First Job: Working from Home - Make Sure it’s Deductible!
by Evelyn Jacks, President and Founder, Knowledge Bureau
Millennials have the distinct challenge of coming into the workforce after the 2007-2008 financial crisis, when unemployment in their age group was particularly high. That is just one of the reasons why Canada’s workforce is changing. Historically, 85% of people have been employed in the traditional sense; however, recent trends show that up to 45% of Canada’s new workforce will be “on demand” or “freelancing” by 20201.
There are tax advantages to working from home or as a self-employed contractor. If that describes you, earning income can be a more risky proposition; if you perform poorly or not at all, you won’t get paid. In addition, you’ll have to invest in equipment, your car and home office expenses, usually prior to receiving payment. But in return, you get to control how you invest the first dollars you earn, and that means you have the option to save more, sooner.
Just as passive investment income sources have different tax treatments, not all active income sources are taxed alike. Here’s a quick overview:
- Employment Income – The full amount of wages, salary, bonus, vacation pay, or sick pay is added to income. You’ll receive a non-refundable tax credit for Canada Pension Plan (CPP) and Employment Insurance (EI) premiums, which your employer will be required to withhold from your gross pay, calculated as a percentage of earnings. You will also have to pre-pay your tax obligations. It’s the number one reason why people file their tax returns – to recover over-deducted income tax remittances. An employee has very limited tax deductions: home office, car expenses and supply costs are common, but can only be claimed with a signed Declaration of Conditions of Employment from the employer.
- Income from a Business – If you’re self-employed, you’re taxed on net business income, after all reasonable expenses incurred to earn your top line or gross income, are deducted. Those expenses fall into the following groups: fully deductible, partially deductible, or not deductible at all. Expenses that are fully deductible are incurred in the course of earning income. But this does not include depreciable assets, which are written off over time, or restricted expenses, that have a personal use component. Unincorporated business income is reported on the personal tax return (known as the T1) with your other personal income sources.
In the “gig economy”, people are increasingly working from home, which means they can claim the costs of operating a home workspace. Here are some tax traps you’ll need to think about in advance of a potential audit:
- To qualify, the space must be the place where the individual principally performs employment or self-employment activities, designated as more than 50% of the time.
- Otherwise, the space must be used exclusively to earn income from employment or self-employment and on a regular and continuous basis for meeting customers or others in the ordinary course of performing duties. This means you must keep a log of how you use the space.
- The space must also be separated from other living spaces in some way. Do measure this, so that you can prorate the expenses incurred for the property as a whole.
- Deductible costs are limited to net income earned, but a carry-forward provision is available.
To claim these expenses, separate personal use of your vehicle from employment or business use, by keeping an auto log for total kilometres driven, and then identify business versus personal use.
Total all your expenses, based on your actual receipts and maintain a log of cash expenditures, such as car washes. Total costs are prorated based on business/total use. Two types of auto expenses that can be claimed are fixed and operating costs. The latter are claimable in full and the former contain caps on how much interest, leasing or capital costs may be deducted.
Managing Cash Flows: Reducing Tax Remittances
If a taxpayer determines they have net tax owing from last year above $3,000 ($1,800 in Quebec), or estimate that will be the case for this year’s taxes due, they will have to make quarterly tax instalment remittances. But there are options to minimize the encroachment of well-invested capital. You can:
- Pay the amount requested by the CRA on the dates specified on their instalment notice
- Pay one-quarter of your prior-year balance owing in four equal instalments (due March 15, June 15, September 15, and December 15)
- Pay one-quarter of your estimated current-year tax liability in four equal instalments (as above)
If the first option is chosen, no penalty or interest will be charged if payments are insufficient. If either of the other two options is chosen, and the amount paid is less than the balance due when the tax return is filed, there is an interest penalty for late or insufficient instalments.
Clever Financial Moves
There are tax perks for home-based workers and taking advantage of these will help you maximize your cash flow. Optimizing tax opportunities that arise from self-employment makes sense for everyone, but it’s particularly true for Millennials who want to take control of their investment strategy as soon as possible.
1 According to Intuit Canada.
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