Tax deductions are important tools for small businesses to lower the overall tax bills.
Whether you are running a brick-and-mortar hair salon or a blog online, you know that starting and maintaining a small business requires a lot of hard work, passion, and dedication. Many of us with an entrepreneurial spirit dream about one day being able to support ourselves fully through our small businesses. Or perhaps you already are!
No matter what your situation is, as long as you have some income, you have to file your tax return and pay taxes. There is no escape around that. Yes, that means that for every $100 earned, you cannot spend it all! You need to set aside at least a portion, and I recommend at least 30%, to give back to the government.
With COVID impacting small business owners especially hard, it is more important than ever to talk about tax deductions that are available for small businesses, so you can keep as much as possible in your pocket to support yourself and your family. Thanks to these deductions, your overall tax rate is lower than if you earn a regular salary as an employee of a company. This is because you only have to pay taxes based on the income after deduction.
So, what are these deductions? Below are some common ones that you should take full advantage of to reduce your tax bill.
Note that these deductions are based on the Canadian taxation system. However, I am confident that many of these tax deductions for small businesses also have their equivalent counterparts in your home country. Therefore, no matter where you are, I still recommend that you read through this blog post!
The general premise is that sole proprietors can deduct any expenses as long as they are incurred for the purpose of earning income. You can even claim a loss if your expenses exceed your income. The only exceptions are home office expenses, which cannot exceed business income.
You can claim 50% of the meals you consume, either because you are travelling for work, or because you are taking out a client. Of course, you cannot claim any meals that you eat alone or with your family.
The 50% rule is very important, so keep that in mind.
Does the 50% include GST/HST/other sales tax that is charged on the meals? This depends on whether you are a GST/HST registrant and whether you claim input tax credits. If you are already claiming the input tax credit for the same meal, then you cannot deduct it again here as a business expense. The principal here is pretty straightforward: you cannot claim the same thing twice!
The entertainment cost is subject to the same principle as meals: you can claim 50% of the entertainment cost while you take out a client. Your personal entertainment costs, whether you are travelling or not, are not deductible. The same rules about GST/HST also apply to entertainment.
Are you thinking about spending some money on ads, flyers, and other promotional materials to help promote your business? Congratulations, all of these are deductible expenses!
This is pretty straightforward. If you have to rent a space to operate your business, then the rental cost is deductible.
This one is a no-brainer. Have you incurred any travel expenses such as taxi or Uber, hotels and airfare? As long as these travel expenses are legitimately for your business, then you can deduct them against your income to reduce your tax bills.
Are travel vloggers and bloggers able to deduct travel expenses related to their vacations?
This is a bit of a grey area because there is quite a bit of overlap between personal entertainment and business. There are specific requirements that dictate whether your blog is a business or a hobby.
According to Business Insider, these requirements include whether:
- You carry on the activity in a businesslike manner and maintain complete and accurate books and records
- The time and effort you put into the activity indicate you intend to make it profitable
- You depend on income from the activity for your livelihood
- Your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business)
- The activity makes a profit in some years and how much profit it makes
Therefore, starting a travel blog as a side hustle and immediately start expensing your vacation costs will get you the kind of attention from tax authorities that you don’t want. However, if you are a travel blogger whose livelihood depends on the income from the blog, and you can show that you are generating a profit from your business even after the deductions, that you have a good case to make!
This pretty self-explanatory category actually has some nuances.
Gas, insurance and license
Let’s start with the most obvious. Your gas, insurance and license costs are deductible, as long as you use your car for business purposes. If you use the same car for personal and business purposes, however, you can only deduct the portion that is strictly for business. Nope, your trip to the grocery store does not count as a business expense.
Your parking costs are also deductible, if, again, they are for business trips.
If you need to have minor repairs done on your car, these costs are deductible as well. I want to emphasize this one because this is one of the tax deductions that many owners of small businesses overlook.
Interest on car loans
Now, this gets a bit more interesting. Interest on car loans is deductible, but it is subject to certain limits. After all, you don’t need a luxury car to conduct business in most cases, especially when you need a loan to pay for it!
In Canada, the amount deductible is the lesser of:
- the actual amount paid or payable
- $10 per day for which interest was paid or payable
If you conduct business in a different country, you will want to check with your home country’s tax authority to find out the exact limit.
Want to save money on cars? Check out this blog post of mine to find out!
All supplies used up entirely during the year for business purposes are eligible for tax deductions for small businesses. These include shampoos and conditioners for a hair salon owner, pens, paper, staples, etc.
Note that supplies that can be used year over year cannot be deducted this way, because they belong to a different category called capital assets. They follow a different set of rules that I will outline below.
Capital cost allowance
Any equipment that is used by the small business owner over a period of time (rather than one-time expense) to produce income is classified as a capital asset. Items ranging from as small as calculators and laptops to as big as buildings are all capital assets. Given the wide variety of capital assets, they are classified under different classes, with different sets of rules applied to each.
Because these capital assets are used over a period of time, in 95% of the cases, you cannot deduct the full amount in the year you acquire the assets. The only exceptions are small items that fall under Class 12, such as books that are part of a lending library, cutlery, kitchen utensils and other tools costing less than $500, and linens and uniforms, and zero-emission vehicles that fall under Class 54.
You can claim capital cost allowance for all your capital assets against your income to lower your tax bill.
Here is a simplified example of capital cost allowance (CCA) for a laptop that you purchased for $1000.
