Note: This is the Canadian version of our Guide to Small Business Sole Proprietorship Taxes. For the U.S. version, click here.
Updated January 2018
A typical small business owner fearlessly wears many hats. However, when it comes to tax season, most just want to grab a pillow and hide under the sheets. Hint: This is only temporarily effective.
With studies from the Canadian Federation of Independent Businesses (CFIB) showing that nearly 80% of small businesses say that paying taxes is the biggest challenge they face — it’s no wonder that tax season brings such a sense of dread.
“I can say quite authoritatively that almost every business in Canada is not fully [tax] compliant – and in 99% of those cases it’s because the rules are so incredibly complicated. Implementing them perfectly is near impossible.” — Dan Kelly, CEO, CIFB
What Can You Do to Make it Through Tax Season?
The simple answer: Get help. Arm yourself with as much information as you can and surround yourself with the best people and resources.
If you are a small business, most specifically a sole proprietorship, this guide has been designed to help you understand the things you need to do to file your annual return. It’s also meant to help you work more closely with a tax professional, such as a tax lawyer or a chartered professional accountant (CPA).
Fact: Recommending that you work with a qualified tax professional is one of the most valuable tips we can provide. Tax laws are complicated and making mistakes only makes them worse. To put it bluntly: If you wouldn’t do your own dental work, why on earth would you risk doing your own small business taxes?
Also, please read this disclaimer in your best commercial announcer voice: The information in this guide is focused on the calculation of taxable income and does not address the calculation of standard or harmonized sales tax (GST/HST) or other business taxes in detail.
Now that we’ve gotten the formalities out of the way, let’s get down to business…
Step 1 — Know Your Goals
“Remember how painful it was to play Little Red Riding Hood last year? Gathering all those pesky receipts you had scattered in the forest on your way to grandma’s house. Only to find out that some big bad wolf or black hole of some kind had eaten some of your paperwork.”
— Jennie Moore, Moore Details Bookkeeping
By doing so, you can:
● Simplify the process saving you and the person preparing your taxes time and stress.
● Minimize the risk of omissions, miscommunications, data entry errors and other little things that can cause big headaches later on.
● Save as much as possible by claiming eligible deductions.
Step 2 — Know Your Business Structure
"Taxes are complicated and the rules are always changing. Be sceptical of tax advice that you get at a cocktail party or from a friend. Just because something worked for another entrepreneur, it doesn’t mean it’s the right decision for your business."
—Omar Visram, Enkel Backoffice Solutions
Can your sprawling corporate headquarters be seen from outer space? If the answer is yes, you’re probably reading the wrong guide. Before you begin reading this information, it’s essential that you understand your business structure.
- Sole proprietorships — As implied by the term sole, a sole proprietorship is a small business owned by one person.
- According to Shopify's Canadian Legal Guide, some of the advantages of a sole proprietorship are:
- It's easy to set up.
- Your business taxes are filed with your personal taxes.
- One disadvantage is:
- If you're doing really well, your business income may push you into a higher tax bracket.
- According to Shopify's Canadian Legal Guide, some of the advantages of a sole proprietorship are:
- Partnerships — This is where the business is jointly owned by one more people or entities.
- Corporations — A corporation is a structure that creates a separate legal entity that does business independently of its owners/founders.
(These definitions are extremely top level and, in this guide, we will only discuss sole proprietorships and partnerships. Corporate taxes are a whole other kettle of fish.)
How Your Business Structure Affects Your Taxes
In her highly informative small business tax guide, Accountess Bookkeeping founder Jennifer Lang explains:
- As a sole proprietorship, self-employed business profits are reported using Form T2125 Statement of Business and Professional Activities, which are then carried forward to line 135 of your personal T1 Income Tax and Benefit Return.
- Partnerships are treated like sole proprietorships, with each partner claiming the percentage of profits equal to their share of the partnership. For example, in a 50/50 partnership with two people, each person would claim 50% of the business income and expenses.
Ultimately the choice is based on what’s best for your business and, if you’re a sole proprietor, you may choose between the two. However, once you pick an accounting method, it’s best to stick with it. The CRA also prefers that you do as well.
Step 3 — Know Your Small Business Tax Deadlines
- If you have employees, you must file your T4 and T4A information returns by the last business day in February. Your employees must also receive their copies by this date. (Failure to do so may result in penalties and/or fines.)
