Tax-Efficient Moves for the Self-Employed

Taking the leap into self-employment creates a lot of new challenges – especially when it comes to filing your taxes – but the extra leg work also comes with new opportunities to reduce the balance owing each year.

Those who are traditionally employed often take for granted the relative simplicity of having income taxes automatically deducted from their paycheques, having consistent and predictable earnings, and relying on just one source of income.

Those who are self-employed, however, are responsible for tracking and reporting their own income, expenses and, in most cases, sales taxes on the goods or services they provide. That is true whether they are officially registered as a “sole proprietor” or simply earning an income independent of any employer.

Understanding what qualifies as business income as well as what qualifies as a business expense is therefore vital to fulfilling tax obligations while minimizing tax burdens for the self-employed.

On the earnings side, the Canadian Revenue Agency (CRA) requires the reporting of “income from any activity that you carry out for profit or with reasonable expectation of profit.” What qualifies as a business expense, however, can be a bit more complicated.

“If you’re a self-employed florist, or IT consultant, or mechanic, or an actor, what’s tax deductible… is almost always exactly the same,” said Bob Gore, managing partner of Scarborough-based accounting firm Robert Gore & Associates CPA.

A full rundown of items that are considered tax-deductible by the CRA for those who earn self-employment income is listed on Form T2125. The 21 categories include rent, utilities, property taxes, meals and entertainment, office expenses, fuel costs, travel expenses and more.

When calculating the taxable income of self-employed Canadians, the CRA subtracts those eligible expenses from their total earnings. That means the more that is spent on approved expenses the lower the tax burden. Mr. Gore, however, emphasizes that you can only include items with the appropriate records.

“A misconception that people often have in the world of self-employment is that a bank statement or a credit card statement is enough for the CRA; it is not,” he said. “The CRA requires original receipts from every supplier you have – everything from a coffee bill to the photocopier to the subscription to a backup cloud storage.”

Mr. Gore adds that digital copies, including photos of paper receipts, are considered valid, but in some cases aren’t enough on their own. “If you buy office supplies, they’ll never ask why; but if you take somebody out for a meal or buy them a Christmas gift or take them to a hockey game, you better have a record of who you were with, and why it’s related to your business,” he said.

While many expense categories are black and white, some occupy a grey zone between business and personal costs. In such instances, self-employed taxpayers are required to calculate the portion of the expense that qualifies as business-related.

“If you live in a place that’s 1,000 square feet, and you have a 150-square-foot office, then in the simplistic sense 15 per cent of the space is a home office,” explained Mr. Gore, adding that in this example 15 per cent of costs like utilities and rent would qualify as business expenses.

“Your cell phone bill, internet supply, computer, vehicle, the place you’re renting or own — a percentage of all these expenses become tax deductible the moment you become self-employed.”

In the broadest terms, Emily Verrecchia, a tax expert at TurboTax Canada, says any expense that ultimately enables the self-employed Canadian to earn a profit is likely deductible.

“Whether you have a home office space where the extra work magic happens or you drive your car to meet your clients, you’ll be able to claim a portion of those necessary expenses that helped you earn income,” she says. “It’s important to claim all of your business-related expenses on your tax return; in addition to lowering your tax payable, you’re also putting together the most accurate picture of your business’s overall health.”

Self-employed Canadians have until June 15, 2023, to file their tax return but are required to pay any balance owing by May 1, 2023. As a result, Ms. Verrecchia advises self-employed Canadians to prepare their return well in advance of the May 1 deadline to avoid late-payment penalties.

She adds that TurboTax’s self-employed expense calculator can help you maximize your tax savings by estimating your business expenses. When you’re ready to get your taxes done, TurboTax Self-Employed asks you questions specific to your industry and finds deductions personalized to your line of work, helping you uncover tax breaks you otherwise may have missed.

“Whether you have a small business, income from a part-time gig, or anything in between, TurboTax has you covered,” she says.

For more top tax tips, click here.