As a sole proprietor, you and your business are considered one entity for tax purposes. This means you report your business income and expenses on your personal tax return using Form T2125, Statement of Business or Professional Activities.
Understanding what you can and cannot deduct is crucial. You can deduct ordinary and necessary expenses for running your business, including advertising, supplies, professional fees, insurance, and business use of your home. Keep detailed records and receipts for all business expenses.
The home office deduction can provide significant tax savings, but you must use the space exclusively for business. Calculate the percentage of your home used for business and apply that percentage to eligible expenses like rent, utilities, insurance, and maintenance.
Vehicle expenses are another common deduction for sole proprietors. You can use either the actual expense method or the simplified method based on kilometers driven. Keep a detailed log of business-related travel, including dates, destinations, and purpose.
Do not forget about eligible tax credits. The Canada Employment Amount, medical expenses, charitable donations, and RRSP contributions can all reduce your tax bill. Review available credits to ensure you are claiming everything you are entitled to.
Sole proprietors must also pay CPP contributions on their net business income. Unlike employees who share CPP costs with their employer, sole proprietors pay both the employee and employer portions. Plan for this additional expense when estimating your taxes.
If your net business income fluctuates significantly from year to year, you might benefit from income averaging. Consult with an accountant to determine if this strategy makes sense for your situation.