- If you are a sole proprietor or you are incorporated with a December year end then you pay your business taxes through quarterly installments they are due on March 15, June 15, September 15 and December 15.
- Most partnerships with individuals as partners must file a partnership information return by the last business day in March. However, if you pass a certain revenue threshold or if the partners are corporations, you may need to file a T5103 Partnership Return, which may also have a different deadline.
- The Last Business Day in April — Normally April 30
- This is when your personal income taxes are due. As a sole proprietor or member of a small business partnership, your business taxes are due at the same time.
- If you qualify as “self-employed” for income tax purposes, you have until June 15 to file. However, your amount owing is still due April 30.
- Any balance owing is due.
- This is also the deadline if your business expenses were mostly the result of capital cost or tax shelter investments.
- Tax returns for those with self-employment income and spouses/common-law partners of those with self-employment income are due June 15.
- If you’re in the construction industry and hire subcontractors, you may have to file a T5018 information return by the last business day in June or the period end date plus six (6) months.
Note: As with all CRA payments and filing deadlines — if a date falls on a weekend or holiday, payment or reporting is due the next business day.
Step 4 — Know What You Need to File Your Taxes [Checklist]
“Would you head to the airport for your next vacation without your ticket, passport and travel essentials? If you forgot anything important, you wouldn’t get very far. While filing your taxes isn’t as enjoyable as a getaway, it requires similar planning and preparation — and leaving things to the last minute is certainly not fun in any way.”
— Lior Zehtser, ConnectCPA LLP
As you’ll be filing your business taxes with your personal income taxes, there are many moving parts to your tax preparation. Here’s a list of the things you’ll need:
- Business and personal identification:
- Your business registration documents, such as the form you receive confirming your registration details, including your business number (BN) and any related program accounts.
- Your social insurance number (SIN).
- If your business is a partnership, you’ll need:
- Your partnership business number and partnership percentage, which will be in your registration documents.
- Records for any expenses deducted from your share of your partnership income.
- The names and partnership percentages of your other partners.
- Relevant tax information:
- The previous year’s notice of assessment.
- Any amounts your business has paid in installments.
- Any communications from the CRA.
- If this is the first year you are working with your tax professional, it is also helpful to provide a copy of last year’s return.
- As you are filing your business and personal taxes together, you will also need to provide personal income information, including:
- Your T4 or T4A
- T5013 partnership income
- T3 income from trusts
- T5 investment income
- Other income — rental income, gains/losses on investments
- RRSP contribution slips
- Charitable donations
- Medical and dental receipts
- Child care information
- Financial statements/reports including:
- Business Income
- Gross sales, commissions and fees
- GST/HST, provincial sales tax, returns, discounts and allowances
- Professional Income
- Gross professional fees
- GST/HST, provincial sales tax, returns, discounts and allowances
- Costs of goods and services (COGS)
- Opening and closing value of your inventory
- Related labour and other costs/purchases
- Discounts, allowances and returns
- Direct wage costs
- Contractor costs
- If you are using small business payroll software, you will be able to pull reports containing this information.
- Business Income
- Internet business activities
- The top five (5) websites that drive revenue for your business, as well as the total percentage of revenue they generate.
- Documentation for any small business tax deductions and capital cost allowances (CCAs) you are planning to claim:
- Expense receipts
- Lease agreements
- Invoices and purchase agreements
- Commercial and passenger vehicle expenses:
- Mileage logs
- Fuel costs
- License and registration
- Maintenance and repairs
- Parking fees
- Leasing information (if applicable)
- Business use of home expenses
- Phone, internet and utility bills
- Mortgage statements (showing interest paid) or lease agreements (if you rent your home)
- Property tax statements
- Property insurance
- Maintenance and repairs
- Equipment additions and dispositions
- Building additions and dispositions
- Land additions and dispositions
While you don’t need to send all these items in with your return, you should keep your records on hand in case they are requested. The CRA recommends that you keep your business tax documentation for a minimum of six (6) years from the date of filing.
A benefit of being prepared: Accountants and tax professionals normally charge by the hour. Think of how much you’ll save by saving this person some time.
Step 5 — Get to Know Form T2125 Statement of Business and Professional Activities
“Overcome your form-phobia. It’s important for business owners to be able to understand how the CRA translates your income into taxable income — even if you’re working with an accountant. This will not only reveal the true cost of certain expenses, it will also shape and influence business decisions throughout the year.”
— Matt Hicks, Flip Accounting Inc.
