As a small business owner, you need to file a tax return each year and pay any taxes you owe. Even if you don’t owe taxes, you’re still responsible for filing each year. The Canada Revenue Agency (CRA) has a specialized form for you to fill out and file at the end of the fiscal year.
What Is Form T2125?
Form T2125, Statement of Business or Professional Activities, is a tax form that small business owners and self-employed professionals use to report income and expenses to the CRA. Sections on Form T2125 include income, expenses, net income (loss), vehicle expenses, and details of equity. The income section on Form T2125 is separated into business income and professional income. Business income is income you earn from selling the products and services of your business. Commissions count as business income as well. For example, the money you receive from sales of homemade pies qualifies as business income. Professional income is income that you earn for providing professional services. For example, if you’re a lawyer, the fees you receive for your legal service are professional income.
Deducting Legal Fees With the T2125
The CRA allows small business owners and self-employed individuals to write off business expenses, and this includes legal fees. You may report legal fees on line 8860 of Form T2125, Statement of Business and Professional Activities. These expenses may include legal fees you incur for advisement purposes, as well as legal fees paid to appeal assessments related to your income tax, Canada Pension Plan contributions, and Employment Insurance premiums. In some cases, you must report legal fees on other parts of your T2125. For example, imagine you’re a landlord and you incur legal fees for drafting leases. You may report those costs on line 8860, as usual. However, if you incur legal fees while buying a property, you must include those fees as part of the cost of obtaining the property.
Handling Deductions for Inventory
If you operate a business as a sole proprietor or in an unincorporated partnership, you need to report your business income annually using Form T2125 Statement of Business or Professional Activities. This extensive form requires many calculations, including one that is often misunderstood: inventory. Here is what you need to know to make sure you comply with the Income Tax Act when reporting your inventory.
Basic Rule for Deducting Expenses
One of the most basic rules regarding reporting business income in Canada is that you are entitled to deduct all the expenses you incur to earn that income. As a basic definition, inventory refers to the goods you purchase for resale as part of your business. Because your inventory earns income for your business, you can deduct its cost.
Inventory and the Cost of Goods Sold
From an accounting perspective, inventory can be described as both an asset and an expense. It’s an asset because you own the actual physical goods, which have value. It’s also an expense because you spend money to acquire the goods.
Annually, you are entitled to deduct the portion of the money you spend to acquire the goods you actually sell. This is called the “cost of goods sold,” and you must calculate it and report it on your T2125 form.
To calculate your cost of goods sold, you need to know three essential elements:
- The value of your inventory at the start of your fiscal period
- The value of your inventory at the end of your fiscal period
- The cost of your purchases during the fiscal period.
To get that information, do an actual stock count at the end of each fiscal period, or use a perpetual inventory system. In all cases, keep detailed records of your inventory at the end of each count. If this is your first year of reporting business income, you need to choose a method for valuing your inventory. In subsequent years, you must continue to use the same method, so choose carefully.
Filling out Form T2125
The inventory portion of Form T2125 is in Part 4, or lines 8300 to 8500. Enter your opening inventory amount at line 8300 and your closing inventory amount at line 8500. On line 8320, enter the amount of purchases made during the year. Your purchases should include the cost of the goods themselves as well as incidental costs such as delivery, freight, and express charges. Conversely, subtract any discounts you may have received. On line 8340, indicate the direct wage costs (remuneration) you pay to employees who work directly in the manufacture of your goods. Do not include indirect wages such as administrative salaries or a salary paid to yourself or a partner. On line 8360, enter the costs of outside contractors (as opposed to employees) you hire to perform tasks related to the goods you sold. Finally, on line 8450, enter any other direct costs you incur as part of producing or acquiring your inventory.
Add lines 8320, 8340, 8360, and 8450 to your opening inventory amount (line 8300). The sum is your total cost of inventory. From that amount, subtract the value of your closing inventory (line 8500). The remainder is your annual cost of goods sold for the year. This is the amount you can deduct from your gross business income to arrive at your gross profit. The secret to making inventory calculations simple is keeping detailed and timely records. When you use those, you’re better able to fill out Form T2125 accurately and efficiently.
As a small business owner, you need to fill out a specific set of forms to comply with the CRA rules for filing taxes. While filling out these forms, make the most of your tax breaks so you don’t owe more money than is absolutely necessary. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.