Tax season for entrepreneurs with their own business can look different case by case. Whether you are a sole proprietor, or have incorporated your business, you will have to file the income/losses associated with your business for tax purposes. These articles will explain how you are taxed on your income from your business, which expenses are and are not deductible for tax purposes, and go a bit in depth on more specific topics.
Canadian-Controlled Private Corporation vs Sole Proprietorship
If your business is currently a sole proprietorship, you will be filing your business income and losses on your yearly T1 tax return. If you have incorporated your business, you will have to report the income made on a T2, which is the corporation income tax return.
The calculation of net income for tax purposes is the same for sole proprietorships and corporations.
After calculating the net income for tax purposes, you come to the Division C deductions to get to table income. In the sole proprietorship section, we touched on net capital losses and non-capital losses. For corporations these carryforwards are also allowed and follow the same restrictions. Corporations are also allowed deductions for donations, which are restricted to 75% of the net income of the corporation. Then any dividend income you included in your net income for taxable purposes will be deducted under Division C deductions as well to get to taxable income.
Once you get your taxable income you can calculate how much tax you owe federally and provincially. Basic federal tax for corporation income is 38%. There is a federal abatement that reduces your federal tax by 10% to make room for provincial/territorial tax, reducing the basic federal tax to 28%. After that, depending on what type of income your corporation makes, your federal rate of tax can be increased/decreased further.
First there is the general rate reduction. Federal tax will be reduced by 13% on all active business income (other than income that qualifies for the M&D reduction, which will be discussed in another article) that is above the annual limit that the small business deduction applies to. The small business deduction, which is available to Canadian-controlled private corporations, allows the federal tax rate to be reduced by an additional 19% only for the first $500,000 of annual active business income or to its taxable income, whichever is lower (federal tax will be reduced to 28%-19% = 9%). The small business deduction and other deductions will be discussed in more depth in the next article.
Buckwold, William, et al. Canadian Income Taxation, 2021/2022. McGraw-Hill Education, 2021.
Wolfe, Kathy. 2022 CPA Competency Map Study Notes, 20th Edition. Densmore Consulting Services Incorporated, 2022.