Published March 2013
Filing Your Business Income Tax Return: A 7 Step Guide for Self-Employed Canadians, Sole Proprietors and Partnerships
How do you file a business tax return? How is it different from a typical return and how do you know what forms to use?
Filing your first business income tax return can be confusing, so we have created this 7-step guide to help. Remember: we can only provide a general overview of the topic and requirements may vary depending on your individual situation. I always recommend seeking professional advice to help address the needs of each individual situation and to optimize your personal tax situation.
With that being said, here is an overview of the steps you need to take to report business income on your personal income tax return.
Step 1: Are you running a sole proprietorship, partnership or corporation?
The type of business you operate determines what tax form you need to fill out. If you are a sole proprietor or are in a business partnership, you report business income on your personal tax return by filling out Form T2125: Statement of Business or Professional Activities. If your business is a corporation, you will need to fill out T2. This article addresses the use of Form T2125.
In a sole proprietorship, the person and the business are the same entity, so if you have earned money outside of regular employment, you are a sole proprietor, even if you did not register your business. Partnerships are similar, except there are stricter rules for registering the business in each province.
All income, not matter how trivial, needs to be reported. If you are not sure whether you should report the money you have earned, be sure to read the discussion of CRA’s test in our article Self-Employed and Contract Earnings: How-To File Your Personal Tax Return.
Step 2: Two options for filing your tax return
Canadians now have two options for filing their tax returns:
- download the tax return package for the year for which you are filing, or
- use one of the software programs certified by the CRA .
Many of the software programs that can be used have free versions available for Canadians whose income is below the set threshold, which ranges from $20,000 to $30,000. StudioTax 2012 on the Windows platform is the only product that is free regardless of income levels.
We are going to look at the downloadable forms in this article, as the usability may range widely for each software program.
If you decide to use the online form instead of a software program, you will need to download or request your tax package for the current year for your province or territory of residence on December 31st of the tax year for which you are filing.
The easiest way to do this is to visit the Canada Revenue Agency website and select the current year tax link from their homepage. Here is where you can download the 2012 Tax Package. <http://www.cra-arc.gc.ca/formspubs/t1gnrl/menu-eng.html>
A list of the certified software that can be used for your 2012 tax return can be found on the CRA website. http://netfile.gc.ca/sftwr-eng.html Make sure that you are eligible to use the software http://netfile.gc.ca/rstrctns-eng.html before choosing this option.
Step 3 (a): Use Form T2125 to Calculate your Net Profit or Loss
The T1 form only has a place for you to enter your gross and net income, so you will need to fill out the more detailed form T2125 as well. (Download the 2012 Statement of Business and Professional Activities form. <http://www.cra-arc.gc.ca/E/pbg/tf/t2125/t2125-12e.pdf>)
This is where the real work in preparing your tax return comes in.
You will want to refer to the Business and Professional Income guide as you fill out form T2125. Here is an overview of what you will need to know.
- Determine your income type. You start by selecting whether you have business or professional income. If you generated both types of income you will need to fill out two T2125 forms, one for each income type.
- Enter all income earned for your income type. Next you enter the gross sales, commissions, and fees, as well as the work in progress, earned during the year for which you are filing.
- Deduct appropriate costs (but not expenses yet). Now follow the process to enter amounts that will reduce the total earnings you entered on either line A or D, which includes things like federal and provincial sales taxes, discounts, other adjustments and cost of goods sold, to calculate your gross profit on line 8519.
- Enter expenses. CRA provides 22 expense categories and there are some nuances to consider. While most expenses can be deducted fully, there are a few exceptions.
For example, you can only claim 50 per cent of valid meals and entertainment expenses and you need to fill out Chart A in the form T2125 to calculate the motor vehicle expenses you are allowed to claim. Tangible assets that you purchase, like furniture or computers, are treated as capital cost allowances where a portion of the asset is depreciated each year and then the depreciation amount is claimed as a CCA expense on line 9936. Also, you will report any business-use-of-home expenses separately (as described in bullet 6 below.)Be sure to read our guide A Guide to Expense Deductions in Your Canadian Business http://www.canadaone.com/ezine/apr11/expense_deductions.html to ensure that you are claiming your expenses correctly.
