Self Employment Tax Deductions
The T2125 Statement of Business or Professional Activities - Line By Line

by L. Kenway BComm CPB

Self employment tax deductions create tax benefits and tax savings for home based business owners like you.

Are you looking for a little assistance on how to fill out Form T2125?

In this chat, we'll be spending some time looking at certain sections of Form T2125 Statement of Business or Professional Activities that may help you gather the information required to prepare this tax form.

As a self-employed business owner, you have a tax planning opportunity to reduce your taxes through some favorable tax rules and income calculations. By knowing what business expenses are tax deductible, you can reduce your business taxes.

Annual tax preparation isn't really fun but it is necessary, so learn all you can to make it a bit more enjoyable. Refill your teacup so we can get started!



Reminder

Before I begin I would like to remind you there is a difference between information and advice. The information provided in this article or on this site should not be construed as advice. Please make yourself familiar with my disclaimer.


Index for Home Business Taxes Series
Click on any image below to go to the chat.

Chat 1

What's not deductible checklist for the sole proprietor in Canada.
  • Sole Proprietors
  • Tax Deduction Checklists
  • What Is NOT Deductible

Chat 2

What's deductible checklist for the sole proprietor in Canada.
  • Self-Employment
  • Tax Deduction Checklist
  • What Is Deductible

Chat 3

Home business taxes forum
  • Home Business Taxes
  • Common Q & A
  • Forum

Chat 4

How to claim home office expenses.
  • How To Claim Home Office Expenses

Chat 5

Business use of your personal vehicle
  • Business Use of Your Personal Vehicle

Bonus Chat

How to claim your ITCs for your vehicle.
  • How To Claim ITCs For Your Vehicle

Home Business Taxes Part 2

Sole proprietors, learn your allowable tax deductions on form T2125.

U.S. visitors, see my chat on self-employment tax on your net earnings.

You'll also find information on U.S. tax deductions at the IRS Self-Employed Individuals Tax Center.

NASE's Schedule C: A to Z: The Sole Proprietor's Guide to Tax Savings is excellent!

Brief Recap of Home Business Taxes Part 1

In the first part of this series, you learned how you were taxed as a self-employed business owner. The Tax Act lays out what expenses are not deductible and what are partially deductible. These were discussed in Part 1.

The tax reporting form T2125 was introduced in 2009 by the Canada Revenue Agency (CRA). It combines two old forms; T2124 and T2032.

I wrote a separate article on Home Office Expenses because there are strict criteria that must be met to take this deduction.

You may also want to read the article on Voluntary GST Registration as a tax planning opportunity to recover your startup costs and business input tax credits if you are under the $30,000 mandatory registration threshold.

Part 3 of this articles deals with Q&A on self employment tax deductions including the home business taxes forum.

Allowable self employment tax deductions is our topic for this article. Let's review them to make your income tax preparation easier.


Take a Look at Canada Revenue Agency's Form T2125

This chat should help you gather the information your accountant will need to prepare Form T2125 for your business.

Form T2125 Statement of Business or Professional Activities is five pages and details all your allowable business deductions. It is a good idea to have it open in a separate browser window while we go through the deductible expenses ... as I'll make reference to the line numbers.

Line 8521 through line 9970 details all your deductions. If an expense isn't listed, it may still be an allowable self employment tax deduction if it meets the test discussed in the next section General Rules for Deductibility. If it does meet the criteria, report it on line 9970.



There are a variety of structures the company can operate within - proprietorship, partnership, or corporation - but what is common to each is that the government must rely on your self-assessment, so the onus of proof for all the income and expenditures, and why you have made them in the way you have is on you, too.

-- Evelyn Jacks, author of Master Your Taxes --
I recommend this book



General Rules for Deductibility

The general rule to keep in mind when doing home business tax planning and spending in your business is ...

... the expense must be reasonable, not personal in nature, made with the expectation of profit, and have original supporting documentation.

Therefore it is always advisable to keep a Business Journal.

Another thing to always keep in the back of your mind is that capital expenditures such as office renovations, equipment or office furniture are treated differently for accounting and tax purposes than operating expenses which are required for day-to-day operation of your business.

This means operating expenses are 100% deductible (unless there are specific limitations) while capital expenditures must adhere to capital cost allowance (CCA) rates.

If you think back to our discussion in Part 1 on how you are taxed, to reduce your taxes, you want to maximize your legal deductions. Knowing what is deductible for tax purposes should help in your spending decisions ... but never make your business decisions solely on tax considerations.

