2. REVENUES & EXPENSES
Net income is simply gross revenues less qualifying expenses and the result may be a loss. Business losses, including rental losses, are first deducted against other income in the year to get Net Income for the year to a zero amount and any remaining losses – – a negative figure at Line 236 of your personal tax return – – may be carried back 3 tax years, so long as you file by the June 15th deadline, and forward for 10 years for business losses and indefinitely with net capital losses. To do a loss carry-back on business losses or on net capital losses, which can be applied against ,taxable capital gains in any of the 3 prior tax returns, you complete the Form T1A “Loss Carry-backs”.
Business statements are based on either the accrual method which reports income if invoiced in the fiscal period and deducts expenses incurred in the same period. The most common method used is the simpler cash method, available to self-employed commission earners, which declares revenue only if received by year-end and deducts only expenses paid by the year-end.
Self-employed agents may receive a T4A slip from their broker showing self-employed commissions in Box 20 and/or an “Annualized Statement of Commissions & Expenses”. You must use the figure for “Gross Revenues” which appears in the T4A slip Box 20. If you do not receive a T4A slip, use the total from the “Annualized Statement of Commissions”. If the Box 20 amount includes 100% of commissions including the broker share in the provision for commission-splitting in your “Independent Contractor” agreement commonly signed between brokers and agents, then declare the Box 20 amount as Gross Commissions AND in the T2125 “Business Statement” in your personal tax return and enter a deduction “Broker Commission Split” to factor out the broker’s share. You do not claim a figure for broker split of commissions if the figure in the T4A Box 2 is ‘net’ after the broker split of commissions has been factored out.
Apart from the T4A slip, agents will enter an amount for “Broker Administrative Fees” which includes any other expenses paid by the broker on your behalf and `passed through’ to you in the annualized statement including any monthly billings. Use the ‘pass-through’ expense figure on the statement and keep the statement as your proof of the expense. Remember that the Income Tax Act requires you to keep your books and records including all receipts and invoices for expenses for a 6-year period. That means for the 6 tax years prior to the current year. For 2016, you are required to keep all documents for the tax years 2007 on. You must always keep the original documents for the cost of rental properties, cottages, stocks and mutual funds no matter the year of purchase which is commonly much more than the 6 years required for documents relating to self- employed activity.
DEDUCTIBLE EXPENSES FOR EMPLOYEES
Employee real estate agents do not collect nor remit HST and are not required to obtain a Business Number. This is because these agents usually have a dedicated office or desk space and are more hours at the broker’s office than time spent driving away from the employer’s place of business. This status is still common in commercial real estate sales where the taxpayer gets a T4 slip showing gross income with a Box 42 amount for commissions earned broken out. As well, employees will pay CPP premiums & ,EI premiums with Federal and Provincial Tax withheld. Commission employees claim expenses in the “Employee’s Allowable Expenses” Form also known as the T777 Form in their personal tax return. The expense will include HST which is then, with computer-generated returns, ‘broken out’ from the expense and claimed as a cash credit in the HST 370 Rebate Form at Line 457 in their annual tax filing. So both employee commission agents and self-employed agents recover the HST in their expenses.
Employees do not collect nor remit HST. A T2200 “Declaration of Conditions of Employment “, signed by the broker, must be retained to be provided to the Canada Revenue Agency (CRA) if requested.
Rules for deductibility of employee expenses are governed by Section 8 of the Income Tax Act (ITA) and are punitive when compared with the more liberal deductions allowed for self-employed agents who are governed by Section 18 of the ITA which allows the deductibility of expenses if “incurred to produce income”. Commission employees and self-employed agents have the onus of making the business connection by relating an expense to the earning of income. That means names on Business Dinner & Business Events and gift expenses. Commission employees are disallowed vehicle usage to and from their broker’s office and may claim a home/office expense only if they work more hours at home than at the broker’s place of business and cannot claim the mortgage interest cost in the home-office calculation. They do get to deduct the interest cost on the first $30,000 of a car purchase but they cannot deduct purchases for computer, equipment and furniture purchases for greater than $500. THIS IS UNFAIR BUT THE LAW. Thus employees must lease any computers, equipment or furniture. This rule is punitive. The figure of $500 is the threshold we use for “Capital Expenditures”; if less than $500 we deduct the amount as a “Current Expenditure” under “Office Supplies”.
DEDUCTIBLE EXPENSES FOR SELF-EMPLOYED AGENTS
Self-employed agents are not subject to paying Employment Insurance premiums and income tax and CPP premiums are paid on the installment basis rather than deducted from each commission. The good news is that self-employed agents may deduct any expense “reasonably connected to the earning of income”. Claim all arguable expenses and don’t blink if you are audited.
