Running your small business can seem overwhelming, from finding new customers to properly categorizing your expenses. Expense classification is important not only to provide you with accurate numbers to base your decisions on, but also because this information gets filed on your tax returns.
Opening a business bank account, utilizing a software program, creating a chart of accounts, and frequently reviewing transactions are four methods that can help you categorize expenses for your small business.
Open a Business Bank Account
If you're a freelancer, the home office deduction can be an important tax break. However, it's important that you understand how to make your claim so that you get the best possible tax result. In this article, we'll explore what qualifies as a home office, how much of your home expenses may be deductible, and how to go about making this claim on your taxes.
As a freelancer, you may be able to deduct certain expenses directly related to earning business income. In order to be deductible they need to be considered reasonable in the circumstances, and they are not capital costs.
- Expenses that are directly related to earning business income: If your home office is used exclusively for your job as an employee or self-employed (sole proprietor) person and you do not have another place of business where you carry on business or earn commission income from your employer, you can generally claim a deduction for any expenses paid or incurred for the use of that part of your home as a workspace.
- Reasonable in the circumstances: Whether an expense is “reasonable” depends on all factors relevant in determining whether it's appropriate for reducing taxable income for the tax year(s) being considered—including who incurred it; how much was spent; whether there were other ways to achieve similar results; who benefited from what was done with respect to each expense claimed and why they did so; whether similar amounts have been claimed before by others doing similar things; whether there was a good reason why more could not have been spent if necessary; etcetera...
If you use part of your home as an office, then you may need to consider the Home Office Deduction.
What is the home office deduction?
The home office deduction allows you to deduct a portion of your rental or mortgage interest, real estate taxes, and qualifying utility costs from your taxable income. The CRA has specific rules for claiming the deduction and how much can be claimed based on the area of your house that you use as an office.
How do I claim it?
To deduct expenses related to operating a business from your home, first, calculate your adjusted gross income (AGI). You must then figure out what percentage of space in your house that is devoted exclusively for business purposes and only for business purposes; this could include a dedicated room or corner of another room if there are no personal items in it such as furniture or clothing items other than those required by law (i.e., safety equipment such as fire extinguishers).
The CRA usually allows this deduction only if you meet one of the following conditions
- You use the workspace only to earn your business income.
- Your principal place of business is in your home and you use it regularly and exclusively to meet customers or clients in the course of earning income from a business.
- The workspace is also used for meeting people, handling administrative matters related to operating your business, or storing inventory and supplies used by you in earning your business income.
Your workspace is your principal place of business (for example, you run your accounting business out of your home)
If you meet the criteria described above, you can deduct home office expenses as business expenses.
Recording Expenses and Business Bank Accounts
In order to claim home office deductions, you must be able to prove the amount of time that you spend on business-related tasks and activities. This can be done through a diary or log of your daily work schedule, including how long it took to complete each task.
As with other self-employment businesses, it's crucial that you keep track of all financial transactions related to your side hustle in one centralized location (i.e., an account that isn't linked to any personal accounts). Keep this separate banking account for at least three years after the year in which taxes were due—this way if there are ever any questions about how much money was deposited or withdrawn from this account during the tax period, or if someone decides they want to access (or wants their share), there will still be documentation available for review by agents from the CRA.
If you want to deduct home office expenses, make sure you follow the guidelines. In order to be deductible they need to be considered reasonable in the circumstances, and they are not capital costs. If you use part of your home as an office, then consider the Home Office Deduction.
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