

In the US, capital losses can reduce capital gains and up to $3000 of regular income. If losses are $3000 more than gains, you can carry them forward to future years.

For more information from the tax agencies’ websites, go here for Canada and here for the US.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

Key Differences Between Canada and US - Health Care and Other Insurance

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' personal tax systems and other factors impacting cost of living.

I’ve been writing a series of posts on the topic.

In my first post I wrote about the differences in tax agencies, impact of moving, filing status, and income tax rates.

In my second post I explained deductions and credits, which can be a confusing concept especially when comparing Canada and the US.

In my third post I wrote about a significant difference for those earning between $50,000 and $120,000 per year: payroll tax.

In this post I’ll take a break from tax-specific topics to discuss differences in health care and other insurance. While not specifically a tax topic, it's an area impacted significantly by government and an important cost-of-living consideration. It’s not enough compare taxes only when figuring out differences in discretionary income.

Differences in health care and insurance is a big deal. My family went from having free primary health care in Alberta to paying over $400/month for less coverage and a $10,000 deductible (meaning I pay out of pocket all health care expenses up to $10,000 per year). Family plans covering maternity and with a lower deductible can easily climb over $1000/month.

Thankfully we have been healthy, so our costs above the $400/month are minimal, but even broken bones, stitches, or minor surgeries could quickly change that.

Health Care in the US

Health care premiums vary widely across the US and have been complicated by the “Affordable” Care Act (ACA, or Obamacare - the quotes are my addition). As a side note, I work with a company that provides group health insurance to their employees, and their premiums doubled when Obamacare took effect.

If moving to the US, I recommend reviewing the healthcare.gov website and finding a reputable health insurance broker to help explore your options. Health insurance brokers are free and very helpful. I found my broker through Dave Ramsey’s ELP program.

Despite the cost (or arguably because of it), the service and quality of care in the US is generally excellent. Unlike in Canada, health care providers compete against other. My wife had two babies in the US and one in Canada. While the Canada experience was fine (we left with a healthy baby, which is the most important thing), she shared a room and received friendly but minimal service. Both times in the US she had a large private room and exceptional service.

Health Care in Canada

Health care in Canada is administered as a monopoly by each province.

There were no premiums for primary care when I lived in Alberta. Alberta is now in the process of reinstating premiums, but they are still almost nothing compared to the US. Those making less than $50,000/year still won’t pay any premiums, and premiums gradually rise to a maximum of $1000/year based on income. Each province in Canada is different, but premiums are roughly comparable across the country.

Canada gets a lot of criticism for wait times and general lack of service. I have heard far-removed horror stories of people suffering and dying while waiting for procedures. However, I and people I know don’t have many complaints. Yes, ER wait times are long, and it can take a long time to get things like MRI’s for non-urgent matters, but I believe people generally get what they need. My mom survived cancer, and she received great service during her many treatments.

When talking about health care in Canada, most people refer to primary health care. It includes basic necessities like doctor visits, surgeries, baby deliveries, cancer treatment, etc. It does not include prescription drugs, dental, vision, etc.

If moving to Canada, go to the health care website for the province you’re moving to and become familiar with residency requirements and waiting periods. Most importantly, enjoy the lower or nonexistent premiums!

Home and Auto Insurance

I will only briefly touch on auto and home insurance. I mention it because my savings in the US made up some of the difference in health care costs. I’m not familiar with the insurance market in other parts of Canada or the US, so I can only speak from my own experience. My combined auto and home premiums went from over $300/month in Canada to less than $100/month in the US (for the same two vehicles and a bigger house in the US).

When comparing costs, I recommend getting quotes from a good broker in the area you’re moving to. Again, Dave Ramsey’s ELP program is helpful in the US.

Health care and other insurance aren’t tax topics, but they are significant costs you should consider along with tax when comparing cost of living between countries.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax or insurance expert or a certified financial planner. This post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax and other advisors.

Key Differences Between Canada and US Personal Tax - Payroll Tax

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

It’s important for people considering moving across the border to understand the difference between the two countries' personal tax systems. Although the principles in each country are similar, the implementation is quite different.

