Running a small business as a freelancer inevitably brings about its share of expenses. When used properly, the deduction of these expenses can substantially alleviate your tax burden. Understand the basic rules that every freelancer in Canada should know about tax deductions.
In Canada, any expense incurred for the purpose of earning income is deductible. In other words, any money you spend to operate or grow your freelance business is tax deductible. Some of the most common expenses include:
- Office supplies
- Taxes, fees, licences and dues
- Legal and accounting fees
- Bank fees, including interest on business-related loans
If you use your car in the course of your business, all the expenses associated with the vehicle (such as gas, repairs, and lease payments) are tax-deductible. You must keep precise records that show the percentage of the vehicle usage that is for business and the percentage that is for personal use.
Current expenditures and capital expenditures are deductible, but they are deductible in different ways. Current expenditures are made to purchase goods and services for immediate use in your business. Capital expenditures are for goods, such as equipment or buildings, that you purchased for long-term use.
As a rule, current expenditures are deductible in the year when you incur them, while capital expenditures are partially deductible in every year over their useful life. This process is known as capital cost allowance or depreciation.
Meals and Entertainment Deductions for Freelancers
Expenses that the Canada Revenue Agency (CRA) classifies as meals and entertainment are subject to special rules. The maximum deduction that you are entitled to for food, beverages, and entertainment expenses is 50% of either the amount you incur or an amount that is reasonable in the circumstances, whichever is less. The limit also applies to the cost of your meals when you travel or go to a convention, a conference, or a similar event.
Membership dues and club fees, such as an annual membership to a golf club, are not deductible. It does not matter if the membership is used to conduct your freelance business, since the Income Tax Act expressly states that no deduction for fees is possible for membership in any club in which the main purpose “is to provide dining, recreational, or sporting facilities for its members.
Why Freelance Workers Need Accounting Solutions
Freelance work comes with tons of perks. As a freelancer, you get to set your own hours and be your own boss. You may get to work from home. Often, you get to work within a speciality niche where you have passion and competency. Unless your speciality happens to be accounting, you’re likely to be somewhat in the dark when you’re left to manage your taxes or evaluate the financial strength of your independent business.
Basic Accounting Needs for Freelancers
As a freelance worker, it’s part of your job to be able to identify business and personal expenses. You need to know what you can deduct from your taxes and how to pay your taxes. You also need to keep records and track your financial progress. This includes being prepared to create and fill out important financial documents and forms. You should have a separate business bank account and know how to properly utilize and track business credit cards.
When you’re well-established as a freelancer, you also have to manage clients, which includes tracking invoices and expenses as they occur. This task can be challenging for newbies, because the act of being self-employed doesn’t necessarily mean that every business expense suddenly becomes deductible.
Are you a freelancer who earns tips when you work? For example, you might be a freelance musician who’s allowed to set out a tip jar at your gigs, or maybe you’re a personal hairstylist who travels to your clients’ homes, collecting tips on top of your fees. If so, you should be aware that the CRA considers tips taxable income.
Cloud-Based Accounting on the Go
The rise of cloud-based computing is exciting news for most freelancers who work on the go or from multiple locations. With a little discipline and the right accounting software, you can put accounting on autopilot. Good cloud-based accounting software automatically generates important forms and reminders, syncs with bank accounts, saves client information, and provides reminders to perform important tasks. As a freelancer in Canada, you’re actually running a business, so you always need to be aware of your legal obligations as business owners.
Another substantial benefit advantage to using professional accounting software (as opposed to tracking everything by hand) is the customer support and expert help you receive. As you build your business, you’re unlikely to have the time or inclination to familiarize yourself with every rule for self-employed workers as expressed by the CRA. Doing so takes a lot of time and is likely to be very frustrating for non-accountants.
Evaluating Accounting Trade-Offs
Freelancers face lots of opportunity costs. For example, should you spend an extra hour sourcing new clients for your business, or should you spend that time working on existing projects for your current clients? Is it really worth the time and money to pick up new skills that might enhance what you can offer to clients, or should you go through continuing education? If you raise your rates, how many of your current and potential clients are you going to chase away?