Remember too that one of the criteria is the expectation of profit. This means at some point you should be earning a profit ... which means you pay taxes. There are only five ways to pay no tax ... and each one means you are not running a successful, profitable business. Your job, as a small business owner, is to learn how to legally minimize your home business taxes owing.



LET'S CHAT ABOUT ...

Vehicle Expenses on Line 9281

Let's get this topic out of the way ... because it is a popular one when discussing self employment tax deductions! It is always scrutinized during an audit.

As a matter of fact, it is so popular, it has its own article titled Business Use of Your Personal Vehicle. It explains how to claim your business vehicle expenses.

How to claim business use of your personal vehicle.

There are special rules to deduct your input tax credits for your personal vehicle ... which you can read about here.

Now let's move on to your regular day-to-day operating expenses ... to see what self employment tax deductions are available to you and your business.



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Advertising - Line 8521

It is not uncommon when working from home to have self employment tax deductions for advertising. But here's what you need to know ...

Canadian ads originating in Canada ... and finder's fees are 100% deductible.

Advertising in periodicals directed to a Canadian market with 80% or more Canadian editorial content is too.

Advertising in periodicals directed to a Canadian market with less than 80% Canadian editorial content has limitations.

Ads with foreign broadcasters directed mainly to a Canadian market are not.

It is my understanding that if foreign ads are taken out specifically to obtain customers from outside of Canada, then it is deductible.

Meals and entertainment cannot be claimed here. They must be claimed on line 8523 and are subject to limitations.

Read my chat below to determine whether any of your website outlays can / should be classified as advertising.




LET'S CHAT ABOUT ...

Web Related Outlays ... and
How to Classify These Home Business Tax Deductions

Domain registrations, web hosting services, web design services ... where do you classify these self employment tax deductions? Are they an eligible capital expenditure, a license or an expense? It depends on the purpose of your website and on the time period ... so read this whole section before you make your choice.

Here is my opinion on your self employment tax deduction options ... but you really need to discuss this with your accountant as it depends on your unique situation.

Domain registration could be categorized as advertising on line 8521, if the purpose of your site is to advertise and promote your business and/or products and services.

When deciding how to record web related outllay, make your decision based on fact.

You could also choose dues and subscriptions on line 8760 as a category if the fee is only for a one year or less time period ... and your site is used to provide information more than for advertising.

If you paid over $500 for the domain name and registration .... and it has a life that is greater than a one year time period, you need to capitalize it under class 14 - licenses if it is for a limited period or classify it as an eligible capital expenditure (property that does not physically exist but gives you lasting economic benefit) and take an annual allowance on line 9935 if it has an unlimited period. The majority of domains allow the registrant an automatic right to renewal for an indefinite period. You can read more on this in Chapter 5 of the CRA Guide to Business and Professional Income (T4002).

Web hosting services could be categorized as advertising on line 8521 or other expenses on line 9270 ... again it depends on the purpose of your site. It is also possible you may want to classify them on line 8760 dues and subscriptions, if you pay a monthly subscription fee.

Are you looking for information on internet sales and GST/HST? You'll find the information in my article on Self Employment Tax Deductions - Q&A.

If you paid over $500 for web design services, you run into ITA (Income Tax Act) limitation rules. This type of self employment tax deduction would be capitalized under class 50 (computer related amounts) ... because the web site will last more than one year.

An argument could be made to expensing the whole amount and categorizing it under other expenses on line 9270 ... but as it is a gray area, I would leave that decision to your accountant as you need to be able to support your classification if you are audited by CRA.

There is a good article on the IPBC website that answers the question, "How do you account for website development for tax purposes?". The CICA Handbook Emerging Issues Abstract EIC-118 "Accounting for Costs Incurred to Develop a Web Site" is discussed.

Costs are broken into 5 categories:

  1. planning-expense it,
  2. website application and infrastructure development-capitalize it,
  3. graphics development-capitalize initially then expense,
  4. content development-expense it, and
  5. operating costs-generally expense it.

EIC-118 has an appendix classifying the various activities under each stage of development.

You can find the complete IPBC article at ipbc.ca> Free Resources> Free Newsletter> Click here to view archived newsletters from over the years> IPBC Newsletter - October 19, 2009.

CCH Site Builder (cchwebsites.com) quarterly newsletter dated February 2011 Issue 15 has a good article on What the CRA is Saying - Web Page Costs. It states that "the question of whether an expenditure is on account of income or capital is made with reference to the purpose of the expenditure and whether it was made for the purpose of bringing into existence an asset of enduring value"; therefore an analysis of the different components would be required to determine if a cost should be expensed or capitalized.