This is the third in a series of posts on the topic.

In my first post I wrote about the differences in tax agencies, impact of moving, filing status, and income tax rates.

In my second post I explained deductions and credits, which can be a confusing concept especially when comparing Canada and the US.

Deductions are credits are one reason income tax rates have little to do with how much income-related tax you actually pay.

In this post, I’ll explain the another reason: payroll tax.

I say "income-related” because payroll tax is not technically income tax, but it is directly related to your income. Income tax and payroll tax are calculated together in both US and Canada tax returns.

Conventional wisdom says taxes are higher in Canada than the US. They must be higher: Canada is more socialized, especially with its universal health care system that residents pay little to nothing for.

This may be true for some situations, but it wasn’t for mine. My income-related taxes went up, mainly because of payroll tax. (On top of taxes, I pay high health care premiums, but that’s another topic.)

Those who move to the US and earn between $50,000 and $120,000 find US payroll tax to be a shocker. In fact, most people earning up to $120,000 will pay much more in payroll tax than income tax.

The payroll tax concept is similar between the two countries. Both contribute to retirement and unemployment programs, and both are mostly split evenly between employees and employers. In both countries self-employed people pay both the employee and employer side.

In Canada, payroll tax consists of:

• Canada Pension Plan (CPP), which pays for retirement benefits (4.95% each up to about $50,000 in earnings)
• Employment insurance (EI), which provides unemployment benefits (up to about $50,000, employees pay 1.88% and employers pay 1.4x the employee rate - 2.63%)

In the US, payroll tax consists of:

• Federal Insurance Contributions Act (FICA), which includes:
  • Social security for retirement benefits (6.2% each up to about $120,000 - there’s the big difference)
  • Medicare for age 65+ health insurance (1.45% each on all wages with an additional 0.9% from employees only on income over $200,000)
• Federal Unemployment Tax Act (FUTA) (6% up to $7000 earnings paid by employers only)
• State Unemployment Tax Act (SUTA) (rate varies, usually paid by employers only)

ADP provides a simple guide to payroll taxes by state here.

The CRA website has a good guide to all Canada tax rates here.

In both Canada and the US, those who earn income without taxing being withheld must pay quarterly estimated tax quarterly. The deadlines and amounts required are different between the countries. Further, the calculations and requirements can be complicated.

If you are self-employed or for other reasons do not have enough tax withheld to cover the tax you owe for the year, I encourage you to review these rules carefully. Otherwise, you could be hit with significant penalties and interest.

Everyone's situation is different of course. My tax in the US is higher than Canada, but others may find the opposite depending on income level, type of income, and deductions and credits available.

When comparing the two tax systems, don’t forget payroll tax. Income tax rates get all the attention, but payroll tax is the largest factor for most people.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Personal Tax - Deductions and Credits

The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

Those considering a cross-border move should understand the personal tax system differences. Although the principles in each country are similar, the implementation is quite different.

In my last post I wrote about the differences in tax agencies, the impact of moving, filing status, and income tax rates.

This time I’ll tackle deductions and credits, which is more than enough for one post.

Income tax rates are deceptive because they have little to do with how much tax you actually pay.

You don’t actually pay 33% if your income is in the 33% combined federal and state/provincial tax bracket. 33% is the marginal tax rate, which means 33 cents of tax is owed for each additional dollar earned.

However, your average tax rate is your income tax paid divided by your total income.

Thanks to deductions and credits, most people would be surprised at how low their average tax rate is.

Deductions reduce the amount of income you are taxed on. For example, in both Canada and the US, qualifying retirement contributions are deducted from taxable income before calculating tax owed.

Credits directly reduce the amount of tax you pay dollar for dollar. For example, the child tax credit in the US reduces tax by $1000 for each child.

Deductions and credits are part of both the Canada and US tax systems, but the implementation is much different. The US primarily uses deductions and Canada primarily uses credits.

In Canada, the amounts used to calculate credits are similar to the amounts the US uses for deductions. However, rather than being deductions, these amounts are added up and then multiplied by 15% to find the credit.