Laptops fall under Class 50, and the rule states that you can claim up to 55% of declining balance, and the Accelerated Investment Incentive (AIIP) applies.
This means that in the first year, you can claim CCA up to $1000 x 1.5 (AIIP) x 55% = $825. The undepreciated capital cost (UCC) at the end of the year will be $1000 – $825 = $175.
In year two, your maximum CCA claim is $175 x 55% = $96.25. Your UCC at the end of the year will be $175 – $96.25 = $78.75.
The above example assumes that the laptop is 100% for business use. If you mix personal and business purposes, then again, you can only claim the portion for business.
Note that you do not have to claim the full amount of CCA available. For example, if you already have a business income loss because your business is just starting up, then you may want to forego claiming CCA altogether this year and wait until you generate a profit before you claim the deduction.
Professional and union dues
Accountants, lawyers, doctors, and many other professionals need to pay for professional and union dues year over year to maintain their status with their professional associations. These dues are all tax-deductible.
Salary to assistant
This is fairly straightforward. If you hire a freelancer to help you with some blog posts, or a social media expert to help you manage your social media accounts, or an employee to help you run your restaurant or hair salon, then all the expenses associated with hiring help are legitimate tax deductions that owners of small businesses like you should make use of.
Can I deduct the salary paid to family members?
If you have family members who are legitimately helping you run the business, then yes, you can deduct the salaries paid to them.
There are two caveats, however:
- You can only deduct salaries according to the market rate, regardless of how much you actually pay them. For example, if you are paying your partner $80,000 for a part-time job with a $40,000 annual market rate, then you can only deduct $40,000 from your income, even though you may very well be paying your partner the full $80,000.
- Your family members will have to pay taxes on the earnings themselves.
Long-distance telephone calls
If you have to make many long-distance phone calls because of your business, then yes, you can deduct them for tax purposes.
Home office expenses
For many small business owners who operate out of their homes, this is the category of tax deductions for small businesses you cannot miss. Home office expenses also get the most scrutiny out of all the business expenses, so you must make sure that you are aware of all the rules and follow them strictly to avoid any bad surprises.
One important thing to note is that you cannot claim home office expenses to create business losses. That is, if your net income is already below zero after subtracting all the other business expenses mentioned above from your gross income, then you cannot claim home office expenses. However, these expenses can be carried forward into the future, and you can claim these tax deductions when you make a profit from your small businesses.
Here are the most common types of home office expenses you can claim:
Your water bills, your electricity bills, etc are all legitimate tax deductions if you operate from home.
This may be an overlooked area for many small business owners. If you hire someone to come and clean your house, then the cleaning fees are deductible.
Cleaning materials and light bulbs
Believe it or not, these expenses are also deductible. Although cleaning materials and light bulbs probably don’t occupy a large chunk of your budget, if you can deduct them, then why not?
Minor repairs related to your home office are also another category of tax deductions small businesses owners can claim. Note that the minor repairs must be for your home office. If you need to repair something in your master bedroom, then sorry, it is not business-related and you will have a hard time justifying to the tax authority if you decide to claim it.
Homeowners pay property tax. If you happen to be a homeowner who works from home, then yes, you can deduct property tax from your income to reduce your overall tax bill.
If you have home insurance on your property (and if you don’t, stop reading this blog post and go get it first!), then you can claim insurance as a tax deduction as well.
If you have to pay the mortgage on your home (and kudos if you are done with the mortgage!), then the interest on your mortgage is a tax deduction available for small business owners.
Note that only the interest portion is deductible. The principal payment of the mortgage, on the other hand, is not. But it is the principal payment that helps you build equity in the house.
Click here if you want to learn some mortgage tips to help you save money!
If you rent your home and works from home, then you can deduct the rental cost as well. One big reminder is that you can only claim the portion of the rent that is associated with the business, not the full amount.
If you ever have to rent equipment, such as a laptop or a printer, for your home office, then the rental costs are also tax-deductible.
An important caveat on home office expenses
One very important caveat is that you can only claim home office expenses on the portion of the home that you use. For example, if you work from a den or study that is 10% of the total space of your home, then you can only deduct 10% of your utilities, insurance, property tax, mortgage interest, rent, etc. Claiming a very high home office expense amount can very likely get you flagged by the tax authority.
Tips on claiming tax deductions for small businesses to avoid bad surprises
Other than familiarizing yourself with all the tax deductions available to business owners, you will want to use the following tips to avoid a bad encounter with your tax authorities.
Keep all your receipts
You will want to keep all your receipts for meals, entertainment, purchase of supplies etc, in case of an audit.
I recommend that as soon as you receive a receipt, you write a small note on it, and write down the 4 W’s: when, where, what, and why. This is because you may not get audited till three years after the event, and you will very likely have forgotten why you spent the money, let alone justify it.
This is especially important if you are mixing personal and business uses. (e.g., your laptop and your home office). You will want to document how you calculate the portions for business use.
This is quite a long post with lots of information! I hope you find this helpful in your journey as a small business owner. If you have any questions or require any clarification, leave a comment down below!
If you are interested in becoming a small business owner by starting a blog, you will not want to miss these posts below:
- Laughter and Tears: a Newbie’s Key Blogging Tips Learned
- Ultimate Resources List (including resources to start and maintain a blog!)
- How I have Grown as a Blogger, and as a Person
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