As you can see, this is a complicated area in self employment tax deductions. When deciding whether a web development cost is to expensed or capitalized; make your decision based on fact and follow CRA's IT-128 guidelines to assist in your decision making as the ITA has no specific provisions for website development costs.

For further guidance, see CRA access letter 2013-0507121e5.



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Bad Debts Line 8590
Recovery of Bad Debts Line 8230
Reserve For Doubtful Accounts Line 9270
Reserve Deducted Last Year Line 8290

Specific accounts receivable (not allowances for doubtful accounts) that have been written off to bad debt expense and were previously included in your income, are tax deductible on line 8590.

If you subsequently recover this bad debt ... and because you took a tax deduction on this amount in a prior year, you must show this recovery of bad debt as income for tax purposes on line 8230 (Part 3 - Gross business or professional income) of Form T2125 in the year the recovery was made.

Learn how to write off bad debts to report on your T2125 tax form.


I just want to take a moment to talk about the difference between the accounting treatment versus tax treatment of bad debts ... because it can be a confusing self employment tax deduction ... and it affects your GST/HST return.



LET'S CHAT ABOUT ...

Reporting Bad Debt

How do you choose between the two methods below? It depends what type of financial statements you are preparing. Read this chat to determine what is best for your business.

GAAP Basis
(accounting treatment)

There are two allowance methods acceptable in GAAP for recording bad debt expense. One method is the Estimation of Bad Debt Expense and the other is the Net Realizable Value of Current Receivables method.

But you may be wondering how to reverse a bad debt write-off once the customer has paid in full. Under either of the above allowance methods, when you recover a bad debt from a customer, you book the following entries in your books so you have a good customer history:

Debit the customer's account in Accounts Receivable (including tax) (current asset)

Credit Allowance for Doubtful Accounts (net of tax) (a contra account in the current asset section of your balance sheet)

Credit HST, GST and/or PST Payable accounts (current liability accounts on your balance sheet) See the sidebar on How Bad Debt Affects Your GST/HST Return

This entry placed the receivable back into the customer's account, in effect reinstating the receivable. The next entry shows the recovery of the bad debt.

Debit Cash in Bank (current asset)

Credit Accounts Receivable (including tax) (current asset)

Booking the recovery in this manner allows you to remember the customer's past credit history. It gives you the option of declining future credit to the customer or limiting the amount of credit you are willing to extend.

So now you can see from the accounting side, how to handle bad debt. However, with that said ...

... neither of these allowance methods is acceptable for reporting bad debt for tax purposes on line 8590.

So let's look at how you deduct bad debt when dealing with self employment tax deductions.


Tax Basis
(tax treatment)

For self employment tax deductions purposes, you must use the Specific Write-off method. This method is not in accordance with GAAP because it does not apply the matching principle.

Now that being said, Bulletin IT-442R says you can report your doubtful allowance on line 9270 (excluding the specific write-offs as said above) as a reserve. The next year you must take the reserve into income on line 8290 (Part 3 - Gross business or professional income) ... and book a totally new reserve but ...

... as with the bad debt write-off, your doubtful reserve must identify which debts are doubtful which the GAAP allowance methods do not do.

If you were doing your books on a tax basis, then you would write-off your bad debt using the specific write-off method as follows:

Debit Bad Debt Expense (net of tax) (expense account on the income statement)

Debit HST, GST and/or PST Payable accounts (current liability accounts on your balance sheet)

Credit Accounts Receivable (including tax) (a current asset account on your balance sheet)

To record the recovery of a debt previously written off, you need to reinstate the receivable and bring the recovered debt back into income. Your entry would be:

Debit Accounts Receivable (including tax) (a current asset account on your balance sheet)

Credit Bad Debt Recovered (net of tax) (income account on the income statement)

Credit HST, GST and/or PST Payable accounts (current liability accounts on your balance sheet)

The next entry shows the receipt of the funds.

Debit Cash in Bank (current asset)

Credit Accounts Receivable (including tax) (current asset)


GOOD TO KNOW

How Bad Debts Affect Your GST /HST Return

Are you like me and wonder ... what lines 104 and lines 107 are for on your GST/HST return?

I learned this from The Jacks Institute Small Business Tax course in the late 90's.

On line 107 (Adjustments) of your GST/HST return, you report your ITCs pertaining to a bad debt write-off previously included on line 103. See 

Any subsequent recovery of the bad debt requires an entry to line 104 (Adjustments) for the ITC portion of the entry.

You can find detailed instructions in the CRA publication RC4022 General Information for GST/HST Registrants under bad debt adjustments and / or bad debt recovered or go to the following URL: cra-arc.gc.ca/tx/bsnss/tpcs/gst-tps/bspsbch/rtrns/djstmnts/bddbts-eng.html


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Insurance Line 8690
Fuel Costs Line 9224

Business insurance is an allowable self employment tax deduction.

