Tax season is officially here. If you’re new to the Canadian small business environment, you may be unfamiliar with the tax laws that apply to small businesses and self-employed individuals. Just like employment income, income from your small business is subject to taxation. In Canada, small businesses and self-employed income can be defined in many ways. Most importantly, taxation will depend on the structure of your business. Navigating Canadian taxes as a small business owner may be daunting at first, but once you know the basics, you will be more than prepared. This article will give you an overview of how taxes and small businesses work in Canada and will share useful information to make filing your taxes in 2022 a not so intimidating task.
Just like any income earner in Canada, you’ll need to file a business income tax return each year both at the federal and provincial or territorial level. An important aspect of running a successful business is knowing how Canadian income taxes are filed and prepared. Of course, this will depend on your business structure, which consists of three distinct types of businesses: sole proprietorships, partnerships and corporations. In every case, all financial documents pertaining to your business should be saved and stored away, such as expenses, receipts, invoices, etc. This can be helpful if you ever get audited and will make claiming deductions much easier once tax season has arrived. Alternatively, you can hire a qualified accountant or bookkeeper to look after your finances, making tax season much less stressful. That said, as a small business owner, it’s important to have a basic understanding of how taxes work and the impact it may have on your business.
Types of Small Businesses & Their Tax Implications
Sole Proprietorships & Partnerships – As a sole proprietor, you will pay personal income tax on the net income generated by your business. For partnerships, each partner files an income tax return to report their share of the partnership’s net income or loss. In both cases, you will have to report business income on a T2125 form along with a T1 personal income tax return.
- T2125 form: this form covers four different sections such as general business identification, details of other partners (if applicable), business income, and net profit and business expenses.
- T1 personal income tax return: your return summarizes your income, net income, taxable income and refund or balance owing. If you have a balance owing, it’s due by June 15, 2022.
Generally, Canadians must file their tax returns by April 30. However, as a small business owner, you have until June 15 to file your return. Caution, if you have a balance owing; the CRA will begin charging interest on any unpaid amounts owing starting on May 1.
Corporations – In the case of a corporation, you and the business are separated legally – the business is a separate entity that’s registered under Canadian law. A corporation requires that you fill out a separate return, a T2 annual tax return to be filed out for the business itself. This filing requires a set of financial statements along with other important information about the corporation. A T2 form must be filled out by all resident corporations, including non-profits, inactive and tax-exempt corporations with annual gross revenues above $1 million. Corporations must submit their T2 forms within six months of the end of a fiscal year or calendar year, regardless of whether it has taxable income.
- T2 Corporation Income Tax Return: This form can be filled out online or printed to be mailed to the CRA. Alternatively, you should consider filing your T2 return electronically using CRA-certified software. It’s easy, safe, and processed quickly!
Income Tax Deductions
To maximize your income tax deductions, it’s important to understand which business expenses qualify as Canadian income tax deductions. The CRA has a list of common business expenses that are tax deductible. The important thing to understand is that expenses must be incurred to earn your business income, they must be reasonable, and supported by invoices or receipts. Here are some common examples of operating expenses that are deductible:
- Business tax and fees
- Office expenses
- Business travel
- Business use-of-home expense
- Telephone and utilities
As you can see, as a small business owner, there’s a lot you can claim! Make sure to do your research so that you can maximize your return.
Deciding Whether to Incorporate Your Small Business
Incorporating your small business can offer many benefits including saving you some money during tax season. Let’s discover a few advantages of such a move to determine if it’s the right choice for your business.
Decreased Liability – If you’re a sole proprietor or part of a partnership, you’re required to assume all liabilities of the company. This can include personal assets, such as your house or car, which can be seized to pay debts from the business. As a corporation, your liability is limited to the amount you invested in the company.
Lower Tax Rates – Many small businesses decide to incorporate because of tax benefits. Generally speaking, tax rates for corporations are lower than personal income tax rates. As an example, you can choose to reinvest your salary back into the business instead of pocketing it as profit, thus lowering your personal tax rate. You may also qualify for the small business tax deduction. This deduction is available only to Canadian-controlled Private Corporations and offers a low federal tax rate of 9% on the first $500,000 of taxable income that your business makes. This alone may convince you to incorporate your business.
Continuous Existence – Unlike sole proprietorships, corporations have an unlimited lifespan. When shareholders pass away, their shares can be sold via a sale or transferred to a family member. As a sole proprietorship owner, your business dissolves if you die.
Easy Access to Capital – As a corporation, it’s much easier to raise capital and to obtain grants. It also adds credibility to your business, making it easier to attract potential investors. The government offers a number of loans and grant programs to corporations. It’s in their best interest that you invest in your business.
If the pros outweigh the cons, then it might be worth looking into incorporating your business solely for tax purposes. You can find additional information about incorporating your business here.
The Bottom Line
While you may consider keeping track of your financials a burden, doing so will help your business run smoothly and make the tax season much easier. There are options to lower the amount of Canadian income tax you may owe each year, but you have to take action to make that happen. If you simply don’t have the time, don’t be afraid to consider hiring an accountant or bookkeeper to manage the process for you.