Accounting decisions are no different. How much is good accounting software worth to your business? How much time should you have to dedicate to keeping track of your financial data? If accounting software simplifies your accounting needs and delivers you peace of mind, how much is that worth?
Home Office Tax Deductions in Canada
To claim a deduction for a home office, you must meet one of two criteria. First, your office must be the primary place where you do business. If you are a freelancer who works exclusively from home, you meet this criteria. Second, if you don’t use your home office exclusively for work, you must meet clients there on a regular basis. To explain, imagine that you own a freelance plumbing business. You spend most of your time working in clients’ homes, but you work in your home office two days a week. In this case, you can only claim this deduction if you meet clients in your office. To prove you use your office in this way, you may want to keep an appointment log in case of an audit.
Home Office Expenses
The Canadian home business tax deduction is not a set amount based on having a home office. Instead, if you use a dedicated portion of your home for your small freelance business, such as a home office, you can deduct a portion of your home expenses based on the size of your office relative to your home. you can deduct a reasonable percentage of the expenses associated with the home. You are responsible for determining what a reasonable amount is under the circumstances. For example, if your home office takes up 10% of your home, you can write off 10% of eligible home expenses as business expenses.
Personal Use of Your Home Office
If you use your home office for personal use, you have to lower the percentage you apply to your expenses accordingly. For instance, if you use your office for business 40 hours per week and for personal use the rest of the time, you divide 40 by 168 (the number of hours in a week) to get 23%. Then, you must multiply this percentage by the home office percentage calculated based on area. To illustrate, if your home office is 10% of your home and you use the office 23% of the time as a work space, you can write off 2.3% of eligible expenses.
Home Office Expenses Eligible for Canada Tax Deductions
Admissible home office expenses include interest on mortgage payments, property taxes, any municipal and school taxes, insurance, energy, repairs, telephone and internet, and cleaning services and supplies.You can also count things such as garbage pickup and even cleaning supplies. To explain, imagine your home office takes up 10% of your home and you use the office 50% of the time for personal use. You spend $500 per year on cleaning supplies for your entire home including your office. When you multiply $500 by 10% and then by 50%, the result is $25. You can claim this amount as a business expense.
If you have a home phone that you use for both personal and business use, you can calculate your deduction in the same manner explained above. If you have a separate phone just for your business, you can write off the entire cost as a business expense. For instance, if you use your mobile phone exclusively for business and its annual cost is $2,400, that entire amount is a business expense.
Calculating Deductions for Rent Versus Mortgage
Renters may include their rent when calculating their home business deduction. For example, imagine that your rent is $1,800, your office is 15% of your home, and you use the space exclusively for work. In this case, you can claim $1,800 multiplied by 0.15, or $270, as a business expense.
If you are making mortgage payments, you shouldn’t calculate your deduction in the same way. Instead, you need to use the price of your home and its current fair market value to calculate your capital cost allowance. You should also claim other significant business expenses, such as computers or motor vehicles, as part of your capital cost allowance.
Small office supplies that you use in your home office are also deductible. These include pens, paper, or any other routine business supplies. The supplies simply have to be for work and not for personal use.
Your home office expenses cannot create a loss for the year. If your expenses exceed your income, you cannot claim them, but you can roll them into a future year and claim them against business expenses in that year. For example, if you earn $6,000 and your home office expenses are $10,000, you can roll $4,000 to a future year. Working from home has huge advantages and a few disadvantages, but generous freelance tax deductions are one of the biggest advantages. To claim your deduction, be aware of the rules so you can avoid an audit, and make sure to track all of your expenses. Records and receipts can be critical when claiming this deduction.
Easily Managing Finances as a Freelancer
Staying on top of your finances as a freelancer is pretty easy thanks to the QuickBooks Self-Employed mobile app. Specifically designed for freelance workers, this app allows you to track your expenses, income, credits, mileage, invoices, personal expenses, and tax information all in one place. This app also allows you to keep track of the overall health of your business in real time. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.