Income Tax and Small Business
Every small business must file an income tax each year reporting on their income and expenses. Even businesses that have not officially registered their business because they earn less than $30,000 a year must fill out an income tax return. Any business income, whether earned as an employee, sole proprietor, partner, owner, freelancer, or contractor, must be reported. This also includes any income from other countries.
What about barter payments? Yes, these too must be included on your T1. If you cut someone’s hair in exchange for accounting services, the value of the accounting service constitutes “income.” If the service or goods constitutes a legitimate expense, you can claim it. That means, if you used an accounting service for your business, this can be claimed as a legitimate business expense.
Which income tax form do small businesses use to file? That depends on whether you are a sole proprietorship, partnership, or corporation.
Sole Proprietorships and Partnerships
Sole proprietorships and partnerships use the T1 income tax return, which includes Form 2125, the Statement of Business or Professional Activities, which reports your business income. This form is also used by home business proprietors to report their income as well as independent contractors and freelancers. As long as the business is not a corporation, the owner fills out a T1 income tax return.
You will need the followings by your side as you fill in your T1 income tax return
- Your business tax-ID number
- Your social insurance number
- A copy of the Canada Revenue Agency’s (CRA’s) “Business and Professional Income Guide”
- Your business records, showing your annual totals for sales, cost of goods sold, and business expenses. You will need this to fill out the Income and Expenses section of the T2125: Statement of Business or Professional Activities form.
Home Based Businesses
Did you operate a home-based business this past tax year?
In the “Total Income” section on the first page of your T1 income tax return, you will see a subsection titled “Self-employment income.” Enter your gross and net business, professional, or commission income on the appropriate line.
If your business is a corporation, fill out a T2 income tax form, as the corporation is a separate entity that must fill out a form as the corporation. In terms of business tax, not all Canadian corporations are created equal. Look into the different types of corporations in Canada, including CCPCs (Canadian Controlled Private Corporation), Private Corporations, and Public Corporations—as they relate to Canadian corporate income tax.
Calculating your small business income
The T2125 form is designed to lead you through the process of calculating your “true” business income—that is, what’s left when you’ve taken away your business expenses from the original amount you made.
To start your calculation follow these steps:
- Calculate your total revenue;
- Subtract your business’s expenses and operating costs from your total revenue. This calculates your business’s earnings before tax;
- Deduct taxes from this amount to find you business’s net income. Your net income will be your business income.
If your business collects GST/HST (i.e., you are not a small supplier and make at least $30,000 a year), add the amount of GST/HST to your gross sales or fees to calculate your adjusted gross sales or adjusted professional fees.
Next calculate your business expenses or, if you are a home-based business, your business-use-at-home expenses.
Which business expenses are deductible?
The amount you can deduct in a given year for any expense depends on whether such expense is considered a current year expense or capital expense.
You cannot claim expenses you incur to buy capital property. However, as a rule, you can deduct any reasonable current expense you incur to earn income. The deductible expenses include any GST/HST you incur on these expenses minus the amount of any input tax credit claimed.
Also, since you cannot deduct personal expenses, enter only the business part of expenses.
Current or Capital Expense
Renovations and expenses that extend the useful life of your property or improve it beyond its original condition are usually capital expenses.
The chart below will help you decide if the expense is a current or capital expense:
Here are some of the most common CRA business expenses for which you can claim a deduction:
- Accounting & Legal fees (related to business activities)
- Advertising expenses (see also: 10 Low-Cost Ways to Promote Your Business)
- Automobile expenses (business use of a vehicle expenses and Capital Cost Allowance deductions on the purchase of a vehicle – see What Motor Vehicle Expenses Can You Claim on Income Tax in Canada? and How to Claim CCA (Capital Cost Allowance) on a Vehicle Bought for Business Use)
- Bad Debts (moneys owed to you that you are unable to collect)
- Bank Charges
- Business Taxes & Business Licenses
- Cloud Computing Service Provider Fees
- Collection Agency fees
- Conference and Convention fees
- Expert Advice (consultant fees, for instance)
- Interest expenses (on money borrowed to run your business)
- Insurance expenses (for buildings, machinery or equipment)
- Internet Service Provider (ISP) fees (for business use)
- Membership Dues (for business-related organizations, also includes subscriptions to business-related publications)
- Meals and Entertainment expenses
- Office Rent/Lease expenses
- Office Supplies expenses
- Postage & Courier expenses (shipping and delivery)
- Private Health Service Plan (PHSP) premiums – you can deduct PHSP premiums you pay to insure yourself or any member of your household as long as you are actively involved in your business and it provides more than 50% of your total income
- Promotion expenses
- Property Taxes
- Repair & Maintenance expenses
- Salaries of employees – including salaries of family members (employing family members is an excellent way to save on taxes by income splitting). Note that you cannot pay family members a salary over and above what you would pay someone else to do the job.
- Business Software and/or Applications – (for example, office suites and tax preparation and accounting software)
- Telephone/Telecommunications expenses
- Travel expenses
Ontario Small Business Deduction
The Ontario small business deduction (SBD) reduces the corporate income tax rate on the first $500,000 of active business income of Canadian‑controlled private corporations (CCPCs). Effective January 1, 2020, the lower rate of Ontario corporate income tax is reduced from 3.5 per cent to 3.2 per cent.
What that means is the net tax rate for Canadian-controlled private corporations claiming the Small Business Deduction, is 9% (2019).
While the federal government announced in 2018 that it is phasing out the $500,000 small business limit for corporations that earn between $50,000 and $150,000 of passive investment income in a taxation year, Ontario is not paralleling this phase‑out.
Ontario does parallel the federal SBD phase‑out where a CCPC’s (and associated groups of CCPCs) taxable capital is between $10 million and $15 million. CCPCs (and associated groups of CCPCs) with taxable capital of $15 million or more are no longer eligible for the lower rate of corporate income tax on the first $500,000 of active business income.
Capital Cost Allowance
In addition to the expense above, you can also deduct equipment that depreciate in value over time, such as filing cabinets, computers, and printers, which fall under the rules for capital cost allowance. According to the CRA, a capital cost allowance is a “tax deduction that Canadian tax laws allow a business to claim for the loss in value of capital assets due to wear and tear or obsolescence.”
Home based deductions
If your home is where you principally conduct your business and where you meet with clients, customers, or patient, then the CRA has deemed you eligible to claim ‘business use of home expenses,” for your home-based business. Basically, you will calculates the percentage of your home expenses that are devoted to conducting your home business. For more about home-based deductions, click here: https://kalfalaw.com/pay-less-tax-on-your-home-based-business/
Registered Retirement Savings Plans (RRSPS) are the best way to reduce Canadian income tax deductions for small businesses that are structured as sole proprietorships or partnerships. Determine the RRSP contribution limits and how to time your RRSP contributions for maximum income tax impact.
Scientific and Experimental Development (SR&D)
Small Business faced technical challenges should consider whether they are engaging in scientific and experimental development projects, which further their technological knowledge and which have gone through a process using the scientific method, including formulating, testing, and modifying the hypothesis, to try and overcome those challenges or uncertainties.
There are many small businesses that keep good business record management and who wish to complete and file their own income tax returns. Others may feel more comfortable with a tax professional, accountant, or tax lawyer to help calculate a business’s income and expenses. Having the right knowledge and know-how can make a big difference in the amount of tax you will owe, so it might be worthwhile to consult with a professional to make sure that you maximize your profits and pay the least amount of tax possible while utilizing legal tax saving deductions, credits, and tax planning tools.
-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law 2021