The end result is similar, but the US system results in more tax savings if your income above the 15% tax bracket.

For example, in the US a $1000 deduction for someone in the 25% tax bracket provides tax savings of 25% of the deduction, or $250. A Canada resident in the 25% tax bracket who is allowed a credit on $1000 gets a 15% reduction in taxes, or $150.

Confusing, I know, but it’s an important concept to understand if you want to understand how you are taxed.

The following comparisons are highlights and not comprehensive lists.

Deductions and credits similar between the US and Canada:

Retirement contributions: RRSP contributions in Canada and 401(k) contributions in the US are both treated as deductions.

Personal and Dependent: deductions or 15% credit for the filer and dependents.

Charitable Donations: Canadians benefit from a 29% credit on donations instead of 15%, and provinces add an additional credit. Alberta adds an extra 21% credit, which means Albertans get back 50% of their donations. Donations are a regular deduction in the US.

Deductions and credits different between the US and Canada:

Mortgage interest: Americans love that they can deduct interest on their personal residence mortgage.

Property tax: To further incentivize home ownership, property tax on a personal residence is deductible in the US.

Child tax credit: The US provides double tax benefits for kids. US residents get a $1000 credit for each child in addition to a deduction for each dependent.

State income tax: US residents get a federal deduction for state income tax.

Deductions and credits can be complicated, but it is important to understand how they impact the tax you actually pay. Thanks to deductions and credits, most people do not pay nearly as much tax as their top tax bracket indicates.

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor. 

Key Differences Between Canada and US Personal Tax - Part 1

The US-Canada border is one of the friendliest borders in the world, despite recent debate by US presidential candidates about building a wall along it. As a result, many people move back and forth between Canada and the US. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.

Those considering a cross-border move need to understand the difference between the two countries' personal tax systems. Although the principles in each country are similar, the implementation is quite different.

In this post I will summarize some of the key differences. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.

The following are some keys areas of difference:

Tax agencies

To establish the terminology, the US tax agency is called the Internal Revenue Service (IRS) and the Canada tax agency is called the Canada Revenue Agency (CRA).

This is a side note, but in my experience the CRA is much friendlier and easier to contact than the IRS. I guess that’s not surprising given the friendly Canadian stereotype. They probably say sorry while seizing all of your possessions… But I digress. On to the next difference.

When you move

Canada only taxes residents, while the US taxes all residents plus all US citizens wherever they live in the world.

The only way for US citizens to escape US tax is to move out and renounce citizenship. US citizens who move to Canada (or any other country) have to file a tax return in both countries. The IRS provides a credit for the tax paid to the country of residence (which is hopefully at least what would be owed to the US, otherwise, Uncle Sam will bill for the difference)

Those who leave Canada can drop their Canadian residency and voila, no more Canadian tax. However, there’s a catch. Canada won’t let anyone escape gains they haven’t paid tax on yet. The CRA treats most assets as if they are sold at market value on the moving day (“deemed disposition”), and tax is owed on any gains.

For example, you paid $1 each for shares in a private company, and they are worth $5 when you move. You have to pay capital gains tax on the $4 gain, even though it’s not a real gain. This can be a shocker if you don’t plan for it, so I recommend carefully reviewing your situation with a tax advisor experienced in this area.

Filing status and income splitting

In Canada, everyone files individually. Until recently, spouses couldn’t split income. This was a disadvantage for families with a sole breadwinner. One spouse pays tax on their full income at the graduated tax rates.  The spouse without income can't take advantage of the lower rates on lower levels of income.

Income splitting under certain conditions was recently added to Canadian tax law, but some parties in the upcoming election are threatening to repeal it.

In the US, married couples file together. As a result, income splitting is not an issue.

Income tax rates

Both countries have a progressive tax system, which means taxpayers pay more tax on higher income levels. The tax rates on given income levels are quite similar above about $75,000 to $90,000 in taxable income.

Canada’s income tax rates are a little higher overall for two reasons.