In addition to gathering all the relevant information, you’ll definitely find it helpful to become familiar with Form T2125 and its companion guide Publication T4002. For example, you can print a copy of the form to review as you pull your tax records together and as you read through this guide. (The writer has one by her side.) This overview will hit on several key sections.
Box 1 — Identification
In order to prevent errors or delays, you want to ensure that all of your identification information is accurate.
- Name — This is the full name of the person to whom the tax return belongs.
- Social insurance number (SIN) — Again, this is for the individual.
- Business name — The full business name as it appears on your business registration forms.
- Business number (BN) — The nine-digit number you receive when you register your business for a federal program account, such as for payroll taxes or HST.
- Business address — The same address you used when you registered your business.
- Fiscal period — A fiscal period is 12 months. Self-employed individuals must use a December 31 year-end.
- Main product or service and industry code — The full list of codes is in an appendix within Publication T4002. Choose the code that most closely describes your business.
- Tax shelter identification number — If you are claiming a tax shelter, you must attach any applicable T5003 Statement of Tax Shelter Information as well as a completed Form T5004 Claim for Tax Shelter Loss or Deduction.
- Partnership business number and partnership percentage — If your business is a partnership, you will get a partnership business number when you register your business. This document will also contain the percentages of ownership.
- Name and address of preparer — This is either you or, hopefully, your professional tax advisor.
Box 2 — Internet Business Activities
You only need complete this section if you have earned income online, such as through e-commerce websites.
- You only need to provide the top five (5) pages that earn the highest income
- The percentage of gross income earned can be an estimate.
Parts 1 & 2 — Business Income and Professional Income
What’s the difference between business and professional income? The good people at Bookkeeping Essentials break it down by explaining that a professional is someone, like a doctor, lawyer, dentist, chiropractor, etc. whose business is predominantly run by offering professional services that require licensing to practice, whereas business income is traditionally things like sales of goods and services.
Professionals also need to ensure that they communicate the value of their services that are currently work-in-progress at the time of filing. Factors for including or excluding these amounts should be discussed with a tax professional.
It is possible to have both professional and business income. In this case, you will need to complete two T2125 forms.
Part 3 — Gross Income
This where you enter to totals for your business and/or professional income from the sections above.
- It where you can deduct allowable reserves, contingent accounts or a sinking fund. For more information, see:
- It is also where you record other income, such as:
- A recovered amount written off as a bad debt in a previous year.
- The value of prizes or vacation trips awarded to you due to your business or professional activities.
- Grants, subsidies, incentives or other forms of government assistance.
Part 4 — Costs of Goods Sold and Gross Profit
This section is completed if your business buys, sells or makes goods. Some of the things to keep in mind are:
- Opening inventory — Includes raw materials, goods in process and finished goods. Whether you choose to value your inventory at the fair market value or at cost, you must use your preferred method consistently.
- Purchases during the year — The purchases you make to use in manufacturing goods, including delivery, freight and express charges. Be sure to subtract any discounts you received on these goods and services.
- Direct wage costs — Includes any wages or salaries paid to employees in the process of buying, selling or making goods.
- Subcontractors — These are the wages and fees you’ve paid to contractors in the process of buying, selling or making goods.
- Other costs — Like freight to bring inventory in.
Part 5 — Net Income (Loss) Before Adjustments (Your Small Business Tax Deductions)
This is the good part where you get to claim your small business tax deductions. However, it’s somewhat nonlinear as there’s a bit of back and forth with other calculations made in the following three (3) pages (Parts 7-19), including:
- Amounts deducted from your partnership income
- Details of other partners
- Home office expenses (deducted from your income in Part 6)
- Details of equity
- Capital cost allowances
- Motor vehicle expenses
- Interest on or leasing costs for passenger vehicles
To learn more about claiming small business tax deductions, like professional fees, employer taxes as well as meals and entertainment, see our Comprehensive List of Small Business Tax Deductions.
Part 6 — Net Income (Loss)
This is where it all comes together — where you calculate your net income (and hopefully not a loss). This amount is then carried forward into your T1 personal income tax form.
Step 6 — Avoid Common Small Business Tax Mistakes
Chinese philosopher and military strategist Sun Tzu wrote, “Know thyself, know thy enemy.” These days it feels like he should have added, “Hey, look out for that bus!” Here are a few ways to stay out of the path of danger:
- Don’t get caught unprepared — In case we haven’t said it enough, use the right forms and document, document, document. In the words of bookkeeper and Canada’s 2017 Intuit Firm of the Future Winner, Jennie Moore, “If you don't have a receipt for an expense it doesn't exist in the eyes of CRA.”
