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How to save taxes for self employed in Canada?

How to save taxes for self employed in Canada? The answer to this question can be daunting and difficult to understand. However, I’ve created a simple list of  my Top 8 Tax Savings Strategies on how to save taxes for the self employed in Canada. I’m sure you’ll be very pleased with these tips, once you see how much you can save!

1. Home office expenses

If you’re self employed and work from home, you can deduct a portion of your household expenses. The portion of household expenses that can be deducted is determined by calculating the percentage that the size of your work space at home (e.g. home office) is of the total size of your home.

Self EmployedFor example, Charles is an accountant and works out of his own home. His office space takes up 700 square feet of his 2800 square foot house (25%). If Charles has office related expenses that total $25,000 during the year he can deduct $6,250($25,000 x 25%)

The following household expenses can be deducted:

- Mortgage interest

- Property taxes

- Maintenance and repairs

- Condo fees

- Utilities (e.g. water, gas, electricity)

It is important that you do not claim dual purpose rooms such as a bedroom. If you intend to designate a part of your house as part of your home office it can only be used for the purpose of business activities. Rooms such as the kitchen or bedroom cannot be claimed.

The CRA is also asking home office users to submit a floor plan of their house, upon audit. This is to make sure individuals are accurately estimating their office to home space ratio. It is important that you don’t make too much of your home a part of your office as it will not be eligible for the principal residence exemption. In my experience I would say 15%-35% is a fare estimate of square footage used in your home as office space.

This is just one way on how to save taxes for self employed in Canada. Let’s take a look at our next strategy.

2. Pay salaries to family members

Self employed Canadians save taxes by paying family members a reasonable salary. This strategy works if you, as the self employed individual, are earning more than your family members. Those earning less than you will be in a lower tax bracket, thereby allowing you to save tax.

In fact, the first $11,038 of employment income is tax free. If your children are not working, you can save taxes in Canada by paying your children $11,038 each. The salary will be tax deductible to you and tax free for your children.

It’s important that an employment agreement be prepared that specifies the duties that your family member will be performing, and their hourly wage or annual salary. In addition, a weekly log should be kept to support the time spent working by each family member. The reason for doing such things is to ensure there’s a bona-fide relationship between yourself and your family members, that will help refute any challenges by the Canada Revenue Agency.

Let’s illustrate an example of how income splitting can save taxes for self employed in Canada. Stephan and Amanda are married and have two kids, Kristie and Rebecca. Stephan is a lawyer and runs his own business which has profits of $150,000 for the year. The following examples show the tax savings that are possible for Stephan and his family through income splitting.

Scenario 1: Stephan is the sole income earner in the business
As the only family member working in his business, Stephan would be taxed at the highest marginal tax rate in Canada of 46.41%. Stephan’s tax owing for the year would be $69,615 approximately (150,000 x 46.41%).

Scenario 2: Stephan, Amanda, Kristie and Rebecca all have jobs in the business
In order to take advantage of income splitting, Stephan hires his wife Amanda to work as the office administrator and gets Rebecca and Kristie to do important research before cases. Stephan can now pay his wife and kids a salary based on the work they performed. If Stephan was to pay his wife $50,000 and two kids $15,000 each, then Stephan would have left over income of $70,000 for himself. Stephan’s family tax rates would be as follows:

Family Member

Salary ($)

Tax Rate (%)

Taxable Income ($)

Stephan

70,000

32.98

23,086

Amanda

50,000

31.15

15,575

Kristie

15,000

20.05

3,007.50

Rebecca

15,000

20.05

3,007.50

Total

$44,676

Bottom line: income splitting has allowed Stephan to save $24,939 on taxes this year.

For more tax information on this subject check out this article on how to save taxes for self employed in Canada.

3. Lease a vehicle – save taxes for self employed in Canada

How to save tax for self employed in Canada

Did you know that many of your daily car expenses are tax deductible when used for business

Canadians who own their own business can save taxes by leasing a vehicle for their business. The following vehicle costs can be deducted for tax purposes:

- Repairs and maintenance

- Fuel

- Insurance

- Toll charges

- Parking

- License and registration

- Lease charges

The maximum monthly lease amount that can be deducted is $800 + taxes. Anything over and above this limit is non-deductible.

The percentage of the vehicle operating costs that can be deducted is calculated as:

(Total KM’s Driven for business purposes / Total KM’s Driven in the year) x 100

For example, if you drove 12,000KM for business purposes during the year and 20,000KM in total, then 60% of your vehicle operating costs can be deducted. To substantiate the KM’s that you drove for business you must keep a daily log. The daily log should include:

- Date of trip

- Location of trip

- KMs driven during trip

- Purpose of trip

You can maintain a daily log on your own or there are many free log book apps that you can download on your mobile device. Visit Google play or the App Store to download your copy.

