Tax Write-Off Advantages with a Home-Based Business: Canada & United States

To fully understand the tax advantages of a home-based business it is important to understand that we have two types of tax systems - there is an employee tax system and a self-employed system.

Employee Tax System

The employee tax system is designed to take a percentage of your income right off your pay. When you earn income in your your job the government has laws that mandate your employer to take a percentage of that off that pay check and send it to them as "income taxes".

For example, let's say you earned $2,000 in your job, your employer might withhold $400 for income taxes, depositing $1,600 in your account as your "net pay". That $400 is then sent to the government by your employer on a monthly or quarterly basis. This is the same taxation situation for both Canada and the USA. 

The biggest difference between the Internal Revenue Service (IRS) and Canada Revenue Agency (CRA) is in how they calculate income taxes. The main difference is for those in higher tax brackets. Canadians have higher tax brackets, so they are taxed at a higher percentage than Americans. This means the high-earning individuals in Canada pay a higher tax than the same income earners in the US. However, the employment system is designed in such a way that the more income you earn the higher the percentage that is taken for taxes.

At the end of the year, as an employee, you are issued an "Employment Income Statement" which is a total of your income for the year and totals in amounts withheld. In the US the statement is called is a W2 and in Canada it is a T4. When you file your personal income tax return with the IRS it is a 1040 return, and in Canada for CRA it is called a T1. The two taxation systems a fundamentally the same. 

Self-Employed Tax System

The other system is for those who generate self-employed income or business income. This system is designed in such as a way that the government allows you to claim expenses (or tax write-off’s) that are incurred in the effort of making the business income.

When expenses are taken into account the taxable income is reduced. For example, if a self-employed person earns $2,000 income, but has $600 in expenses in the effort of earning that income, they are taxed on just $1,400 in income. This is the same taxation situation for both Canada and the USA. 

The difference comes in filing income tax as it depends on the legal business structure; sole proprietor, incorporate, LLC, etc. For the purpose of this article we will focus on the sole proprietor business. 

A person who operates a sole proprietorship could be full-time, or part-time in their business and also be an employee. In both situations, the person would file the same income tax returns (1040 in the US and T1 in Canada), however they include a second part to the return that is called the 'Statement of Business Profit/Loss'. For the IRS, it is called a 'Schedule C' and for CRA it is called a 'T2125'. 

Tax Advantages of a Home-Based Business

The exciting part are the advantages we have being in a home-based business as we can include many expenses that the employee has, but as an employee they are unable to use it to bring down their taxable income. As with the 'Statement of Business Profit/Loss' as a home business, we include one more statement, called 'Business Use of Home'. In the US for the IRS it is called '8829 = Part 7' and in Canada for CRA it part of the 'T2125'

These expenses can include every day life expenses like rent or mortgage interest on their home, heat, electricity, cell phone, vehicle expenses and so much more.

Things get even more interesting when an employee starts a side business and claims these expenses to reduce their taxable employee income. This might sound complicated but is very easy and simple.

So if we take the above employee example, where the employee earned $2,000 and had the $400 withheld from their pay for income taxes. Lets say they made no income in their home business but had "ever day life expenses" they can claim on their taxes, they can still use some of these to bring down their taxable income on their employee income.

By leveraging their home business expenses, they put themselves in a situation of getting tax refunds from the money that was withheld from their income.  For more than a decade, I have been helping people understand this and they have been getting $2,000 to $10,000 back in the form of a TAX REFUND from the government. 

Sadly, most people do not understand this simple tax strategy. This is why I call it a Tax Secret. In this video Pam was able to get $10,000 in tax refunds and save $3,000 each year on her taxes as a result of this knowledge.  

A Home Business is still 'THE BEST' kept Tax Secret!

Even most people who have a home business do not take full advantage of this. By understanding this it can be one of your greatest financial breakthroughs. What would you with a $5,000 tax refund this coming tax season?