- Don’t go it alone — work with a qualified tax professional. (Another perk, bookkeeping and accounting fees qualify as a valid tax deduction.) Here’s a very quick breakdown of who does what:
- Tax lawyers — They handle legal issues with taxes as well as the establishment or reconfiguring of planning structures.
- Accountants — Are your gurus for your tax returns and general best practices throughout the year.
- Bookkeepers — Help you keep your books and ensure that you’re able to implement best practices.
- Don’t miss out on deductions — Learn about all the known and lesser known options and tactics, including:
- RRSPs (Registered Retirement Savings Plans) are considered one of the best small business tax deductions — allowing you to contribute up to 18% of your earned income.
- Delaying the disposal of depreciable assets until the new tax year, in order to claim the depreciation for the current tax year.
- Delaying or deferring income to the next calendar year, if the amounts have the potential to raise your tax bracket.
- Income splitting by employing a partner, spouse or family member — therefore, splitting the income in lower tax brackets.
- Don’t get creative without talking to your tax advisor — Even if the idea sounds good, you need to find out if it works for your business and what you need to do in order to properly claim a specific deduction or execute and income- or cost-saving plan.
- Don’t get caught by changes to the tax rules — Working with a tax professional and using financial and accounting tools created for small business will help eliminate this risk.
- Don’t be late or miss payments — The CRA generally frowns upon this.
- Interest starts to accrue from day one — meaning May 1, the day after April 30.
- When you have a balance owing, the penalty is 5% of the total plus 1% for each month the payment is late, up to 12 months and a maximum of 17%.
- If you’ve been late before in any of the 3 previous tax years, the penalties double to 10% plus 2% for each month, up to 20 months and a maximum of 50%.
- If you’re concerned about having enough money to make your tax payments, consider alternative sources of funding, like invoice factoring.
- Don’t let an audit get you down — If you’ve been working with an accountant and bookkeeper as well as following best practices, you will be prepared for an audit. You’ll have the records and the people you need by your side. This won’t take away all the stress, but it will certainly lower it.
Step 7 — Plan for Tax Season All Year Long
“More often than not I see small business owners (especially when starting out) push off tax planning, compliance and alike. Even in the area of general bookkeeping, many small business owners prefer to cut corners. Understandably, this is done in order to save costs or perhaps because they do not see the immediate significance or because they feel that they can do it themselves. However, this approach most often backfires.”
— Daniel Talkins, CEO, Future Balance CPAs
While, thankfully, tax season comes only once a year, you’re running your business all year. By implementing best practices and using the best tools, you can make tax season a whole lot less “taxing” on your time, your emotions and your bottom line.
- Work with your bookkeeper and accountant throughout the year to establish systems that make sense.
- Use this year’s return as a guide for categorizing and recording expenses going forward.
- Simplify and automate with the following tools
- Start with a strong foundation by choosing online accounting software, like QuickBooks Online, Xero and FreshBooks.
- Then add functionality and ease with:
- Expensify and Receipt Bank for expense and receipt tracking.
- Hubdoc that makes it easy to store and access documents.
- Payroll software, like Wagepoint, to automate an otherwise time-consuming process.
- Time tracking and scheduling tools, like TSheets, When I Work and Jobber.
- Easy invoicing and accounts payable from Plooto.
Step 8 — Cherish the Little Things, Like a Good Break
You’ve done it. You’ve read the guide. You’re either getting things in order or already have. What now? We think you’ve earned the right to a few diversions.
- Skip astrology and go for foodology — find out what your choice of foods says about you.
- Get yourself a new recliner (or your first, we won't judge).
- Relax and enjoy some serious binge watching.
Business owners, sole proprietors and tax professionals — if you have a resource, correction or clarification you’d like to provide, please share it in the comments below. All valuable knowledge is welcome. For that matter so are any funny tax season jokes or anecdotes (as long as they’re clean).
The information in this post does not constitute or replace the need for professional bookkeeping, accounting or tax advice. Wagepoint has gathered this information from several sources and has done its best to ensure accuracy. Any errors or omissions will be corrected in a timely manner. As tax laws are constantly changing, it's important to ensure that you have the most accurate and up-to-date information.