4. Keep accurate books

How can accurate books and records help save taxes for self employed in Canada? The answer is that accurate books and records ensure that all expenses are captured on your business’ financial statements and personal tax return. This way, nothing is missed.

The best way to keep accurate books and records is to purchase an accounting software program such as QuickBooks or Simply Accounting. For very small businesses, a spreadsheet can also be used to record business expenses.

5. Incorporate to save taxes for self employed in Canada

By incorporating your company, your business profits will be subject to a very low tax rate of 15.5%(2013). On the other hand, the business profits of unincorporated businesses are included in the owner’s taxable income, which are taxed at 49.53% (the highest income tax bracket).

Incorporating your company you will also open yourself to more tax saving opportunities through income splitting. As mentioned earlier income splitting is a major way to save taxes for self employed in Canada.

When a corporation is formed shareholders are needed. A major benefit to being a shareholder of a company is the payment of dividends. Typically a corporation will declare dividends on after tax profits once a year. If you were to make your spouse a shareholder in your company then it would be fair to pay them a dividend. This can be advantageous for saving tax when one spouse earns significantly more than the other. The higher income spouse can pay an appropriate dividend to the lower income spouse through the corporation, so that the income will be taxed at a lower marginal rate.

It is important that you do not make kids under 18 a shareholder in your corporation. To avoid families from taking advantage of splitting income through their children, the CRA introduced what is known as the “kiddie tax” rule. If you issue a dividend to a minor (under 18) then they become taxable at the highest federal tax rate and not eligible for any tax deductions. Now there is no incentive to income split with your children through dividends as it ends up penalizing you with more taxes.

For additional information about incorporating your small business, please see our FAQ on things you should know before incorporating.

6. Individual Pension Plan (IPP)

For individuals who are higher income earners, you may want to invest in an Individual Pensions Plan (IPP). Unlike a Registered Retirement Saving Plans (RRSP), an IPP will allow you to continue living a high income lifestyle upon retirement.

An IPP is a defined-benefit pension plan that is registered with the provincial government as well as the CRA. Defined-benefit pension plans will provide the investor with a specified monthly benefit. This will be distributed to you upon retirement. The amount is predetermined by a formula based on factors which include:

- Employee earning history (T4)
- Tenure of service and age

The annual contribution amount of the IPP is established by an actuary. Since contribution amounts are more expensive they tend to produce greater returns than an RRSP.

Along with greater returns an IPP will save you on taxes. Contributions made are tax deductible by the employer. However being self employed in Canada means you are financing your own policy. Another major plus, is that you will not be taxed on your earned income until it is withdrawn.

For more information on what an IPP is and how it can save taxes for self employed in Canada check out this Scotiabank article on Individual Pension Plans.

7.) Health and Welfare Trust

Another way on how to save taxes for self employed in Canada is through a health and welfare trust. This trust is a tax free vehicle used for corporations to finance its employees’ health care expenses. This can be used by self employed individuals who have incorporated their own business.

The first step to establishing a Health & Welfare Trust is setting up a bank account exclusively for the purpose of health care spending. It must however abide by the CRA guidelines as follows:

a.) Funds cannot be personally used by the employer or used for any other purpose than health and welfare expenses.
b.) Funds contributed to the trust must equal the amount required for the benefit, no more.
c.) Once you have rendered payment terms they cannot be changed during the year.
d.) Withdrawals from the trust must meet the criteria of medical expenses defined by the Canadian tax act section 118.2(2).

By setting up a health and welfare fund you can also take advantage of two key tax savings for self employed individuals.

1.) Contributions made into the trust are tax deductible on your corporate return.
2.) When the trust is used for a medical expense, funds can be withdrawn on a tax free basis.

Thus when you withdraw money from the trust it will not be considered income for tax purposes. Another major advantage of this form of saving is employees can submit medical claims for their dependents.

8.) Multiplying the Small Business Deduction

Another potential tax saving tip for self employed Canadians is multiplying the small business deduction. In Canada, Canadian Controlled Private Corporations (CCPC) will pay federal tax of 11% on its first $500,000 of active business income as opposed to 17%.