On starting self-employment, value furniture and equipment used for business and vehicles at FMV or at their Undepreciated Capital Cost (UCC) if deducted in prior returns on other than a self-employed basis and enter the amounts for depreciation. Claim the HST on the FMV, at commencement of self- employment, on furniture, equipment and on any car bought after 1990 in your first HST remittance. Mortgage interest, often your largest home expense, may be added to the home/office deduction. This expense is pro-rated based on the area used exclusively for business or on a “room-by-room basis” not counting washrooms or you can choose, “square footage basis” ,depending on what basis is most advantageous. The home/office expense must be carried forward once self-employed income is reduced to NIL.
Self-employed agents may treat driving to and from the broker’s place of business as deductible business usage since their home is their “primary place of business”. Dinners and event costs have been only 50% deductible since February 22, 1994 under Section 67 (1.1) of the ITA. ,The cost of food and beverages purchased for open houses is included here and only half-deductible and gift cards to restaurants and events are also included here and only 50% deductible. Cars purchased after 2001 are capped for depreciation purposes at $30,000 plus HST – – self-employed taxpayers claim back the HST as an Input-Tax-Credit (ITC) in their HST remittance – – with a monthly lease cap of $800 plus taxes. Car loan interest is capped at $10 per day. The full HST may be claimed back on the purchase of a car and on all operating expenses – gas, repairs, lease etc. – if the car is used at 90% or more for business. If you drive only 89% for business you will get only 89% of the HST back.
Replaced HST numbers in 1996 and are used for HST and payroll returns and in corporate tax returns. You must register for a business number and charge HST if gross earnings in the year exceed $30,000. If annual revenues are under $30,000, you must still complete the BN application and claim exempt status from charging and remitting HST which is not favourable since you recover HST spent on a dollar-per-dollar basis if you obtain a Business Number.
QUARTERLY TAX INSTALMENTS
Tax instalments are paid on March 15th, June 15th, September 15th, and December 15th of each year and may be based on the LEAST of: 1) prior year; 2) current year; or, 3) 2 years back for first 2 payments and 1 year back for the last two. Pick the method that minimizes the payments while avoiding interest charges. For HST annual filers, they must do HST instalment payments if they paid over $3,000 in HST for the prior tax year. Take the amount and divide by 4. You then pay 4 equal amounts on April 30th, July 30th, October 30th and January 30th of the next year. The rule is you must pay by the 30th day after the end of each calendar quarter. With both personal taxes and HST payments, you pay more taxes or get a refund depending on the figures in your personal tax and HST final returns
OPERATING OR CURRENT EXPENDITURES
We have enclosed a separate column sheet to track your revenues and all broker fees as well as an expense sheet. For both revenues and expenses govern yourself by the principles of accuracy and thoroughness. These expenditures are fully deductible subject to specific limitations such as only 50% deductibility for business dinners, events, gift certificates for those first two expenses, travel meals when more than 12 hours away from your “regular place of business” and for groceries and drinks purchased for open houses.
TAX TIP: Most accounting firms make 90% or more of their revenues from corporate clients and place little importance on preparation fees for personal tax returns. CAs and CGAs also tend to be conservative in preparing personal tax returns yet frequently charge $600 to $900 or more for self-employed tax returns. This conservatism leads them to adopt practices which prejudice their clients such as claiming only 75% business usage on a car and not claiming a home-office expense as they mistakenly believe it jeopardizes getting a full exemption on the sale of your home when claiming the Principal Residence Exemption on sale.
At the Taxperts Group, our staff specializes in tax filings for small corporations, personal tax returns for self-employed taxpayers and real estate investors and CRA audits and appeals. We also specialize in real estate and believe that we do the best and most economical tax returns in the city. We charge only a base $600 for a self-employed personal tax return plus $50 for the HST filing which includes one-half hour of bookkeeping time and another one-half hour of time to review general tax issues and tax planning. We also routinely claim 90-95% business usage for the auto expense which accurately reflects usage in real estate sales and we always claim a home-office deduction for every one of the 700 real estate agents who use our firm. Agents became home-based once TREB required them to subscribe for the full MLS service which agents now access from their home. This was THE MAJOR CHANGE in real estate sales in the last 10 years and something which CRA auditors do not understand. It converted the real estate profession to an essentially home-based profession.
