Reserves

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.

Reserves

Reserves are accounts in which you have put money aside for a specific purpose. No reserves are allowed to be deducted from the calculation for your taxable income, but there are two exceptions.

Reserves for doubtful debts & bad debt expenseReserve for delayed payment revenues
This reserve is allowed to be deducted if you can reasonably prove that amounts that are owed to your business will most likely not be paid back to you, and that the debt you incurred was for creating incomeThis reserve is allowed to be deducted if inventory has been sold and all/part of the payment is not due for the next two years after the sale.
If you deduct a reserve in one year, in the next year you must add that amount back into income and recalculate your reserve, since in that year you either collected an amount or you didn’t

If there is still an amount in doubt, you can deduct a new reserve in the current year

If you write off a bad debt you don’t have to include it in income in the following year, unless you get the payment and reverse the entry.
Important to note that this reserve cannot be used for more than three years, even if you will not be fully paid by that time

If you reach year three after deducting this reserve from your taxable income, you must add the whole reserve back to the income and fully tax it in the third year

Reserve = gross profit/gross selling price * amount receivable

It’s also important to note that you do not have to deduct this reserve from your taxable income if you do not want to.

Resources

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.

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