First, using approximate 2015 numbers, Canada tax is 15% up to $45,000 and 22% up to $90,000. US tax is 10% up to $20,000 and 15% up to $75,000.  Above that, rates are close to the same.

Second, Canada’s provincial rates are higher on average than US states. For example, Utah (where I live) state tax is about 5%, and Alberta (where I moved from) provincial tax is 10%.

Closing

That’s enough tax excitement for one post. In my next post I’ll tackle some more differences, including:

- Why income tax rates have little to do with how much tax you actually pay

- The type of tax that most working US residents pay the most of (hint: it’s not income tax)

Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I don’t practice tax accounting, and this post is not meant to be professional advice.

Should I Use Xero or Quickbooks Online?

Choosing the right accounting software for your business is an important exercise for small business owners. It may not be the most exciting exercise, but the choice will affect your business every day going forward. Plus, switching is difficult if you make the wrong decision.

Your business runs on accounting software. How well the software fits your business will determine how much time and money you spend on separate products and processes. How well the software works will be a big factor in how productive (and sane) your team is. The information you rely on to make decisions needs to be accurate without taking too much extra work to generate.

I’m a big fan of online accounting software, or software as a service (SaaS), as opposed to desktop software. With SaaS you don’t have to manage software installations or data on your own equipment.

Two of the leading accounting SaaS products for small business are Xero and Quickbooks Online (QBO).

I wrote a post almost a year ago extolling the virtues of Xero. I criticized Intuit for how slow they were to release QBO and build out its features.

However, I recently noticed that QBO has rapidly improved. I think it’s time to update my opinion.

I still love Xero and use it for most of the companies I’m involved in. It was good when I started using it five years ago (much better than QBO), and it has improved since then. QBO was extremely bare bones at the time and didn't come close to having the features we needed, such as bank feeds and multi-currency.

I recently took another look at QBO, and it has come a long way in the last 5 years. As far as I can tell, it has all the features of the Quickbooks desktop version, and possibly more. It just added multi-currency support and redesigned many of its standard reports.

Here is a comparison between Xero and QBO in a few key areas.

1. Data entry

Quick and easy data entry is essential, especially for high-volume businesses. Even a few extra seconds on each transaction adds up over time.

Both Xero and QBO have bank feeds, and the process for entering transactions from the bank feed is similar. Both allow you to create new transactions or match to existing transactions right from the feed.

Xero has a feature called cash coding. Cash coding puts all new and unmatched transactions in a list with fields that can be edited without going to a new screen. This allows you to quickly tab through and assign a name, account, and description to a long list of transactions.

Winner: Xero

2. Flexibility and ease of use

Xero is easy to use, but it is not very flexible. Usually there is only one way to do something. In addition, you can’t edit some transactions. Instead, you have to delete and re-enter if you make a mistake. For example, you can’t edit bank transfers or payments applied to bills/invoices.

Also, you can’t apply one payment to multiple bills denominated in a foreign currency. You have to pay each bill separately, and then match the separate payments to the actual payment in the bank statement.

QBO is extremely forgiving. As far as I can tell, any transaction can be edited. Further, any transaction can act as any other similar transaction. For example, you may add a bank feed withdrawal as an expense. After reconciling the bank account you may realize the withdrawal should have been a bill payment.

You can simply change the name on the expense to the vendor name and change the account to Accounts Payable. This creates a credit on the vendor account, and then you can apply the credit as a payment against the bill. No need to delete the expense, re-enter a bill payment, and re-reconcile the bank account (as you would have to do with Xero).

QBO also has familiarity going for it. Many accountants are familiar with Quickbooks desktop version, and the QBO functionality is similar.

Winner: QBO

3. Stability

Software bugs are frustrating. QBO seems to be more buggy to me. I don’t have specific examples, but often screen don’t load properly or features don’t work as expected. Sometimes the Xero site will go down for a few seconds, but I don’t remember coming across any bugs.

Winner: Xero

4. Reporting 

Neither product has the great reports compared to more expensive systems, such as Netsuite. Of course, you can find all of the standard reports like Income Statement, Balance Sheet, Aged Payables, Aged Receivables, General Ledger, etc. However, customization options are limited.