We claim deductions accurately and legally but deduct every qualifying penny. We feel our expertise saves the average agent at least $2,500 to $3,000 in taxes compared to returns prepared by other firms. The 4 Toronto-area Tax Service Offices all set up “Real Estate Audit Teams” during 2008 to go on a full-out audit attack on real estate agents. A bad audit can result in up to 30% or more of your expenses being disallowed as a result of the militant and uninformed approach adopted by CRA auditors. You will be assessed with extra taxes payable plus interest and lose the HST Input-Tax-Credits on the disallowed expenses. The latter is particularly painful with HST now up to 13%. Our firm aims to preserve 90% to 95% or more of expenses claimed in tax filings, if the agents keep good books and records as discussed on our web-site. Lawyers draft tax legislation, understand the rules in the Income Tax Act when preparing returns and represent taxpayers when a tax appeal reaches the Federal Tax Court of Canada. If audited, get someone with legal experience to act as your agent on an audit. Fees incurred on tax audits and appeals are fully deductible. Our firm obtains excellent results.
“QUALIFYING EXPENSES UNDER S. 18 (1) OF THE INCOME TAX ACT – – THE “BUSINESS CONNECTION TEST”:
Subject to specific restrictions and limitations, the general rule for the deductibility of expenses to corporations or self-employed taxpayers is set out in s. 18 (1) of the Income Tax Act. Expenses are deductible if: “incurred by the taxpayer for the purpose of gaining or producing income”. This is referred to as the “business connection test”. The onus is on the taxpayer to show that any expense claimed was incurred to earn income. This is why you need to note names on gift, dinner and event receipts. If you fail to do so, you fail the ‘business connection test’ and the expense is disallowed. If you receive a CRA letter to produce “all bank records, an automobile logbook, ledgers and all receipts and vouchers for the 2015 and 2014 personal tax years” you are being audited. This audit is referred to as “current return and 1 year back”. Get advice at once and retain an agent to represent you. Money well spent.
Our firm has free computer spreadsheets available for download from our web-site for commission agents, fee-for-service taxpayers such as consultants, professionals and tradesmen and a third one for actors, performers and models. The first task in any bookkeeping is to distinguish between expenses with HST and those without. On the expense column sheets referred to, expenses not subject to HST are indicated with the second or middle column blacked out. This includes payments to banks, insurance companies, government bodies as well as those paid outside the country or for salary, casual labour and interest costs which do not include any HST. If you are audited on HST returns, Input-Tax-Credits (ITCs) claimed in an HST filing will be disqualified if there is no HST number on the invoice for services and HST was paid. This will happen even if the expense is clearly business-related. You will be punished since the business does not set up its invoice correctly. The CRA will adopt a strict application of the law but this is typical of the punitive and unfair positions taken by CRA auditors.
“S. 230 (1) OF THE INCOME TAX ACT – – “KEEPING ACCURATE BOOKS & RECORDS”:
This section of the ,ITA ,is entitled “Records & Books” and is a little antiquated – – a typical audit letter from the CRA will refer to the need to produce “ledgers” which shows how this request has no relevance in the modern era of computerized bookkeeping software. The section reads: “Every person carrying on business shall keep records and books of account in such form and containing such information as will enable the taxes payable under this Act that should have been deducted, held or collected to be determined.” Note that this requirement applies to personal and corporate income taxes as well as to payroll issues.
There is a similar provision for collecting and remitting of HST which is governed by the ,Excise Tax Act. Note also that there is no reference in this general provision or anywhere else in the Income Tax Act to maintain an automobile log-book. For self-employed real estate agents – – referred to as “sole proprietors” or “independent contractors” – – revenues should be determined using invoices, trade record sheets and bank records. Expenses should be documented as to their nature and there should be proof of payment. In real estate, most brokers issue a T4A slip with a Box 20 amount for gross commissions and/or an annualized “Statement of Commissions & Expenses”. The latter should conform to the T4A slip in terms of gross commissions and will also show any commission split to the broker as per the standard agreement called an “Independent Contractor” agreement which was adopted by the real estate industry around 1986 when agents commenced going off employee status to self-employed status.
That development resulted from an Ontario Court of Appeal (OCA) decision wherein Justices of the OCA concluded that real estate agents ought never to have been on employee status since there were virtually none of the indicia of an employer-employee relationship. The Court said the real estate agents 1) did not work fixed hours, 2) did not work at a fixed location, 3) operated with little or no supervision from the broker, and 4) bought their own equipment such as cars and computers whereas these items were routinely provided by an employer in employment situations. A close look at these points made in the decision explains why many if not most agents working in the area of commercial real estate, when they might be in the broker’s office 6 hours or more each day, are still on payroll status. They are governed by the more punitive rules for deduction under Section 8 of the Income Tax Act as discussed above.