- Calculate net income (or loss). You are now ready to calculate your final net income or loss. This is done in two stages. First, you enter your expenses and deducting the final total from the gross profit. You will then subtract the final adjustments, including business-use-of-home expenses, to calculate your final net income or loss. The business-use-of-home expenses
Step 3 (b): Report your Business or Professional Net Profit or Loss
Once you have calculated your gross and net income, you now report this on your T1.
Most self-employed Canadians will report their net profit or loss on lines 135-143 in the self-employment income section.
However, if you were a silent or non-active partner in a partnership you would enter the net profit or loss from the business on line 122 of your T1 return. There are two exceptions to this: If the partnerships was a rental or farming operation you will report your income either on lines 126 or 141.
Step 4: Calculate CPP amounts owing using Schedule 8
The obligation to continue paying CPP as a self-employed worker or contractor can be a shock at tax time. While these amount seem relatively trivial when they are taken off each pay cheque, many self-employed workers find that the CPP owing builds up over the year, adding an unexpected amount to the amount owing at year-end.
Also, the amount you pay as a self-employed Canadian is higher than you would pay as an employee, because you must pay both your personal share as well as the employer’s share.
There are two versions of Schedule 8 that are used to calculate your CPP contribution amount. Residents of all provinces outside of Quebec use one version, while residents of Quebec use the version for Quebec (QC) only form.
Step 5: When you opt-in to EI
Self-employed workers have traditionally not been required to pay EI and also have not been eligible to receive EI benefits due to the fact that they do not have an arm’s length relationship with their business. However, in recent years the federal government has opened up the ability for self-employed workers to opt-into the EI system, which allows them to access some benefits such as employment insurance for maternity or paternity leave.
If you have entered into an agreement with the Canada Employment Insurance Commission through Service Canada to participate in the EI program for access to EI special benefits you need to fill out Schedule 13 and report your EI premiums payable on your self-employment earnings from line 10 on your T1 tax return.
Step 6: Filing and payment deadlines
As a self-employed person, sole proprietor or partner in a Canadian partnership that is not a corporation, you have until June 15 of each year to file your tax return. However, you must pay any balance owing in full by April 30, so your taxes are actually due on the same date as other Canadians.
Step 7: Do you need to make instalment payments going forward?
If your net tax owing exceeds the threshold set by the CRA, going forward you will need to make instalment payments during the tax year.
Currently CRA requires self-employed Canadians who are not residents of Quebec to make instalment payments when the person’s net tax owing is more than $3,000 in 2013 and in either 2011 or 2012.
Quebec residents should use a limit of $1800 instead of $3000 for the year that year. Different rules apply to fishers and farmers.
Instalment payments for 2013 are due on March 15, June 15, September 15, and December 15, 2013. You can find more information on paying installments in CRA’s publication, Paying Your Income Tax by Instalments http://www.cra-arc.gc.ca/E/pub/tg/p110/p110-e.html.
Final considerations: the value of professional advice
This article provides a summary of how you would fill out your business income tax return for sole proprietors and partnerships. However, we have not looked at any other aspect of filing your personal tax return.
There are many subtleties to filling in a tax return to maximize your tax situation. For example, there may be tax credits that you can claim as a business or better ways to handle some of your deductions. Unless you are a tax professional, there is a good chance that you may not be aware of these opportunities and we would recommend that you seek professional assistance.
Nonetheless, even if you are going to use a tax professional, it is a good idea to understand these essential basics of how businesses report income and determine what, if any tax they must pay.
Further Reading: More advice to help you understand your tax obligations
Help! What Taxes Must I Pay?
Provides a good overview of the tax obligations of self-employed workers and small business owners in Canada.
Self-Employed and Contract Earnings: How-To File Your Personal Tax Return
This article explains when you need to report business income on your personal tax return and provides an overview of how to claim expenses.
Demystifying the GST/HST
Understand how and when you need to charge the federal sales tax as a business.
An In-Depth Guide for Independent Contractors in Canada
This guide provides a thorough overview of things you need to be aware of when working as a contractor or self-employed Canadian.