Business insurance is an allowable self employment tax deduction. Include regular business insurance expenses on line 8690 ... and the cost of gas, diesel and propane on line 9224.

Do NOT report life insurance premiums, vehicle insurance or fuel expenses, or home insurance here. Follow the links to see where they are reported.


Interest Line 8710

Generally, you can deduct interest on money borrowed or land acquired for business purposes.

Do NOT report vehicle loan related interest here.

Fees paid to get a loan, buy or improve property, reduce loan interest or prepay a loan are all deductible ... I think you get the picture.

Fire insurance appraisals and business insurance appraisals are two self employment tax deductions that are claimed on this line ... I know very odd. I'd have chosen to deduct them under insurance.

All fees related to buying or improving business property are deducted over a five year period and are not tied to any loan period.

Guarantee or stand-by fees, filing fees however are deductible in the year they are incurred.

You have the option of capitalizing your interest expense pertaining to money you borrowed for depreciable property, resource property or E&D costs.

Bank service charges (if you have a separate business bank account) are deducted on line 8871 - Management and administration fees.

You cannot deduct interest expenses related to your home office. This self employment tax deduction must be claimed on line 9945

It is worth your time to read up on this self employment tax deduction in CRA's T4002 publication.



Dues and Subscriptions Line 8760

Business taxes (not income tax though) and business license fees are an allowable self employment tax deduction. Report these expenses on line 8760.

Also report dues, memberships in a trade association, and subscriptions amounts if they pertain to running your business or trade on this line.

Read about club dues and memberships here ... they are dealt with separately.




Tax talk can be exhausting. Let's take a short break by taking a quick poll.


Home Business Taxes

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Please enter the word that you see below.

  


Okay let's keeping moving along with our discussion of
Self Employment Tax Deductions.


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Office Expenses Line 8810
Supplies Line 8811
Delivery Line 9275

Line 8810 is where all the self employment tax deductions pertaining to running your office go .. copy paper, envelopes, toner, paper clips ... but NOT capital items like office furniture or equipment.

Capital items go on page four of T2125 Capital Cost Allowance ... Areas B Additions or D Deletions and then totals are carried up to Area A CCA claim.

Supply items that indirectly help you provide your service or product are reported on line 8811.

Self employment tax deductions like business delivery, freight and express expenses are claimed on line 9275.

It's interesting to note that the IRS definition of supplies allows you to claim coffee, bottled water and food for clients under supplies as well as off the shelf software.

In Canada, coffee, bottled water and food for clients should be claimed under meals and entertainment as it can be consumed by humans. An argument could be made for deducting off-the-shelf software under $500 here though.


Professional Fees Line 8860

This is the spot to deduct legal fees, accounting fees, consulting fees, bookkeeping fees, tax preparation fees and tax compliance fees.

You can also deduct objection or appeal fees for accounting and legal work pertaining to government assessments.

Fire insurance appraisals and business insurance appraisals are deductible on line 8710 - Interest.

Look here for what is not deductible as an expense.


Management and Admin Fees Line 8871

Include your bank service charges here.

Do NOT claim salaries, property taxes or rent here.

Meals and Entertainment - Line 8523

Meals and entertainment limitations are discussed in Part 1 of this series. This self employment tax deduction item is a frequently audited area.

Make a note that coffee, bottled water and food for clients should be claimed here as it is consumable.

6 company lunches or parties a year are tax deductible.
The meals and entertainment 50% limit does NOT apply in the following situations:
  • You are in the hospitality industry and the expenses were to provide food, beverages, or entertainment to paying customers.
  • It is related to fundraising for a charity.
  • You billed your client for the expenses.
  • It is included in an employee’s income.
  • The employee cannot be expected to return home daily (such as work camps).
  • It is a special work location (at least 30 kilometers from a city with 40,000 plus in population).
  • It is a company party for all employees (6 per year limit).
  • You attended a conference, convention or seminar (2 per year).

See CRA's publication IT-518R Food, Beverages, and Entertainment Expenses for more detailed information about exceptions to the 50% meal limitations.

I'm going to repeat this as it is important. This area if always audited so be very familiar with your self employment tax deduction rules.


Rent Line 8910
Repairs and Maintenance Line 8960
Property Taxes Line 9180
Telephone and Utilities Line 9220

These self employment tax deduction items are allowed BUT ... anything related directly to your home office must be claimed through home office expense.

