Tax returns for the self-employed

06 December 2021 by National Bank
A female accountant reviews tax documents to prepare her company’s taxes.

The tax rules for self-employed workers are more complex than they are for employees. It’s normal to have questions when doing your taxes. What expenses are deductible? What do should you include? Do you need to collect and remit sales tax? Our experts have the answers. 

What similarities are there between tax returns for salaried employees and for the self-employed? 

Here are three situations that apply to both salaried employees and people who are self-employed: 

  1. Everyone living in Canada has to fill out the same basic tax return each year, which is called the “T1 General” return. 
  2. Quebec residents also have to fill out a form called a “TP1.” 
  3. These returns are used by the federal and provincial governments to calculate how much of your income is due to them for the services they provide, such as our health and education systems and social services. 

What’s different about tax returns for people who are self-employed? 

  1. People who are self-employed also have to file a special form called a T2125 – Statement of Business or Professional Activities, as part of their federal tax return. 
  2. In addition, Quebec residents who are self-employed have to file a form called a TP-80 – Business or Professional Income and Expenses.
  3. The numbers from these forms are added to your basic return in order to calculate your taxable income.

How to fill out the forms for self-employed workers

The T2125 form for people who are self-employed (and the TP-80 for Quebecers) is like an income tax return for your business. Include it with your basic return.

You’ll need to indicate: 

  • The total income generated by your self-employment
  • Your eligible deductions for the year, i.e., your expenses.

By subtracting your expenses from your income, you’ll get your net business income.

What do I have to declare as income?

Have your invoices on hand

When preparing your tax return, you’ll need to look at all of the invoices billed to your clients over the course of the year. By adding all those amounts together, pre-tax (if you have to charge tax), you get your self-employed income. That’s your total business revenue. It’s the amount you indicate on the forms for people who are self-employed.

A note about tax: If you’re newly self-employed and you make less than $30,000 a year, you can choose to not sign up for GST and QST, in which case you won’t have to charge them to your clients. Some services, such as medical services, aren’t taxed. Find out what applies to your situation. 

How to pay less tax by deducting eligible expenses

As someone who’s self-employed, you obviously have work-related expenses. To calculate your taxable income, you have to deduct expenses from your revenue. Here are the rules you’ll need to follow.

Eligible expenses

All expenses aren’t necessarily eligible. Be sure you understand and follow the rules so you don’t run into any trouble if you’re audited and won’t have to pay extra tax plus interest.

The basic rule is simple: to be eligible, an expense must allow you to generate income.

You can deduct workplace-related expenses, the materials needed to produce your goods or deliver your services, and your office supplies, for example—all according to certain conditions.

Your eligible expenses include: 

  • Office expenses
  • Some insurance
  • Rent
  • Materials
  • Inventory
  • Salaries 

Good to know: It’s a good idea to take out disability or life insurance to protect your loved ones in the event of your death. But because these kinds of insurance don’t allow you to generate income (i.e., help you make money), they’re not deductible.

Are business development expenses deductible?

You can deduct some of the costs involved in business development. 

The rule is always the same: the expenses must help you generate income. If a tax inspector audits your expenses, your receipts for meals out with friends probably won’t make the cut. Note also that business development expenses are only 50% deductible. They can include meals at restaurants with clients, as well as tickets for shows and sporting events if they’re used to build business relationships.

What to deduct when you’re self-employed and working from home

To be able to deduct residential expenses, you need to meet at least one of the following two criteria: 

  1. You meet clients or patients at home on a regular, ongoing basis
  2. You spend at least 50% of your time working from home

If either applies to you, you can deduct a number of residential expenses, such as:

  • Insurance
  • Electricity
  • Property tax
  • School tax
  • Rent

But not your mortgage! Only the interest on your mortgage is considered an eligible expense.

You’ll need to calculate the percentage of your home that you use for work. For example, if you work in your office and it takes up about 15% of your total home space, you can deduct 15% of eligible home-related expenses. 

Good to know: In some situations, an expense that’s entirely related to working from home can be 100% deductible, such as renovating your home office.

How to deduct vehicle expenses when you’re self-employed

If you use your personal vehicle for work, you can include certain expenses in the deductible expense column. Regular commuting costs cannot be included.

You’ll need to keep a record of your mileage, with notes of your trips indicating the reason for each in case you’re audited by Revenu Québec or the Canada Revenue Agency. Just like you have to calculate the area of your home that you use for work, you’ll need to calculate the percentage of your vehicle use that’s work-related. You can then apply that percentage to all of your vehicle expenses, such as:

  • Repairs
  • Gas
  • Tire changes
  • Wheel alignments 
  • Oil changes 

How do you deduct amortizations when you’re self-employed?

You can include what’s called “capital expenditures” in your company budget. Capital expenditures are for items that you’ll use for many years and that require a significant investment, such as a car or computer. They can also be for work done to improve such items.

Instead of deducting the entire expense in a single tax return, you’ll need to amortize the amount. Revenu Québec and the Canada Revenue Agency have predefined percentages for calculating amortization based on item category. The longer the lifespan of the item, the lower the percentage you’ll be able to apply.

What proof do I need for my expenses?

If you’re filing a tax return as someone who’s self-employed, you’ll need to have your bookkeeping in order. There are a number of programs and apps that allow you to record expenses and revenue quickly and easily, often with your smartphone. Ideally, you should be keeping track of your expenses throughout the year to avoid any headaches when it’s time to file your return.

Good to know

  • You need invoices or receipts for all of the expenses claimed for your business. 
  • You’ll need to keep them as proof for a minimum of 6 years. 
  • You can keep digital copies to make them easier to organize, but don’t throw out the paper copies before the 6-year period is up.

Should I do my taxes myself or use an accountant?

There aren’t any rules in this regard. Everyone has the right to do their own taxes or to have a professional do them. If you’re well versed in accounting, you could save money by doing them yourself, but if you make mistakes or fail to apply all of the rules to your advantage, you could end up paying more taxes than you actually owe. There are programs that make filling out your tax return easier, but some of the calculations are fairly complex and there are a lot of rules you need to know. When in doubt, trusting a good accountant is always a good option. 

Being self-employed gives you more freedom in some ways, but it also comes with more responsibility. You must file a tax return based on your work situation. If you need help with tools and techniques that will make it easier to do your taxes, talk to our team. 

We’re here to answer all your questions.

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