Xero has better options for customizing individual report layouts. You can group accounts together and create various detail and summary templates. It has the awesome feature of being able to use the same template across multiple companies. For example, I customize the layout of the income statement and balance sheet based on the range of account codes (from the chart of accounts). I use the same chart of account rules in most companies, which allows me to use the same template.

QBO has a wider range of reports and better ability to drill down into detail. They have also recently released a new set of nicely redesigned reports.

Winner: it’s a toss-up with a slight edge to Xero

5. Payroll integration 

Both products have integrated payroll. Xero’s service is relatively new and is being gradually rolled out to US states, but it still has a ways to go. I haven’t used Xero payroll so I can’t speak authoritatively, but it appears that state and federal filings are not automatic (a big drawback in my opinion).

QBO has both basic and full service options. I use Intuit full service payroll for several companies, and I find it extremely simple, easy to use, and inexpensive. Tax filings are completely automated. All you have to do is enter hours (if you have hourly employees) and press a button to submit payroll.

Winner: QBO

As you can see, Xero and QBO have their strengths and weaknesses. Until recently I would have recommended Xero hands-down. However, QBO, with its recent improvements, is now a contender.

Rather than recommending one over the other, I suggest signing up for a free trial and exploring the features that are most important to your business.

If you are moving from Quickbooks desktop, you can automatically convert the Quickbooks data file to either Xero or QBO. This will allow you to test the software with real data. You can re-import the data file when you make a decision and are ready to move forward.

Good luck with your accounting software search!

Question: What other accounting software should small businesses consider? 

Nail Your Small Business Accounting

Small business accounting is like staying healthy. Everyone knows the importance but few enjoy it. Although important, usually only a crisis makes it urgent. Staying reasonably healthy only requires that you understand (and follow) a few basic principles. For example, excess sugar and processed foods are bad for your health. Walking 10,000 steps per day and elevating your heart rate for 20 minutes, 2-3 times per week is a good exercise plan.

Likewise, you only need to know a few basic principles to maintain a good accounting system.

At a minimum, you need to understand the accounting roles needing to be filled and then assign people to fill those roles. You may not even need to hire anyone. Think of your accounting team as a collection of roles that need to be filled and not necessarily a collection of people.

Your accounting may be so simple that you fill the roles to start with. You may have another team member who can handle a few extra duties. You may hire a part-time bookkeeper for a few hours per month. It doesn’t matter how. What matters is that these roles get filled from the beginning (before a crisis).

Getting your accounting done doesn’t have to be complicated or expensive. You just have to know what to do.

The followings are accounting roles that need to be filled in most businesses:

Chief Financial Officer (CFO). Don’t be intimidated by this title. It takes a fairly large company to need a full-time CFO, and it may be a while before you formally give this title to anyone. The title simply describes a role that needs to be filled.

Someone needs to oversee the accounting. Someone needs to make sure the accounting roles are filled effectively. Someone needs to make sure the books stay clean. Someone needs to make sure the data provided by the books is both accurate and interpreted correctly. Someone needs to use the numbers to advise other leaders on decisions. Someone needs to make sure you are complaint with tax, labor, and other laws.

In the beginning, this role may be filled by you as the business owner, ideally with help from a CPA or contract CFO. Someone needs to make sure the rest of the accounting function is operating effectively.

I’ve written other posts about why a startup needs a CFO and what your CFO should do for you.

Bookkeeper. This function makes sure the books are accurate at least monthly. The bookkeeper should follow a month-end checklist to make sure all transactions get into the accounting software and the bank accounts are reconciled. Depending on the nature of the business, they may handle other transactions such as fixed asset purchase/disposal/depreciation, inventory adjustments, loan and investment schedules, etc.

Once the books are accurate for the month, they can run financial statements and other reports helpful to management.

Accounts Receivable. This function is responsible for the process from customer order to customer payment. This role is simple in a retail store with only point of sale transactions. However, in many businesses customers get billed for products or services and then pay on agreed terms. Someone needs to make sure customers get billed accurately and pay on time. They also need to make sure payments get entered in accounting software so customer accounts remain accurate.

