The issues in a nutshell:

1. Were the costs personal or business in nature?

2. If the costs were for business, do they relate to the specific business in which you’re claiming the deduction?

3. Are the costs capital expenditures, or current expenses? (Capital expenditures aren’t deductible, except perhaps through capital cost allowance.)

4. Are the costs reasonable?

This means that when a small business owner sells a qualified small business, the first 750,000 is tax free and capital gains is paid on the rest. You only use this exemption once in your lifetime.

This raises a couple interesting points to consider:

• it’s a big mark on the “pro” side of the column for the age-old “why incorporate” question. Self-employed people are often temped to operate as a sole proprietorship or partnership for simplicity’s sake: lower startup costs to incorporation, no need to file a separate tax return, but being incorported has it’s advantages (like limitation of personal liability) and this one, when time comes to sell the business.
• From a tax planning perspective it starkly demonstrates the downside to “crystalizing” your capital gain exemption. This is a strategy your financial advisor may recommend to you at some point where effectively “lock in” your capital gains exemption now, even tho you may not be selling your business for years to come. There are reasons for doing this, one of them is to defend against the possibility that capital gains exemption may someday be done away with.
• Unfortunately in this case, for anybody who has already crystalized before the new budget goes into effect, they’re stuck at the old $500K level and will miss out on the extra $250K.

But for anybody who hasn’t crystalized, and perhaps hasn’t even incorporated, it gives you food for thought. If you ever plan to build your self-employment operations into a self-generating business concern that you may want to sell someday, you can incorporate your sole proprietorship or partnership into a corporation in a tax friendly manner using something called a “Section B Rollover”, your lawyer should know the details.

If you’re married, you should think about having your spouse holding some of the shares. That way if you get an offer you’re prepared to accept down the road, you can each use your lifetime capital gains exemption, which under the current rules would give you the first 1.5 million tax free, a nice base to a retirement nest egg.

Ideally, you should be contributing your maximum allowable RRSP contribution limit every year to maximize your deductions from income.

Here are a few things to consider now that we’re near the end of the year.

If you have your business as a separate incorporated entity and draw your salary from it, here’s something you can do to get a bit of extra bang for the next tax return:

• If you’ve had a profitable year (always good), and room in your RRSP, bonus out some of the profits and roll it into your RRSP. This will reduce the taxable income in your corporation and top up your RRSP. If you have the room in your RRSP and roll in directly you can do it without paying source deductions on your bonus.
• If you haven’t maxed out your RRSP contributions in prior years, you can carry forward the unused portions into the current year. Your Notice of Assessment from Revenue Canada should specify your RRSP contribution limit and factor in the unused portion from previous years. If you have the money to use it, use it.
• Think about waiting until after the New Year to do this. Any contributions to your RRSP made during the first 60 days of 2007 can be counted on your 2006 tax return, but the income won’t show up until your 2007 return.
• If your RRSP is maxed and you have a spouse whose RRSP isn’t, consider topping off your spouse’s RRSP. Contributions to your spouse’s RRSP are also deductable from your taxable income.

As always, check with your accountant to find out if these strategies work for your personal situation.