If you are new to business, or even if you’ve been around the block – this one is for you! We’re going to go through how to file your income tax return if you’re self employed and the all-so-important question of how can I pay less taxes on what I earned. Even if you hire someone to prepare your tax returns for you, it’s a good idea to have a solid understanding of what you can and can’t claim as business expenses for a few reasons:
- Firstly, because your tax preparer doesn’t know what you’ve spent money on for your business unless you tell them. Even the best preparer can’t read your mind. They can ask questions and give suggestions that may apply based on your industry, but there’s likely to be things that will get missed if you aren’t up to speed yourself.
- Second, having this information together and tallied up will save you in accounting fees and will save your tax preparer time (win, win!)
- Thirdly, at the end of the day, if there is an audit, you will be the person who is responsible for proving and backing up why you claimed certain things. You best be certain that what you’re claiming is legitimate and reasonable.
The first question I get about business and income tax is ‘How do I file taxes for my business?’ or ‘Is it a separate return?’ There are two basic scenarios depending on what type of business structure you have. If you are a sole proprietor, or a partnership (read: not incorporated,) your business income gets reported right on your personal tax return. There is a statement that gets attached to your income tax return called a T2125 – Statement of Business or Professional activities. Your income and expenses get entered on this statement and the difference between your income and expenses (net income) is what you will be taxed on.
If your business is incorporated, it’s a different process to report your business income and expenses. In this case, there is a separate income tax return for the business called a T2 (a regular personal income tax return is a T1.) The income and expenses for the business all get reported on the T2 and your personal income would be what the company pays you. This is a more complex set up for income tax purposes and it would be wise to have some help from an accountant to prepare your returns and do some tax planning.
This post is focused on sole proprietorships and partnerships and the T2125 statement, although it doesn’t hurt to pay attention if you’re incorporated to make sure you aren’t missing any possible business expenses as a lot of it overlaps.
A lot of people assume that to have a business you must also have a business number with CRA or that you must incorporate. Neither is true. If you start a venture with the intention of earning money, it is a business and you must report your earnings to CRA – either on a T2 if you are incorporated, or on your personal T1 if you aren’t.
So what is a business number? When do you need one? You can get a business number at any time with CRA. It is a very quick and easy process to do. Once you are given a 9 digit business number, you can then open different accounts underneath it. You can have a business number with no accounts under it or you can have one with several accounts under it. The most common account types are payroll (RP#### suffix at the end of your business number), incorporation (RC#### suffix) and GST/ HST (RT#### suffix.) Each account represents a business activity that must be reported to CRA. Most people don’t register for a business number until they need one of these accounts.
A lot of people get a little mixed up when it comes to HST, and they don’t quite understand how HST ties into income tax. They are two separate things and two separate returns. That said, whether you’re registered for HST or not does affect the numbers you put on your income tax return.
If you are NOT registered for HST, then you don’t charge HST, meaning all the money charged to your customers is your income. As for your expenses, you include the full amount of what you paid out too. So if your phone bill is $80 plus tax, the full amount you paid of $92 is what goes in for the expense.
If you ARE registered and collecting HST, it’s a different scenario. HST collected on sales and HST paid on purchases do NOT get included on the T2125 statement of your income and expenses. They come into play when you file your HST report. HST that you charge on sales is NOT income. You’re basically just holding onto it for the government. So if you earned $50,000 in sales and charged $7500 in HST. $50,000 is what gets entered as income on your T2125 form. If your phone bill is $80 plus tax, $80 is what goes in for the expense.
HST is outside the scope of this post. If you aren’t sure if you should be registered for HST, or how to fill out your HST return or anything along those lines, check out the government website for more information. For today and the T2125, we just need to know if you’re registered and have been collecting HST or not.
Now that we know where to report our income and expenses and how HST impacts the numbers we enter, we can dive into the income and expenses themselves.. the juicy stuff!
Income. This is the income that you earned in the year. Depending on the type of business you run, you may be given this number on a T4A slip. This is common in MLM type businesses, for real estate agents, massage therapists, etc. If you work under a company, you may want to check and find out if you should be expecting a T4A slip. If you file your return without it, it could end up with CRA doubling your income in error.
If you aren’t due a T4A, you need to track your own income. Hopefully you have invoices, or some other record of what you have earned for the year. If you’re real small, a little notebook with a list of date, description and amounts earned will suffice.
Purchases during the year. This would be supplies directly involved in what you’re selling. If you’re a carpenter, this would be your lumber and nails. If you sell scentsy, this would bars that you bought for samples and what not. If you’re an artist this would be your paints and canvases. If you operate a daycare it may be books and toys, etc. I put all the direct costs of creating whatever you sell, or to do whatever you do, here.
Subcontracts. This is especially common in the trades. If you are doing a kitchen reno for a client and you subcontract out an electrician for example.
Advertising. This includes paid advertisements, business cards, website fees, signage, branded merchandise or vehicle decals used for advertising, etc.
Meals and entertainment. This is a category where people tend to get carried away. You can claim meals for yourself while travelling for conventions or trainings. You can claim meals and entertainment that happen for the sole purpose of doing business. For example if you are taking a potential client out for a meal to discuss business. These are all calculated at 50% of costs though. You can claim 100% of the cost of meals and entertainment if you host staff functions such as a staff Christmas party. (limit of 6 per year). Buying yourself lunch and coffee every day does not count as a business expense. In case of an audit, it’s a good idea to note the client you entertained on your receipt.