This deduction is a major way to save taxes for self employed in Canada. The Canada Revenue Agency realizes how vital this deduction is and has association rules in place to prevent self employed business owners from claiming multiple small business deductions. Under section 256(1) (a-e) of the income tax act you will find a list of associated corporation rules. These rules make it difficult for multiple small business deductions to be claimed by more than one corporation.

a.) Paragraph 256(1)(a): one corporation controls the other:

How to save taxes for self employed in Canada

If your corporation has already used up your small business deduction setting up a new corporation will not work if it is owned by your existing corporation. In the example above if Corporation A has used up its small business deduction. Corporation B is established by Mr. X and sells the majority of its equity to Corporation A. Since Mr. X is the owner of corporation A and is the majority shareholder thus he is the majority owner of corporation B. He will therefore not qualify for multiple small business deductions with both of theses companies.

b.) Paragraph 256(1)(b): Both corporations are controlled by the same person or group of persons:

How to save tax for self employed in Canada

In this example we have a husband trying to get another small business deduction by making his wife a shareholder in his new corporation. However section 256(1)(b) does not allow this. Since Mr. and Mrs. X are considered related persons according to the CRA only one small business deduction will be allowed for both corporations

Tax Tip: If your wife owned 100% of Corporation B and you owned 100% of corporation A then both corporations could qualify for two small business deductions.

c.) Paragraph 256(1)(c): Each corporation is controlled by a person which are related and one owns at least 25% of the issued shares in any class of capital stock in each corporation:

How to save taxes for self employed in Canada

Above we have a similar situation to the example shown in part b. However this time Mrs. X owns a majority share in one of the corporations. Many of you may think that since Mr. X is not the owner of Corporation B theses companies should not be associated. Since Mr. and Mrs. X are married they are considered related parties. Thus under section 256(1)(c) related parties cannot own more than 25% of the shares in each others companies.

Tax Tip: You can take advantage of multiple small business deductions in this situation if Mr. was to own less than 25% of Corporation B’s shares.

d.) Paragraph 256(1)(d): One corporation is controlled by a person and another by a group of people. If the individual is related is related to everyone in the group and owns no less than 25% of the issued shares in the other corporation they are considered associated:

How to save taxes for self employed in Canada

Under this situation Corporation A is associated to Corporation B because Mr. X owns at least 25% of the shares and is the husband and father of Corporation B owners.

Tax Tip: If Mr. X owned less than 25% of the shares in Corporation B then both corporations could have a small business deduction. Furthermore if another owner was added to Corporation B say one of Mr. X’s friends then the association rules would not apply and Mr. X could own as much stake in Corporation B as he wanted.

e.) Paragraph 256(1)(e): Each corporation is controlled by a related group where each member of one group is related to all the members of the other group. In this situation if one of the groups owns over 25% of the shares in the other group they are considered associated:

How to save taxes for self employed in Canada

In this last scenario both corporations are owned by a group which is considered related. Since everyone in Corporation A is related to everyone in Corporation B then the companies are considered connected. If however Corporation A owned less than 25% in B then they would not be connected and could qualify for 2 small business deductions.

About the Author – Allan Madan

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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How to save taxes for self employed in Canada? was last modified: September 16th, 2014 by superAmin
This entry was posted in Corporate and business tax and tagged , , , , , . Bookmark the permalink.

About the author

is a Chartered Accountant, CPA and Tax Expert and enjoys working with business owners, individuals and entrepreneurs.

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

34 Responses to How to save taxes for self employed in Canada?

  1. Gurpreet Singh says:

    I am interested to open a company for self employment and trading . Please Guide your charges.

    • superAmin says:

      Hi Gurpreet,

      Thank you for your inquiry.

      We will be more than glad to assist in in opening a corporation.

      This will include the following:

      -Articles of Incorporation
      -Corporate By-Laws
      -Minute Book
      -Share Certificates
      -Determination of Shareholders,
      -Director’s Resolution for appointment of Directors and Officers
      -Detailed Tax Plan to minimize corporate and personal tax (integrated with the incorporation documents)
      –We will also guide you with the income splitting process

      You may feel free to contact us at the contact details provided in our contact page.

      Thank you !

      -The Team at Madan CA

  2. Vanessa says:

    Very Interesting article. learned a lot

  3. Trina says:

    I spoke to my accountant and he mentioned I should work on getting better internal controls. I was wondering how this will help me save money?

    • superAmin says:

      By having appropriate internal controls it will allow accountants to look at other areas and not have to fix journal entries that may be incorrect. This can add additional time and as such increase your accounting costs. By having weak internal controls income could be wrongly stated leading to a CRA review and penalties added on to your cost.

  4. James says:

    Just curious as to what other benefits incorporating my business will have I hear about a small business deduction available to certain businesses?