POINTS FOR KEEPING GOOD RECORDS AND PROTECTING YOURSELF IF AUDITED:
- Set up a business checking account and deposit all commissions, referral fees received from mortgage brokers and fees received for such as a tenant placement into a rental unit into the account. Do not mix any personal income such as from cashing an RRSP or selling shares or any personal expenses or activity into the account – – known as ‘commingling’ business and personal activity.
- Pay all business expenses out of the account. This would include all house expenses or rent if a tenant if you are claiming a home/office expense which is the case with 99% of self-employed agents. The amount of the home used for business will be indicated in the breakout between personal and business usage of your home in your personal tax return. Pay your spouse from this account if they are on payroll as an administrative assistant or to your children if they invoice at least monthly and pay them by cheque for casual labour.
- Have any overdraft privileges and any money drawn on a line-of-credit set up on this business checking account. This will allow you to claim all bank and interest charges as fully deductible since they are against an account wherein no personal expenditures are commingled. Arrange to receive your bank statements as you can also pull out all interest and service charges from the bank statement. Request copies of your cancelled cheques as invoices might be misplaced and the check can serve as proof of an expense. e.g., a check for $525 noted by you as paid to “The Printing House Circulars” will allow our firm to get the deduction on the basis that the nature of the expense and the name of the payee lead to the only reasonable conclusion that the expense was business-related.
- The CRA routinely requests the bank records for your `business’ and personal accounts on an audit. This is a new attack to purportedly identify undeclared income. We have to point out to CRA auditors that all payments made to agents go through your broker’s trust account and are totaled in a T4A slip and/or the broker’s annual statement. The request for the bank records for your personal accounts amounts to a CRA `fishing expedition’. If you have set up a business account as suggested here, we tell the CRA that we will not provide records on personal accounts as they are not relevant. We cannot adopt this strategy if you are running your commissions and expenses through a joint bank account set up with your spouse which includes or for any accounts which include personal expenses. You will complicate an audit and incur more time and cost if operating with a joint account or mixing personal items into your “business account’. More explaining to do.
- Document expenses thoroughly. The more proof, the better. If you use a credit card, keep the credit card `chit’ and cash register print-out if given. Note on the ‘chit’ or cash register tape the nature of the expense if it is a gift, business dinner, event or for any expense CAPABLE of being seen as personal in nature. The CRA will characterize as “personal” virtually every expense that could be seen as personal unless the business connection is noted. Also, the typical CRA auditor will attempt to disallow every expense where your only proof is a credit card statement. Our firm where get you gas, auto repairs and other obvious business-related expenses such as a payment to The Printing House if you have only credit card statements as proof of an expenditure. You WILL lose almost all other expenses as YOU will not be able to remember what the expense involved. That would include for flowers, gifts, dinners and anything of a personal nature.
- Get a credit card for your business account and then use that credit card exclusively for business expenses and use a second credit card exclusively for personal expenditures. CRA auditors will always try and argue agents are trying to run personal expenses such as wardrobe, gifts and dinners through the Business Statement. This challenge can be rebutted by providing the credit card statements for the card used for personal usage and showing those types of personal expenditures in those credit card statements. This will knock the wind out of the CRA auditor who says that personal expenses are being disguised as business-related.
- Get into good record-keeping habits. This will allow you to claim every possible cent in your Business Statement and get you good results on an audit. Bad record-keeping will lose you a lot of money on an audit and turn the audit experience, which is inconvenient and time-consuming at best, into a financial nightmare.
- The general rule is that the better, if not meticulous, proof of business expenses you keep, the better your expenses will hold up to challenge on an audit. The goal of CRA auditors is to attempt to disallow 30% or more of expenses claimed as non-deductible by reducing the business proportion of auto usage, unfairly disallowing the home/office deduction and disqualifying as many expenses as possible as “personal” or “not connected to business”. A tax grab mentality. Keep good records and aim to get from 95% to 100% of your expenses if audited. Full-time agents who want to deduct 90% and higher for vehicle usage and avoid having to keep hand-prepared auto logbooks as provided by the CRA should subscribe for the Odotrack, GPS computerized logbook service as discussed in our Bulletin “Motor Vehicle and Home-Office Deductions”.
