20 Essential Tax Facts for Small Business Owners

Probably the most popular question posed to accountants and tax preparers (especially around this time of year) is “what types of expenses are deductible?”.  The short answer is that a business expense is considered to be deductible if it has been incurred with the ultimate purpose of earning income.  For example if you purchase a domain name  with the intent of setting up a website to sell your goods or services, this would be a deductible expense.  However, if the purpose of your website is simply a place to show pictures of your cat, this would not be considered a business and therefore not a deductible expense.  Of course if  your cat picture website starts to become popular and you decide that you want to actively build this business by advertising on the site or partnering up with cat product resellers, your non commercial hobby could then be considered a business. Since you now have the intent to build a business the income earned would have to be reported and expenses incurred to earn this income would be deductible. 

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Tax Deductions:

What types of expenses are deductible?

There are a number of deductible expenses which apply to any business structure and are listed below:

• Direct costs used to run your business which can include the purchase of raw materials or products for resale. This can also include shipping costs, duties and packaging.

• Wages, salaries, fringe benefits paid to employees

• Amounts paid to subcontractors who perform work for you business and provide you with an invoice

• Advertising and marketing costs including online advertising, website related costs and commissions paid to salespeople.

• Rent, Utilities, Insurance, property taxes incurred for office for factory space

• Office supplies, postage, courier costs

• Conference expenses including travel , business trips etc.

• Business travel expenses

• Transportation costs like public transit passes and taxis fares incurred when meeting with customers, suppliers and other business contacts.

• Ongoing subscriptions like dropbox, google, Quickbooks, etc (assuming they are used for business) and business publications

• If you belong to a professional or industry organization, these would be deductible as long as they directly relate to your business.

• Accounting, legal and business consulting fees

• Bank charges and interest on loans, including credit cards, relating to the business

• Credit card fees paid to merchant service providers on payments from customers.

• Meals and entertainment in which business was discussed. 

• Car expenses

• Home office expenses, subject to certain rules

A comprehensive list from Revenue Canada (CRA) can also be found here

What to keep in mind when deducting expenses

1. The above list captures major expenses, but keep in mind that most expenses that are incurred to earn business income are considered to be deductible. For example a writer can expense cost of paper, payments to writing associations, research costs and home office expenses.

2. With certain exceptions, only 50% of meals and entertainment can be written off. You must be able to demonstrate that the meals related to earning business income. It is a good practice to write the name of the client/customer or business purpose on all receipts in case of audit.

3. Life insurance premiums are not tax deductible unless the beneficiary is the business.

4. Purchases of “Capital Assets”, i.e. larger ticket items which have a useful life exceeding one year cannot all be expensed in one year. Instead the government allows for what is referred to as CCA (capital cost allowance) which is essentially a depreciation charge over a period of time at specific rates. The class to which the asset belongs and the rate at which it can be depreciated is specified by the Canada Revenue Agency. Note that CCA cannot used to create a loss for an unincorporated business. If you do have a loss in a year as a result of taking depreciation, this would be carried forward to the next year and deducted against business income.

5. Computer hardware is generally reflected in Class 50 which allows for a depreciation rate of 55%. This includes computers, smartphones, tablets, hard drives and any other hardware that is essentially a computer or computer accessory.

6. Automobile Expenses including lease costs, interest on financing, repairs, gas and rental of vehicles for business purposes are deductible but are subject to specific rules. Keep in mind that CRA and MRQ (revenue Quebec) tend to require a log book i.e. a record of mileage, dates and clients. As long as you can demonstrate that they relate to business, they are deductible. There are also limits to how much you can deduct with respect to lease payments or car costs (which means that your brand new BMW is probably not deductible in its entirety).

7. Home office expenses can be used to reduce business income as long as the office represents your principal place of business. The deduction is based on the percentage of your home that you can allocate to the home office.

8. Business losses, excluding CCA and home office expenses, can be used to reduce income from other sources and corresponding income taxes if you have an unincorporated business. Corporations are separate entities and as such losses cannot be deducted against personal sources of income . Sustained losses over a few years will however lead the CRA to look more closely at your business. As such it is important for business owners to take care that there is a reasonable expectation of profit.

9. There are specific rules with respect to tax deductions for clothing expenses. To summarize, unless the clothing or accessory forms part of a uniform it is likely not deductible.

Tax Administration:

1. Sole proprietorships and unincorporated businesses are required to include their business income and expenses in their personal tax returns by filling out the T-2125. This form can be found in most online tax filing software including Ufile and TurboTax.

2. Corporations are required to file a separate corporate tax return. Given the more complex nature of a corporate tax return it is usually a good idea to get a professional accountant to help with this.

3. Care should be taken to ensure that the business is not regarded as a hobby otherwise tax deductions/expenses that exceed the income of the business will not be allowed by CRA.

4. Business should record their revenues and expenses based on the accrual method i.e. when the sale or expense is made rather than when cash is received. The only exceptions to this rule are farmers, fisher(wo)men and self employed commissioned sales agents.

5. It is extremely important to keep all receipts, bills, invoices, cancelled cheques, deposit slips. If you have any doubts, then keep it! As well ensure that you retain all documents received from the government including notices of assessments and other requests for information. If you receive a letter from CRA or RQ and aren’t sure what it means, ask an accountant (or someone who might know) as ignoring it can lead to a host of other problems.

Tax Filing Deadlines:

1. The income tax filing deadline for unincorporated businesses in Canada is June 15th which is later than the April 30th for individuals. However any tax amounts that are payable are on due on April 30th, after which both CRA and RQ start to charge interest. Penalties will only apply if the business tax returns are not filed by June 15th.

2. Incorporated entities are required to file their tax returns 6 months after their year end, but similar to unincorporated business, taxes payable are due 3 months after year end. Similar interest and penalty provisions apply.

3. Sole proprietorships who are registered for GST/HST and QST, have less than $1.5 million in sales and have selected an annual reporting period are required to pay their GST-QST returns by April 30th. Penalties, particularly by Revenue Quebec can be significant so it is important to pay these by the deadline.

4. T4s and RL-1s along with payroll summaries and any underpayments are due by February 28th of the year following the calendar year in which they were paid.

5. In Quebec, CSST Summaries and amounts due (in Quebec) are due by March 15th.

6. Tax instalments are due for small business that estimate they will owe in excess of $3,000 and are due March 15,June 15,September 15, and December 15,. Instalment payments can be calculated based on prior year amounts or if estimated based on the current year income.

   A complete list of business tax filing deadlines for 2023 for sole proprietors

Although preparation for tax filing is rarely an exciting time for small business owners,  understanding what it entails and being prepared can make it a little less harrowing.  A good accounting system will significantly streamline the process, and can actually result in significant savings by increasing tax deductions and eliminating potential interest and penalties.  A well organized set of books can also reduce the pain and possibility of audits. 

Are you an unincorporated small business owner or freelancer looking to better understand your small business/self employed taxes? Download our free small business/self employed tax return checklist and check out our small business tax guide .