If you operate a Canadian small business, you'll need to file a business income tax return each year. Part of running a successful business is knowing how Canadian income taxes are filed and prepared, which can help you get the best return. This includes understanding which business expenses qualify as legitimate Canadian income tax deductions, as well as knowing how to maximize those deductions.
Canadian Income Tax Returns for Small Business
The tax return you need to complete and file for your small business depends on how your business is structured. If your business is a sole proprietorship or partnership, you report your business income on your T1 personal income tax form. Your small business is you, so to speak, and the T1 income tax return package includes Form T2125, Statement of Business or Professional Activities, which you will use to report your business income.
If your small business is incorporated, you will need to report your business income on a T2 corporate income tax return. Legally, your incorporated small business is a separate entity and must complete and file its own Canadian income tax return.
As a separate legal entity, you are also required to complete and file your own T1 personal income tax return.
Legitimate Canadian Income Tax Deductions
Before you complete your tax return or take it and all relevant forms and documents to your accountant, it's helpful to know which business expenses qualify as Canadian income tax deductions. You can also maximize your business income tax deductions by doing the following:
- Keep track of your receipts, income tax deductions related to the cost of doing business, and income tax deductions for home-based businesses.
- Understand the rules for vehicle business expenses, travel-related expenses, employing your child or spouse, advertising expenses, and the kind of business expenses that fall into the Canada Revenue Agency's "other" category.
- Refer to the Canada Revenue Agency website to find out if a particular business expense qualifies as a legitimate Canadian income tax deduction and the rules for claiming that particular business expense.
Home-Based Canadian Income Tax Deductions
Being a home-based business owner does have some Canadian income tax advantages. Business expenses related to home maintenance and home ownership are two common types of business expenses home-based business owners often overlook.
There are also several home-based business tax deductions for which your business may qualify. Understand the rules for claiming the business-use-of-home expense and how to calculate the amount of the deduction if your home-based business is eligible.
Other Canadian Income Tax Deductions
You may also be able to make additional deductions:
- Capital Cost Allowance. No discussion of Canadian income tax and small business would be complete without mentioning capital cost allowance (CCA). Understand how to calculate CCA and how to make the most of your capital costallowance claim.
- Registered Retirement Savings Plans. 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 Research and Experimental Development. Many small businesses are under the impression that scientific research and experimental development (SR&ED) tax incentives are something that only larger or incorporated businesses can use. However, the SR&ED Tax Credit Program may also apply to your small business.
- Gifts to Employees as Canadian Income Tax Deductions. If you're the generous kind of employer who gifts your employees, you should understand the income tax deduction rules for gifting.
Preparing Your Canadian Income Tax Returns
The following tips can assist you in preparing and filing your tax return:
- Your first business income tax return provides details on how to fill out the T1 personal income tax return, the Canadian income tax return you need to complete and file if your business is structured as a sole proprietorship or partnership.
- If you own a corporation doing business in Canada, you should understand how to prepare and file corporate income tax, including the current corporate tax rates, who can use the T2 Short Return, and when corporate income tax is due.
- There are several tax software programs for small business that can help you complete T2 corporate tax returns as well as T1 personal income tax returns.
- A FAQ source can assist you in answering any questions. Canadian Income Tax FAQs for Small Businesses provide answers to questions ranging from how having a business that made no money in the relevant tax year affects your business through what to do if you can't pay the Canadian income tax you owe.
- In terms of business tax, not all Canadian corporations are created equal. Look into the different types of corporations in Canada as they relate to Canadian corporate income tax.
Using an Accountant to Prepare Your Canadian Income Tax Returns
Many small businesses prefer to have an accountant or other certified tax preparer complete their Canadian income tax returns. Expertise and saving time are two obvious reasons, but having a tax professional's "seal" on your small business's Canadian income tax return can also provide assurance of accuracy.
Locate a good accountant if your small business doesn't already have one. Also prepare your tax information beforehand, so it is clear to the accountant and they can readily determine if they have all of the necessary information.
Filing Your Canadian Income Tax
When you have an accountant or other professional income tax preparer complete your Canadian income tax return, it's common for them to also file your income tax forms. If you are filing your Canadian income tax return yourself, the Canada Revenue Agency (CRA) offers several different options:
- Individuals—those filing T1 personal income tax returns—can file their income tax returns electronically by using Netfile if they meet the conditions. Efile is the version of Netfile used by tax preparation professionals. Electronic filing is also available for corporations.
- Individuals can also mail or hand deliver their income tax returns to the appropriate CRA tax center.
Internet Filing a T2 Corporate Tax Return
As most corporations already make use of commercial tax processing software, the CRA has implemented mandatory internet filing for corporations with a gross revenue over $1 million, although all corporations are encouraged to file electronically. The only exceptions are insurance companies, some non-resident corporations, and others with unique reporting requirements.
A corporation subject to mandatory internet filing can still send in a paper return; however, the CRA will assess a $1,000 filing penalty for additional processing.
Using the CRA Online Accounts
The CRA offers online accounts to better keep track of your tax information regardless of whether your business is incorporated. The Canada Revenue Agency Online Accounts for Businesses provides additional information including how to register.
Deciding Whether to Incorporate Your Small Business
If you are thinking about incorporating your small business, consider the advantages and disadvantages of such a move. Decreased liability—as compared to a sole proprietorship or partnership—and business tax advantages are two of the most common reasons for choosing the corporate form of business. But is it the right choice for your small business?
You should first look into the advantages and disadvantages of incorporation and determine if the pros outweigh the cons in your case. Then, look at the corporate tax advantages of the Canadian-controlled private corporation. If you are going to incorporate, this is the type of Canadian corporation you want to have as a taxable entity.
With the right knowledge, tax time can be an easy and efficient process for your small business. While you may consider business record management to be a low priority, properly managing your records throughout the year can help your business run smoothly as well as make tax time easier. You can also reduce the amount of Canadian income tax your small business owes each year, but you have to take action to make that happen.