Bad debts. This is one not many know about. If you do work for someone and they refuse to pay you and you are unable to collect the payment for work performed, you can enter that amount as a bad debt expense.
Insurance. You can include business liability type insurances here, insurance on equipment, Errors and Omissions, etc. Don’t include vehicle insurance. That is part of a separate calculation.
Interest and bank charges. This would be for loans and bank accounts that are solely for business. You can also include fees for debit/ credit machines here too or online payment processing like stripe.
Business taxes, licenses and memberships. This could be business taxes paid to the town you operate in. This could be food licenses if you operate in that industry, a lot of health practitioners may have licenses or membership fees.
Office expenses. These would be things like stationary, file folders, postage, etc. If you operate out of a separate space, this could also be things like toilet paper, etc. that would be required for the functioning of the office.
Professional fees. This is things like accounting costs, or legal costs. The cost of having your tax return prepared also falls in here.
Rent. This can be the obvious renting of a space to run your business or to do your work. It could also be the renting of a table or smaller, more temporary vendor setting.
Repairs and maintenance. This is repairs to equipment, or to a space. Don’t include vehicle repair costs here.
Salaries, wages and benefits. If your company has employees, their salary and associated costs go here. You can also include the employer paid CPP and EI, Workers compensation costs, medical insurance costs to the company, etc.
Property tax. If the company owns property, that would be included here. If you operate from your home, don’t include the property tax here. There’s a separate calculation for business use of home.
Travel expenses. This would be flights, cabs, etc. for business purposes. Regular vehicle expenses don’t get included in this.
Utilities. This is things like heat and light, phone, internet, etc. This is for a designated office space or store front. Again if you operate from home, there’s a separate calculation for business use of home.
Fuel costs. This would be fuel for heavy equipment, or generators or something. Gas for a vehicle has it’s own calculation.
CCA. (aka amortization or depreciation) of larger equipment or vehicles. Again, this could be pages all in it’s own to cover the rules, classes and calculations. In short, large equipment costs get spread out over several years. So if you buy a dump truck for instance, you wouldn’t claim the entire cost of the dump truck in the year you bought it, it would be spread out over it’s useful life. If you have large purchases, bring the receipts for those to whoever is doing your tax return.
Vehicle expense. This one can be tricky. If you do childcare and the children come to your home, you cannot claim a vehicle expense for example. Seems obvious, but many people try to claim this who really aren’t eligible. If you have a designated work vehicle and a separate vehicle for personal use, you can use 100% of the use and associated costs of the work vehicle. If you use your vehicle for work and personal use, there’s a little more math involved.
In that case, you have to keep a log of the kilometers on your vehicle. You jot down the kilometers on your vehicle at the start and end of the year to get the total kilometers driven in the year. You also make note of all the business kilometers driven. Include in your log the date, purpose of the trip and number of kilometers. At the end of the year you tally up all your business kilometers. The business kilometers divided by the total kilometers gives you a percent. That percent gets applied to all the vehicle expenses.
Many MLM companies for example will tell you that you can claim your vehicle, which can be true. Often times with those types of businesses, by the time you tally up the percent of vehicle use for business, it is a very tiny amount and not worth all the time spent doing the log and paperwork. For real estate agents however, it can add up to a significant amount as they are often visiting multiple homes per day as part of conducting business.
Vehicle expenses are gas, repairs and maintenance, licensing, insurance and either amortization and interest or lease costs. (not going to go into amortization here, but bring your purchase agreement for your vehicle with you to have your taxes prepared. Or you can look up how to do the calculation on the government website. It’s called CCA) Again you have to keep track of the total expenses for your vehicle for the year, all gas, all repairs, etc. Then you apply the business use percent afterwards.
Business use of home. This is another area that is often misunderstood. The general rule of thumb is that you need to see either 80% of your clients at your home space or you need to do 80% of your work there. If you have a designated, single purpose space in your home where you see your clients on a regular and consistent basis (like a massage therapist, or hair salon) you can absolutely claim this portion of your home . If you primarily do your work from a designated home space (like an artist studio, or a bookkeepers office) it’s also clear cut and you can claim this portion of your home expenses. If you fall into one of those two camps it’s very clear that you meet the criteria to claim a portion of your home and the method to calculate the area of use. It can be more grey for people who work from their dining table for example, or who only have a part time business. It is worth asking your tax preparer about though to get their opinion. If you look up business use of home on the CRA website there’s a large document outlining all the criteria along with all the stipulations and how to calculate it if it’s a shared space.
Assuming you do meet the criteria and it’s a designated space, you simply take the area of your work space divided by the total area of your home. This will give us a percentage to apply to all your home expenses, similar to how we did it with the business use of a personal vehicle. Home expenses are heat/ electricity, home insurance, repairs and maintenance, mortgage interest and property tax or rent.
That covers off the majority of business income and expenses! Hopefully you’ve got some ideas of things you could possibly be claiming for your business, or that you’ve got a better idea of how to prepare for tax time at least. Having all this together will save you lots on your tax bill. Having it organized and tallied will save you even more in accounting fees.
Looking for help getting yours filed? Book a quick consult or submit your things here 🙂
We can also book a full hour to go through your specific tax situation in detail. That can be done here 🙂
Happy tax season!
Dawn
Tax Wise 