Income taxes for Sole Proprietors

February 23, 2015

Income Taxes for Sole Proprietors

It’s that time of year again that most people dread, the time to start thinking about your taxes. Taxes can get complicated enough for every small business owner, and can be even more confusing for sole proprietors. Here are some points to keep in mind when going over your taxes this year to help ease the pain.

How to report your sole proprietor income

To report the income and expenses resulting from your sole proprietorship, the form to complete is T2125 – Statement of Business or Professional Activities, effectively this is your business income statement. As some entrepreneurs like to juggle a few different businesses, a separate T2125 must be completed for each type of business that was carried on.

Most proprietors use accounting software or Excel to keep track of their income and expenses. If you use good accounting software it should give you the ability to export an income statement for the calendar year. This will be your starting point for your T2125 as all income earned by the business and expenses will be listed out on the T2125, similar to your income statement.

Here are a few common adjustments most proprietors need to make and complete their tax returns correctly.

Meals and entertainment

For income tax purposes you can only deduct 50% of meals and entertainment.

Capital assets

Some of your purchases during the year are for equipment or office supplies that have a useful life beyond one year of business. These items must be classified into the appropriate class of depreciable property and then included as an expense based upon the prescribed rate.

For example, class 8 relates to furniture, appliances, tools over $500 and other equipment and has a rate of 20%. This means that if you purchased items such as office desks, chairs and other furniture you will be able to only deduct a portion of it each year. To make this easier at the end of the year, consider keeping track of this in your accounting records.

Inventory

If you have a retail business and you hold inventory at the end of the year, you have to ensure that it is accounted for in your T2125. Most proprietors forget this and deduct the full amount of purchased inventory in their tax return. The total cost of goods sold must be reduced by the total inventory that is remaining at the end of the year. The formula for cost of goods sold is: Beginning inventory + purchases – ending inventory.

While these are common adjustments, you may need more adjustments depending on the nature of your business. If you are not sure if you have them all, consult a professional.

Other tips to optimize your tax position and reduce your headache

Most sole proprietors will have to pay the tax man at the end of the year compared to individuals who are employed by an organization who usually receive refunds. It is important to keep a balance in a separate account to help meet this burden at the end of the year.

Ensure that you are claiming all relevant expenses for your business. CRA allows you to deduct any expenses that were related to earning income in your business. Take advantage of this and ensure that you keep up to date with your expenses throughout the year so it is easier at the end of the year.

Expenses to consider accruing at the end of year include anything you paid for personally that would relate to the business:

Home office space

You can claim a portion of your home expenses if you often work from home and have a designated workspace in your home.

Auto expenses

Most entrepreneurs use their personal vehicle for their business; include the amount of gas, insurance, repairs and other fees you paid that are related to earning income.

As a sole proprietor you are effectively filing your business and personal income taxes together. Take advantage of personal income tax deductions to help reduce the amount you owe to CRA. Any contributions to RRSPs or expenses paid out, such as medical, donations and child care, are allowed to be deducted on your personal income tax return. This can help reduce the amount you pay resulting from your sole proprietorship as these credits will help reduce the income taxes payable.

Filing deadline

Self-employed individuals get an extension on filing income taxes. Your income taxes are not due until June 15th. However, if there is a balance owing as a result of your income taxes, the amount owing must still be paid by the April 30th deadline.

Avoid a tax headache and take your time reporting your sole proprietor income. Have all documentation stored, as the CRA may call upon you to support any expenses or income figures. Most of all, if you are not sure on how to complete your return, ask for help from a tax professional.

Image credit: by 401(K) 2012, via flickr.com.

Author

Nav Dhaliwal

Nav Dhaliwal is a Chartered Accountant based in Toronto, Ontario with several years of experience and a partner at ND LLP. Believing in doing accounting differently, he integrates the accounting world with technology by providing virtual solutions to organizations of every size.