    • superAmin says:

      Yes James. If you set up a CCPC you will be able to claim a small business deduction. This deductions reduces your taxable income rate to 11% on your first $500,000 of taxable income

      Thanks

      Allan

  5. Shellby says:

    Hi there just wondering how long the CRA has to audit previous years tax returns. I keep a certain amount of money aside in case I have reported something wrong and was wondering if I can now use that money for my businesses.

    Thanks

    • superAmin says:

      Hi Shellby,

      The CRA may audit your return up to three years back. However, if there was found to be an error in your return or omission made out of neglect, carelessness or willful default, the CRA can audit your return as far back as possible.

      Thanks

      Allan

  6. Tina says:

    I’m spending $450 a month on a dog walker, plus another $100 for food. Not to mention vet fees which can costs up to $500 sometimes. Is it possible to claim any of these expenses on my business or personal tax return? I sure could use some relief.

    thanks

    • superAmin says:

      Hi Tina,

      As a fellow pet owner, I agree it would be great to have a tax deduction for expenses related to pets. Unfortunately, costs related to maintain an animal are not tax deductible. The only exception is if the animal was assisting someone with special needs, such a guide dog for someone who is blind. Then all the expenses can be deducted,

      Thanks

      Allan

  7. Adel says:

    So after reading tip 8 the CRA will allow you to create two separate corporations and as long as each is owned 100% by the husband or wife they will both be eligible for two small business deductions? Is my logic correct?

    Thanks

    • superAmin says:

      Yes you are. If you and your husband each own separate corporations and don’t have any controlling interest in each others than you are both entitled to a small business deduction.

      Thanks

      Allan Madan

  8. Chris says:

    Hi,
    I run my own snow removal business and purchased a new blower in 2013.I was wondering how would I file this on my tax return as a business expense or capital asset?

    Thanks

    • superAmin says:

      Hi Chris,

      The purchase of your snow blower will classify as a capital asset not a business expense. Thus you will need to capitalize it at the given CCA rate. The snow blower would classify under Class 8 or if the snow blower was under 500 dollars, Class 12. You can find more information on the rates through this CRA bulletin.

  9. Matt says:

    Hi there,

    By incorporating, if I am a day trader, I may treat the gains from the stock as Business Income rather than Capital Gains right?

    • superAmin says:

      Hi Matt,

      Day traders may be considered to be carrying on a business. The CRA examines several factors to assess whether a business is being conducted including:

      1) Frequency of trades
      2) Expenses incurred
      3) Length of ownership
      4) Intention to earn profit through ‘quick flips’

      Canadian controlled private corporations in Canada can claim the small business deduction and pay a low rate of tax on business income.

      Thanks,

      Allan Madan, CPA, CA
      Tel: 905-268-0150

  10. jarek says:

    Hi, How do you claim purchase a a cell that is use for the business, don’t see anything under business expenses for it.

    • superAmin says:

      Hi Jarek,

      Smart phones (such as the I-phone) are included in Class 50 of the CCA schedules, and are depreciated at a rate of 55% annually. In the year of purchase, only half of the depreciation amount for the year can be claimed.

      Thanks,

      Allan Madan, CPA, CA
      Tel: 905-268-0150

  11. Justin says:

    I’m a doctor due to work in next few months in Toronto for a period between 12-18 months. I request if you could set up a self employment company for me to be able to save as my wife won’t be working during this period..(for a fee of course)?!
    Cheers

    • superAmin says:

      Hi Justin,

      Medical doctors can open professional corporations in Ontario only if they are permanent residents of Canada, or Canadian Citizens. Are you a PR Card holder or a Canadian citizen?

      Thanks,

      Allan Madan, CPA, CA
      Tel: 905-268-0150

  12. Jim Root says:

    I’m thinking of starting up a new PC repair business with my wife, and have an accounting question. How do I choose the right year-end for my business?

    - Jim

    • superAmin says:

      Hello Jim. Thanks for your question.

      Choosing a year-end for your business can be a tricky subject. These days, all proprietorships and partnerships must report income on a calendar-year basis for tax purposes. If you should choose a non-calendar year date for your year-end, you’ll have to adjust your business income each year to reflect a December 31 year-end.

      Since you have to report your income as though you have a calendar-year end anyway, it may not be worth the hassle to choose a non-calendar year end. Also, because this is a somewhat complex matter, I recommend that you speak with me for further details.

      Regards,
      Allan Madan and Team

  13. Jerome Crewson says:

    Hello Allan. I’m a carpenter that has just opened his own business. When is the deadline to file my tax return this year? Am I still liable for late-filing penalties? What form do you need to complete? If I operated at a loss, do I still file?