GO TO OUR BULLETIN FOR THE AUTOMOBILE AND HOME-OFFICE DEDUCTION. ,WITH THE CRA NOW FORMALLY ,REQUIRING AN AUTO LOGBOOK, AGENTS FACE GETTING, A MAXIMUM OF ONLY 75% BUSINESS USAGE AND LESS ABSENT A LOGBOOK. THE NEW LOGBOOK RULES WILL INCREASE THE NUMBER OF CRA AUDITS. NO LOGBOOK EQUALS A, BIG REDUCTION OF AUTO BUSINESS USAGE. AGENTS WITH A COMPUTERIZED LOGBOOK CAN USE THE NEW RULES TO GET 90% AND MORE AUTO DEDUCTIBILTY WHILE THE CRA WILL HAVE NO GROUNDS TO REDUCE VEHICLE EXPENSES CLAIMED. READ IT!
CRA REASONS FOR DISALLOWING EXPENSES AND ADDING INCOME
Since the “business connection” limitation on expenses as set out in s.18 (1) of the ITA is general in nature, CRA auditors will cite general reasons for disallowing expenses. Auditors are often militant, unreasonable and unfair. Auditors are often unfamiliar with trade and industry practices for real estate agents. They do not know the difference between an `agent’ open house versus a `public’ open house. Reasons cited for disallowing expenses include:
- “personal in nature”. Any gifts, dinner and event expenses or purchases of flowers will be characterized as personal unless you notate the name of the client and, preferably, an address if a vendor or purchaser or even an address where an offer was made. Generally, CRA auditors will characterize as personal anything capable of being viewed as personal in nature.
- “insufficiently documented”and/or “no proof of payment”. You need an invoice with a clear description of the type of product or service with a clear indication that payment was made. Credit card statements are not sufficient proof of an expense but since basic reasonableness is required of auditors our firm will always get the amounts for gas and car repairs but you are in jeopardy of losing the other expenses on credit card statements that are not backed up by the original credit card `chit’ or an invoice. Keep the credit card `chit’ and/or the cash register tape and note the nature of the expense and notate a name if the expense is a gift, business dinner or event expense. Your credit card statement should be only a fallback or secondary form of documentation of expenses.
- A new attack based by CRA auditors being a variation of “insufficiently documented”relates to paying a business expense via automatic bank payments for such as car or computer lease expenses, your cell-phone and internet expense for Bell or Rogers, monthly car insurance, monthly flat-fee flyer printing and distribution etc. Keep the original contract and connect it to the automatic debit on your bank statement. CRA auditors will play stupid and say that the short notation that routinely appears in your bank statement is not sufficiently clear to conclude that it is business expense. This disgraceful practice is becoming more common on the part of auditors. Auditors will try and argue that expenses are not clearly of a business nature. Insist that the expense IS business-related. So deduct, don’t blink and fight for every expense.
- “not clearly connected to business”. This is a variation of the previous reason. It can involve an invoice or automatic bank payments. Where auditors can note that an expense is not clearly of a business nature – – the implication being it is capableof being viewed as personal in nature – – they will conclude it is personal in nature. This is common with such expenses as furniture for ‘dressing/staging’ of client homes or a chair bought for usage in your home-office area. Do not let an auditor bully you out of a deduction.
- They will try to disallow a home-office expense in virtually every audit by contriving reasons like “space is provided at the broker’s office” or, the legally incorrectexcuse that “the agent has not given proof that they meet clients at their home on a regular basis”.
- CRA auditors will propose to reduce the business proportion of car usage by 20-30% or more based on your failure to provide an automobile log-book. Claim 90-95% business usage and be prepared to concede only 5% of business usage on an audit. In many cases where we get only 75% business usage on an audit, we appeal and the appeal officers are more receptive to raising the business proportion to 85% to close the appeal.
- CRA auditors will ask for 12 monthly bank statements for all of you and your spouse’s bank accounts. If you have been commingling business and personal expenses within or between accounts, they will track the deposit of your real estate commissions then ask you to explain deposits of over $1,000 for ALL of your other accounts. There is usually an innocent explanation as a lot of deposits into your main business account will be mere bank transfers into the account to allow you to pay business expenses. We have had fights with CRA auditors saying that the record-keeping section of the ITA – – s.230 (1) — does not require you to track personal transactions that do not relate to business. We usually get all transactions explained but it is time-consuming and exasperating. Where agents have set up a dedicated checking account with a related business-dedicated credit card, when the auditors ask for bank statements for all accounts we tell them that we will ONLY provide the 12 bank and credit card statements related to business. We are lawyers so they whine to us that their Team Leader has instructed them to request all other bank statements and when we tell them to go fish, they drop the request. DO NOT provide to auditors any records that do not relate to business. They can only audit the current and 2 prior tax years. Give them no records for any tax years prior to that. Go fish!!!! You must keep your business records for 6 years back but that does not mean you are going to give them records for anything before the last 3 tax filings. Auditors are bullies. Bully them back.