Also make yourself aware of this labor limitation when deducting the cost of labor and materials for MINOR repairs and maintenance to property.

Phone equipment is not expensed but capitalized on page four of T2125 Capital Cost Allowance ... Areas B Additions or D Deletions and then totals are carried up to Area A CCA claim ...

... and make sure you understand this limitation on your home phone line before you make your claim for business use of your home phone line.

Computer and other equipment leasing costs are claimed on line 9270 NOT as rent on line 8910. Please note that if you buy a computer or other equipment, you cannot deduct the cost ... but you can deduct CCA and interest on borrowed money to purchase the equipment.


Salaried and Indirect Wages Line 9060
Direct Wages Line 8340
Subcontracts to Outside Help Line 8360

Deduct salaries, wage, employee benefits and payroll taxes (CPP, EI) that are reported on T4s on line 9060 with the following exceptions:

  • direct wage costs are reported on page 2 line 8340 of the T2125 Part 4 - Cost of goods sold and gross profit ;
  • subcontract amounts paid to outside help are reported on page 2 line 8360 of the T2125 Part 4 - Cost of goods sold and gross profit; and
  • your draw or equity withdrawals are reported in the equity section on the bottom of page 3 of the T2125.

Wages paid to family members must meet specific criteria and be T4d annually.


Travel Line 9200

These costs incurred for business purposes are deductible and include public transportation fees and hotel accommodations.

Meals and entertainment have limitations and are discussed in Part 1 of this Home Business Tax series. They are generally reported separately on line 8523 (see above).

However, unlike convention meals, S. 67.1(4) of the Tax Act does not require any adjustment for your meals when they are included in your ticket for travel on bus, airplane, or train.

Convention expenses will be discussed in the Other Expenses Line 9270 immediately following.


Other Expenses Line 9270

CRA is quite specific of what type of self employment tax deductions they want claimed here instead of other lines ... so here goes:

  • disability related modifications;
  • computer and other equipment leasing costs;
  • property lease payments ... but you do have the option to capitalize this instead so you claim interest expenses and CCA instead;
  • convention expenses - 2 per year IF they relate to your business or professional activity AND are held by an organization in the same geographical area where you normally conduct business; (Make sure you see conference expense notes below on what you can't claim.)
  • allowable reserves;
  • private health services plan premiums if you meet certain conditions;
  • plus other legitimate business expenses not listed previously on Form T2125.


Self employment tax deductions you do NOT claim on this line:

Do NOT claim lease payments related to vehicles on this line. See Auto Expenses on Line 9281.

If you bought a computer or other equipment, you cannot deduct the cost ... but you can deduct CCA and interest on borrowed money to purchase the equipment.

The Tax Act, in S. 67.1(2) and S. 67.1(3), has special rules for convention meals. You should deduct $50 per day from the convention fees for meals and beverages (if it is not separately itemized on your bill) ... and report it on line 8523 subject to the stated limitations of 50% deductibility.

If you add on a personal vacation to the convention trip, you must prorate expenses between business and personal. Usually the travel to and from the convention, accommodation for the convention and convention meals are fully deductible.

Of interest to you may be this August 28, 2009 CRA release GST/HST Memorandum 27*2: Conventions. In it, what is a convention and what is not a convention is discussed.

In The Bookkeeping Forum, a question was asked about the difference between a workshop and a conference.


BOOKKEEPER'S HANDY REFERENCE

CRA Guides on Business and Professional Income

If you require more information on self employment tax deductions, the main CRA guide is Publication T4002 Business and Professional Income.

There are other pamphlets and booklets published by CRA on the subject as well. For example, using your home for daycare has a separate publication as does food, beverages and entertainment and motor vehicles. Here is an index to them all - Business and Professional Publications and Forms.



I am leaving discussions of capital properties for another article as this one is focused on self employment tax deductions.

I would like to make the point that you may have legitimate business expenses that are not tax deductible. These should still be tracked and recorded in your books in accounts that are clearly labelled as not tax deductible. Why? You want to know the true cost of operating your business.

I know this all sounds very complicated but ... if you have been doing your record keeping through the year and ... use a software program like QuickBooks ... you just have to print a report and you have all the information you need for preparing your tax return.

That's why I have called this series a tax planning opportunity. By knowing and learning the rules ahead of time, you can record your transactions into the proper accounts while you are taking care of normal day-to-day operations, making tax time a breeze and ...

... NO BIG SURPRISES which is always nice. Tea anyone? :O)



It's been great chatting with about bookkeeping today.

It's been great chatting with you .
Your tutor Lake


Main sources for this article are my notes from various tax classes, seminars and the CRA website.

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