Author: Dana Du Perron, Associate Lawyer at Nelligan O'Brien Payne
In our information era, electronic communications have, in many cases, changed the face of business. Almost anyone can set up a business doing – and selling – what they know, from home. Yet the typical tax deductions associated with a traditional business model are not as easily applied to business-owners working out of their homes. If this is you, it is important to know when and what you can and cannot deduct to ensure you’re maximizing any potential tax benefits, while minimizing any liabilities or future expenses for improper deductions.
There are two main tests the Canada Revenue Agency (‘CRA’) will apply in determining whether an expense is deductible – the taxpayer must only satisfy one of these tests:
- The work space for which you’re seeking the deduction is where you mainly do your work; or
- You use the workspace only to earn your employment income. You also have to use it on a regular and continuous basis for meeting clients or customers1.
To satisfy the first prong of the test, a work space will be ‘mainly’ used for work where it is used for work more than 50% of the time.
If you fall into one of these categories, you can deduct a portion of the expenses traditionally associated with your home, such as electricity, heating, maintenance, property taxes and home insurance. The CRA advises using a ‘reasonable basis’ for calculating the appropriate portion to deduct. Generally, this will involve determining the percentage of your total home space that is occupied by workspace and deducting a corresponding percentage of your total expenses for the entire home space.
For example, if your workspace takes up 200 square feet of a 2,000 square foot home, you can deduct 10% of the eligible expenses you incurred. If however, the expenses can easily be traced to your workspace only – such as a separate Internet connection or business telephone line – the entire amount may be tax deductible. Some notable expenses are not eligible to be deducted such as mortgage interest or capital cost allowance.
Expenses incurred for work-space in the home can only be deducted from employment income, and not from other forms of income such as capital gains. Similarly, you cannot use work-space in the home expenses to generate or increase an employment loss – the total expense can only bring your employment income to $0.00 and not below this figure. On the bright side, unused expense amounts can be carried forward to reduce your taxable employment income in the following year, provided you are still reporting income from this employer.
For example, you own and operate ABC Corp. (‘ABC’) out of your home. Through ABC, you earn $30,000.00 in employment income in 2013. After all other deductions (outside the scope of this article), your employment income is reduced to $5,000.00. You have $6,000.00 worth of eligible work-space in the home deductions. You can only use $5,000.00 of the total $6,000.00 in 2013 as; to use the total $6,000.00 would create an employment loss, which is not allowed. The remaining $1,000.00 can be carried forward and deducted in 2014 if you are still receiving employment income from ABC in 2014.
Tax issues are not always easily understandable and certainly present challenging legal issues. Permissible deductions may vary depending on individual circumstances, so it is important to keep clear records in order to support your position if challenged by the CRA. Understanding eligible deductions are important, however in the long run, they will help put more money in your pockets, where it belongs.