You won’t be in business long if you don’t pay attention to this role. Customers will be frustrated by inaccurate billing and statements. Failing to invoice a customer means lost revenue. Cash flow will suffer if customers don’t pay on time.

Accounts Payable. This function is responsible for the process from making a purchase to paying for that purchase (the mirror of Accounts Receivable). This usually involves receiving bills, verifying they are legitimate, entering them into accounting software, and making sure payments are on time and accurately entered. Even point of sale purchases require the receipt to be tracked and the transaction to be categorized accurately in the books.

HR/Payroll. The function handles hiring and compensating employees. It makes sure new employee paperwork is complete. It makes sure working conditions and practices comply with labor laws. It makes sure employees are paid accurately and on time. It administers employee benefits. Perhaps most importantly, it makes sure payroll tax is remitted accurately and on time.

This function can be completely outsourced to a professional employer organization (PEO). At a minimum, every company should outsource payroll. An abundance of service providers make payroll extremely cheap and easy. You shouldn’t spend more than a $100 and a few minutes per month on payroll if you have a small team. Company like Zen Payroll and Intuit do everything from calculating taxes to direct depositing pay into employee bank accounts to submitting payroll taxes.

Putting it all together

If these roles' workload doesn’t justify new full-time employees, how do you fill them?

I’m biased because this is the work I specialize in, but I recommend hiring a contract CFO to help you set up accounting systems and plug your existing team into the necessary roles. The future headaches you’ll avoid is well worth the hourly rate you’ll pay for an experienced CFO. It shouldn’t take very many hours.

For example, many businesses already have some kind of administrative assistant. A CFO can set up a system simple enough to be run by someone not training in accounting. The admin can handle 99% of the work, and the CFO can be available as needed to answer questions and handle the more complicated transactions. A contract CFO combined with low-cost administrative staff can inexpensively handle the accounting for most small businesses.

That said, there is no one-size-fits-all approach to accounting. Business owners must first recognize that a good accounting system is important, and then they must understand the roles that need to be filled. From there they can build a team to make it happen.

Question: What tips do you have for running small business accounting?

Why You Should Create Systems to Automate Your Business

In my last post, I wrote about why it’s important to keep your business books clean. Accounting is one of those mundane details that most business owners don’t like to deal with. They would rather spend time building and selling their product or service. However, it is important to invest some time, attention, and money in keeping your books clean. This will allow you to make better decisions and help you avoid costly and distracting tax nightmares and clean-up projects.

Hopefully I’ve convinced you that it’s important to invest in clean books.

Now where do you start? Unless you have an accounting background or lots of business experience, getting started may be intimidating.

The answer is to start by creating systems. Creating a system begins with defining roles that need to be filled and then building a team to fill those roles.

Before diving into accounting systems specifically, I want to talk about the importance of creating systems in all areas of your business.

In business and life, the key to creating order out of chaos is systems. Systems allow us to automate the mundane so we can focus our greatest efforts on fine tuning rather than cleaning up messes.

It doesn’t mean smart and skilled people aren’t required to carry out the system. It means these smart people don’t have to waste their brainpower trying to figure out the process each time. Instead, they can use their valuable mind to work on the business rather than in the business.

Those familiar with with The E-Myth will recognize the principle of working ON your business rather than IN your business. The author encourages business owners to look at a business like a system. That system needs various roles to be performed to operate smoothly. You start by defining what roles need to be filled and then plug people into those roles. The roles should be so well-defined that they can be performed by almost anyone (within the parameters of certain skills sets).

No role should be completely dependent on a specific person. People should be interchangeable. This may sound cold, but the reality is people come and go. Turnover is always somewhat disruptive, but having well-defined roles and systems will minimize the disruption.

Hopefully I’ve convinced you that you should create systems in all areas of your business, including accounting.

In my next post I will get into more detail about how to create accounting systems specifically.

Question: How have systems helped your business?