Bookkeeping for sole proprietors in Canada

If you're a sole proprietor, the business isn't a separate taxpayer. You are. Its profit goes on your personal return, worked out on Form T2125, Statement of Business or Professional Activities. So the goal of your bookkeeping is simple: at the end of the year, every number on that form should already be sitting in your books.

This guide covers what to record, how to set up categories that match the form, and the parts of self-employed bookkeeping that catch people out.

Your year, your deadlines

The CRA's guide for the self-employed, T4002, sets out the calendar:

• Your fiscal year generally ends December 31. Self-employed individuals generally have to use a calendar year-end. A small group of eligible individuals can use another one, with extra paperwork.
• File by June 15 if you have self-employment income.
• Pay by April 30. Any balance owing is due then, even though the return isn't due until June. Interest runs from April 30.
• Instalments, if the CRA asks for them, are due March 15, June 15, September 15 and December 15 for business, professional and commission income. Tax instalments for the self-employed explains who has to pay them and how much.

The gap between April 30 and June 15 is a trap. If your books aren't done by April, you're estimating what you owe. Underestimate it and you pay interest on the difference.

Cash or accrual?

The CRA's rule is short: farmers, fishers and self-employed commission agents can use the cash method or the accrual method. All other self-employment income must be reported using the accrual method.

Under accrual, you report income in the period you earn it, whether or not you've been paid, and deduct expenses in the period you incur them, whether or not you've paid them. If you invoice a client $4,000 on December 20 and they pay on January 10, that $4,000 belongs to the year you invoiced. The full explanation, with examples, is in cash vs accrual accounting.

Set your categories to match T2125

T2125 has its own expense lines. If your bookkeeping categories match them, year-end is a matter of copying totals across. These are the lines most small service businesses use, from the T4002 expenses chapter:

• 8521 Advertising
• 8523 Meals and entertainment
• 8690 Insurance
• 8710 Interest and bank charges
• 8760 Business taxes, licences and memberships
• 8810 Office expenses
• 8811 Office stationery and supplies
• 8860 Professional fees (legal and accounting)
• 8910 Rent
• 9200 Travel expenses
• 9220 Utilities
• 9270 Other expenses
• 9281 Motor vehicle expenses (not including CCA)
• 9945 Business-use-of-home expenses

Add balance-sheet accounts for your bank and card, GST/HST collected and paid if you're registered, and owner's draws. Money you move to your personal account isn't wages and isn't an expense. The CRA says not to deduct salaries or drawings paid to yourself. Your income is the business's profit. How to pay yourself as a sole proprietor covers how much to draw and what to set aside, including CPP.

The three items that need extra records

Meals and entertainment

You can claim at most 50% of the lesser of what you spent and what is reasonable. Record the full amount in your books, and note who you met and why. The 50% cut happens on the form.

Your vehicle

The CRA says you can deduct motor vehicle expenses only when they're reasonable and you have receipts, and to get the full benefit you keep a log of total kilometres and business kilometres, with the date, destination, purpose and distance of each trip, and the odometer reading at the start and end of the year. There's a shortcut. After one full year of logging as a base year, you can keep a three-month sample log in later years, as long as the result is within 10% of the base year.

If you drove 22,000 km and 13,200 of them were for business, your business use is 60%. Record all vehicle costs in full during the year and apply the 60% at year-end.

Your home office

You can deduct business-use-of-home expenses if the space is your principal place of business, or if you use it only for the business and regularly meet clients there. You claim a reasonable share of heat, electricity, insurance, maintenance, rent, or mortgage interest and property tax if you own, usually by floor area.

Say your office is 12 m² of a 120 m² apartment, and rent plus utilities and tenant insurance come to $24,000 for the year. That's 10%, so $2,400. One rule matters for your books: the claim can't be more than your business income before it, so it can't create or increase a loss. Any amount you can't use carries forward.

GST/HST as a sole proprietor

You have to register once you stop being a small supplier, which for most businesses means more than $30,000 of taxable revenue in a calendar quarter or over four consecutive calendar quarters. As a sole proprietor, the CRA counts revenue from all your businesses together, plus those of any associates.

Once you're registered:

• Record sales without the tax as revenue, and the tax as a liability.
• Record expenses without the recoverable tax. The CRA says to reduce the expense on T2125 by the input tax credit you claim, so a $226 phone bill in Ontario with $26 of HST is a $200 expense.
• If you file annually with a December 31 year-end and had business income, your GST/HST return is due June 15 and the payment April 30, the same dates as your income tax.

If your expenses are low, as they often are for consultants and trades doing labour-only work, check whether the quick method would cost you less. Note that bookkeeping, accounting, legal and tax preparation businesses can't use it. When it's time to file, how to file a GST/HST return has the line-by-line.

A worked year

A self-employed graphic designer in Toronto, registered for HST:

• Invoiced $84,000 of fees plus $10,920 HST
• Software and subscriptions $3,600, office supplies $400, phone and internet (business share) $1,200, accounting fee $900, all before HST
• Meals with clients, $1,000
• Home office, 10% of $24,000 = $2,400
• Vehicle, 60% of $6,000 in costs = $3,600

Expenses for T2125: $3,600 + $400 + $1,200 + $900 + $500 (50% of meals) + $2,400 + $3,600 = $12,600. Net business income: $84,000 − $12,600 = $71,400, which is the number that goes onto the personal return.

The $10,920 of HST isn't income. It's owed to the CRA, less the input tax credits on the business purchases. Book it as revenue and you'd pay income tax on money that was never yours.

Records to keep

Keep invoices you issued, receipts for what you bought, bank and card statements, your vehicle log and your home-office measurements for six years from the end of the tax year they relate to. For a sole proprietor, the tax year is the calendar year. The detail and the exceptions are in how long to keep business records.

Doing it in Spark Books

Spark Books is set up for sole proprietors as well as corporations. Upload your bank and card statements and it sorts each transaction into a Canadian chart of accounts with the GST/HST split out. If it can't tell whether a Costco run was for the business or for home, it asks, and it remembers your answer. Receipts are matched to the transactions they paid for, and at year-end you get a package mapped to the T2125 lines for you or your accountant to file. It's free, and you don't need a card to sign up.