7 Income Tax Tips for the Self-employed
It’s tax time—everybody’s favourite time of year! Well, maybe not…
One of the reasons it’s “maybe not” is that it sure can be a headache to do all of the paperwork needed to file your taxes, especially of you are self-employed.
So, how can you make this aspect of running a business less painful? I have a few tips for that!
Tip #1: Learn some basic accounting.
Since you are going to be the one who has to do all the paperwork (unless you hire an assistant, or get your accountant to do it all) it’s a good idea to learn some basic accounting.
Here are the basics I think you should be able to do accurately and efficiently.
· Track sales
· Track expenses
· Track PST/GST charged and paid (if you have to charge them to customers)
No matter who does your taxes, whether it’s you or someone else, they need this information, and they need it in an easy-to-use format.
In addition, I also highly recommend you be able to do simple monthly cash flow statements. These may not be required by say, your accountant, but it’s a great way to keep an eye on the health of your business, in an ongoing manner.
The bigger your business becomes, the more important good bookkeeping will be. So start of doing it correctly, from the beginning, and it will be easier to handle when business grows.
Tip #2: Talk to an accountant.
There’s no better way to make sure your paperwork is up to snuff than to have an accountant’s advice. Meeting with them early on in your business (or in your year) means you will get the benefit of their professional advice on how to properly track all of your business transactions. They can give you guidance on how to organize your documents, what totals you need to keep track of, and what you need to have ready when it comes time to file your taxes. That makes your taxes a whole lot easier for you, and your accountant, to manage.
Accountants are also a great resource for identifying all the deductions you may be entitled to. In addition, they can give you recommendations on various tax strategies you can use to reduce the tax you have to pay (or increase the refund you get).
Tip #3: Defer deductions
There are certain deductions that you don’t have to claim in the year they were incurred. Instead, you can leave them until the next year, and claim them then. This makes sense when you expect next year’s income to be higher than this year’s. Those deductions may very well save you more tax next year, than they will this year.
However, not all deductions can be deferred. In fact, relatively few can. But if they are ones you have, then deferring them may be worthwhile to you.
Here are some of the deductions/expenses that you may be able to defer.
Capital Cost Allowance
In simplest terms, this refers to depreciation of assets. Typically, the CRA doesn’t allow you to claim the full cost of a new asset in the year you purchase it. Instead, it only allows you to claim the depreciation of that asset. And the CRA has rules for how much depreciation you are allowed to claim each year, depending on the type of asset.
However, while the CRA says you CAN claim depreciation each year, you don’t have to. Instead, you can defer it to a future year.
So if Rob, who is just starting out as a self-employed professional, makes $10,000 this year, with no other income, his basic personal exemption alone will bring his taxable income to 0. That means any of his asset depreciation amounts, such as that for a new computer, won’t make any difference to how much tax he has to pay (or how much of a refund he gets). So it would make more sense for him to defer the depreciation cost and not claim it until next year, when perhaps his income (and taxes) will be higher, and the deduction might help his tax go down.
Business use of Home
If you work from home, you use at least some of your square footage to run your business. And that square footage may be deductible (as a percentage of your total housing costs such as rent, mortgage, utilities). But if you don’t need the deduction to reduce your tax to zero, you can defer it until the following year.
Medical costs
Technically, medical costs can’t be deferred. But you can pick the end of your medical “fiscal year” (it doesn’t have to be December 31). The rule is that you can claim expenses that fall within a 12-month period, with that period ending on any day in the tax year. For example, for your 2022 return, you can claim medical expenses for the period Feb 1 2021 to Jan 31, 2022, or from Oct 14 2021 to Oct 13 2022, etc. It has the same effect as deferring other deductions: if it doesn’t make any difference to your tax payable this year, maybe it will next year.
However, the higher your income, the less likely you will get any deduction for medical costs. To get this deduction, you generally need high medical costs (at least 6% of your income). So if your income does go up next year, it’s also possible that this deduction won’t work for you.
RRSP
Many people make sizeable RRSP contributions each year, and that can add up to a large deduction. But if your tax is already low, and you expect your business to pick up next year, it can make sense to not claim that deduction in the year you made it. Unlike other deductions, you can defer your RRSP deductions indefinitely. So you can wait to claim it until a year in which that deduction will make a difference to your total tax payable, or the size of your refund.
Charitable Donations
If you give to charity, then deferring that deduction may make sense. This is especially true if your donation is less than $200. That’s because you get a higher deduction (29%) if your donation is above $200. For total donations under $200, you an only deduct 15%. So, saving your deduction from this year, and adding it to next year, may bring your total donations next year to over $200, giving you a larger deduction.
Tuition
You can defer tuition costs you paid for your own education, or for that of your dependents. This can result in a significant deduction, since tuition fees are so high. But if claiming it this year doesn’t make your total tax payable go down very much, then deferring it to next year might be a better idea, especially if you expect to make less then.
One final note about deferrals: You don’t necessarily have to defer the whole amount of these deductions/expenses. You can deduct some in one year, and defer the rest to the future. Also, for most deferrals, you can only defer them to the next year, or in some cases the next few years. So you can’t wait indefinitely.
Tax tip #4: Use tax software
Tax software can make doing your taxes MUCH easier. Here are some of the benefits of using them.
1. They do the math for you (who doesn’t love that?)
2. It is much faster than doing it on paper
3. They automatically capture various deductions that you might otherwise miss.
4. You can immediately see the effect that adding or deleting an expense or deduction has on your tax due/refund expected. This makes it easy for you to determine whether or not you should defer that expense to the following year.
5. You can file online (and get your refund, if you are expecting one, in less than 2 weeks)
And you don’t even need to spend money on a package. Every year, the CRA provides a list of tax software that it recommends. Several of these are free and can be downloaded straight from the CRA’s website. (Learn more about CRA Certified Tax Software)
Tax tip #5: Use Accounting software
It is much easier to do your ongoing paperwork throughout the year if you use an accounting software package. They are fairly easy to use, and will make your life a whole lot easier. And, when it comes time to filing taxes, it makes THAT a whole lot easier too, because the software generates many of the totals you need to enter into your tax software or forms.
Tax tip #6: Start charging PST/GST
Many newly self-employed professionals dread reaching the income level at which they have to start charging their customers tax. Not only does it complicate the business’ paperwork, there is a feeling that the resultant higher cost may chase away potential customers.
Generally speaking, I don’t find the latter is the case. And there can be huge financial benefits to your business if you DO charge your customers tax. That’s because the CRA allows you to claim, as an expense, any PST or GST you pay on products or services you buy in order to run your business. But that’s only the case IF you charge your customers those same taxes.
Known as Input Tax Credits, these tax refunds can mean hundreds or even thousands of dollars per year back in your pocket. This can be particularly true for the first year or two of your business, when start up costs can be high.
Tax tip #7: You have until June 15 to file
If you are self-employed, you have an extended filing deadline. You don’t have to file your taxes until June 15. HOWEVER: if you OWE money, that is still due on April 30.
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I hope these tax tips are of help to you. Just remember, I’m not an accountant, so make sure you check with your own accountant to determine which of these tips will work for your particular situation.
Cheers,
Tim
Helping you engineer the business of you
Information in this article is for general purposes and is not intended as professional advice.