In this blog post, we’ll look at one of the biggest tax advantages of self-employment – the deductibility of business expenses.
For tax purposes, you are allowed to deduct any expense incurred during the year to earn business income, as long as it is reasonable under the circumstances. However, certain expenses are specifically disallowed as business expenses. For example, club dues (such as golf or other sports clubs) and personal expenses.
As a small-business owner, make sure you separate your business and personal expenses. Personal expenses are not deductible under any circumstances. If you have expenses that have both a personal and a business component, like business travel with a few extra days tacked on for vacation, make sure you claim only the business portion of these expenses.
Other business expenses are restricted; for example, amounts spent on meals and other costs of entertaining clients.
You can deduct 50 per cent of either of the following (whichever is lower):
- The actual amount spent on meals and entertainment
- An amount that is reasonable in the circumstances
With the technology available today, it’s really efficient and convenient to work from home or run a home-based business. Not only are you saving the outlay for office rent, but you can also deduct home office expenses. Your home must be your principal place of business or the place where you meet clients or customers and conduct your work. You can deduct a portion of the rent or mortgage interest, property tax, home insurance, utility bills and maintenance costs. To determine the business portion, divide the area of your workspace by the total area of your home. Your home office expenses cannot be greater than your income for the year. If you are in start-up mode with limited revenues and other deductible expenses, home office expenses that you don’t deduct in the current year can be carried forward and deducted from your business income in the following year.
Generally, interest on money you borrow to use in the business is deductible. For example, interest on a line of credit on your home but used in the business is deductible as long as you can demonstrate that the proceeds of the loan were used for business purposes. Make sure you keep detailed records as to the source and the use of borrowed funds.
One final important distinction for tax purposes is between current and capital expenses. Current expenses are the regular recurring expenses of a business and are fully deductible when incurred; they include rent, insurance, telephone, Internet and other office expenses. In contrast, major purchases of capital property – such as a building, office furniture, computer or manufacturing equipment, and trucks and cars – must be treated as assets since they depreciate over time. For tax purposes, depreciation is called capital cost allowance (CCA). Different types of properties have different CCA rates, so make sure that you use the appropriate CCA class and rate.
My next post will explore the different ways you can structure a business – as a sole proprietorship, a partnership or a corporation – and the tax consequences of each structure.