    • amadan says:

      As the usual day for filing the self-employed tax return falls on a Sunday, the date for filing has been extended to Monday, Jun 16, 2014. Though you are exempt from late-filing penalties, you are liable for interest or any taxes you owe to the CRA as of the filing deadline. If you aren’t incorporated, you need to fill out a T2125 form as part of your personal tax return to include business revenue and expenses.

      If your business operated at a loss for 2014, it is still important to file a T2125 form to show your activities. Some of these losses may be able to be deducted from employment income. Though you are not expected to see a positive cash flow in the first year, the CRA will want to see that you have a plan

      for generating income.

  14. Rackham George says:

    My wife is going back to work, and we are thinking of hiring a live-in nanny. I understand the nanny would be an employee, and I would I be responsible for CPP, EI, and tax remittances. Would we need to submit a business return? Could we submit other expenses for the nanny other than childcare amounts?

    • amadan says:

      Hello Rackham,

      You don’t need to file a business return if you employ a nanny. However, this means you cannot deduct expenses. You just need to file a T4 return to record your nanny’s income and deductions with the Canada Revenue Agency. You can file more details at the CRA’s website: http://www.cra-arc.gc.ca/esrvc-srvce/rf/t4/menu-eng.html. Since your nanny is renting a space in your home, you can deduct rental expenses to offset the rental income earned from renting space to your nanny.

      If you children are born in 2007 or later, you can claim $7,000 dollars. If they are born from 1997 to 2006, you can claim $4,000. When claiming, the tax deduction is applied to the lower income spouse.

      Regards, Allan Madan and Team

  15. Veronica Santiago says:

    Hey Allan, I am about to open my own catering business. How do CPP plan payments work when you’re self-employed?

    • amadan says:

      Hello. If you are self-employed, you are required to pay both employer and employee portion of CPP/QPP contributions to a maximum. For 2014, the maximum will be increased to $2,425.50. If you’re paying both the employee and employer portions, your maximum will be $4,851. Self-employed individuals can claim a deduction on line 22 of the T1 for the portion of CPP or QPP contributions that represents the employer’s share (one-half of contributions made). Only the portion of CPP or QPP contributions that represent the employee portion qualify for the 15% federal non-refundable tax credit. Regards, Allan Madan and Team

  16. Yao says:

    Hello Allan. I started an online business last year in my home. I make jewelry, clothing, as well as other merchandise. In total, I made about $25,000 in gross sales. Should I claim this on my personal taxes, or is there a way I can claim these expenses that won’t put me in a higher tax bracket? What forms will I need to fill out?

    • amadan says:

      Hello.

      Unless your business is a corporation, the income earned by the business is inseparable from your personal income. This is because as a sole proprietor, the government sees the business as an extension of you. When you fill out your tax return, you will be able to deduct business expenses (these have to be reasonable) to reduce your taxable income. If you are thinking of incorporating your business, make sure you understand both the risks and the steps involved. The form you’re looking for is a Form T2125, Statement of Business or Professional Activities. You can find it at http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/rprtng/t2125/menu-eng.html?=slnk.

      Regards,
      Allan Madan and Team

  17. Camille Michel says:

    Hi Allan,

    I have recently arrived in Canada on a work permit. I have secured a short term employment contract with IBM over the summer. The contract will only last 2-3 months, and I will leave Canada after that time. What is the best business structure to enable payment of the contract? Should I incorporate? I would like to minimize the paperwork, if possible. I will be completing the job remotely from Canada for a US based company, so I will be paid in USD.

    • superAmin says:

      Hello Camille.

      First, I’d make sure that you’re self-employed, and not an employee. This is because contractors can claim deductions that employees cannot. As a contractor, you should be able to work when, where, and how you want. For more information, please visit the CRA at http://www.cra-arc.gc.ca/E/pub/tg/rc4110/rc4110-e.html#employee_selfemployed. Because of the location of the billing, you may be able to claim an exemption for paying HST/GST.

      In terms of business structure, it makes the most sense to operate as a sole-proprietorship. Based on the short amount of time you are here, a partnership and corporation would take too long to set up. Also, there would be a lot of paperwork required, which you stated that you want to avoid. If you want to want to do consulting on a full time business, you can talk to an expert in your host country when you return.

      Regards,
      Allan Madan and Team

  18. Ute says:

    Incredible points. Great arguments. Keep up the great work.

    Feel free to surf to my web blog :: CPA Profit Secrets

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