Starting your own business is exciting, and it can bring your big rewards in the future. However, it also means you are taking more responsibilities. Setting up your startup business taxes is one of them you have to take.
First, make sure you have a business, not just a hobby.
An unprofitable business can be a tax shelter. If you have another income, you may be able to use your business losses to offset your other taxable income and pay less tax. However, CRA may believe your “business” is just your hobby, and deny your business deductions, especially if you are losing money years after years. If you fail to prove you are really running a business, you have to pay back all taxes plus interest and penalty.
According to the CRA tax code, “a business is an activity that you intend to carry on for profit and there is evidence to support that intention.”
To prove you are really running a business, you should do the following.
- Keep Good Records – Track each expense with as much detail as possible. Keep your business accounts completely separate from your personal ones and maintain an accurate spreadsheet of all expenditures.
- Show Your Marketing Efforts –Make sure you keep copies of all of your marketing materials so you can show it to CRA. This includes business cards, flyers, newspaper ads, online ads, etc.
- Run A Legit Business – Make sure you register for all the necessary permits and licenses to run your business. If you do everything strictly by the book, you are showing CRA that you are putting your best efforts to make your business profitable.
Secondly, choose the right type of business for your startup business.
Your startup business taxes are highly affected by the structure of your business. The two most common types of business structure are:
1. Self-employed
If you are running a business and you haven’t incorporated it, you are self-employed. If you have a business by yourself, CRA consider you have a sole proprietorship. If you have a business with a partner, CRA consider you have a partnership.
Advantages for self-employed
- Your business losses can be written off against your other income.
- Setting up your business is easy and the costs are low.
Disadvantages for self-employed
- Unlimited liability. You are liable for all debts and other liabilities of the business. If your business is sued, all your business and personal assets are at risk.
- If your business is profitable, you will usually have to pay higher taxes than if it was incorporated as a Canadian Controlled Private Corporation (CCPC).
- Business loss cannot be carried forward.
To report your startup business taxes as self-employed person, you should use tax form T2125 in your T1 General Return.
2. Corporation
You can set up your business as a corporation by completing articles of incorporation, and filing them with the appropriate provincial or federal authorities.
Advantages for corporation
- Limited liability. This means that the liability is usually limited to the amount that you have invested in the corporation.
- If your corporation is profitable, you will pay tax on a much less tax rate then your personal tax rate.
Disadvantages for corporation
- Business losses cannot be written off against your other income.
- Higher setup and administrative costs
To report your business tax as a corporation, you should use tax form T2 – Corporation Income Tax Return.
Third, keep good business records for your business taxes
You are required by law to keep records of all your transactions to support your income and expense claims. You report business income by using the accrual method of accounting. With this method, you:
- report your income in the period you earn it, regardless of when you receive the income; and
- deduct expenses in the period you incur them, whether you paid them in that period or not. Incur usually means you either paid or will have to pay the expense.
Keep your records and related vouchers for a minimum of six years. If you do not keep the necessary information and you do not have any other proof, CRA may have to determine your income using other methods. They may also disallow expenses you deducted if you are unable to support them.