Brand new to the world of being a self-employed entrepreneur? You’re not alone. With a new business comes new tax responsibilities—including filing a T2125 form along with the regular T1 (personal tax documents) each year.
The Form T2125 is an important document. It helps the Canada Revenue Agency (CRA) assess how much money you made in your business, along with any expenses incurred while running your business. This information is used to determine your tax return or any money you need to pay in business taxes.
Getting this form correct is important, so here’s what you need to know about it:
What is a T2125?
There are a lot of Canadian tax forms out there, so it’s not surprising if you’re not familiar with every one of them—especially if you’re new to entrepreneurship.
The T2125 Statement of Business or Professional Activities form is used by sole proprietors or partnerships to report the income they earn from their business in a given tax year.
If you run a business in Canada and that business is not incorporated, chances are you are considered a sole proprietor or, if you work with one to four more individuals, a partner. This means you are required to file a T2125 as part of your T1 tax income package. The T1 General or T1 Income Tax and Benefit Return is what the average Canadian is required to fill out.
The T2125 is a six-page document from the Canada Revenue Agency. There are nine sections that need to be filled out:
- Identification: Who you are, including your business name, SIN and business number, if you have one
- Internet business activities: This needs to be filled out if you have internet business activities that generate an income
- Business and professional income: Report all of your income in this section
- Net income (loss) before adjustments: Report expenses you incurred while running your business
- Net income (loss): Calculate your final net income or loss for that year
- Other amounts deductible from your share of the net partnership income (loss): Write down any expenses that might not fit into the other two income categories
- Calculation of business use-of-home expenses: Calculate how much of your home office expenses is deductible from your business income
- Details of other partners: Provide the personal contact information of any partners in your business
- Details of equity: Report any debts your business owed at the end of the year, and any personal contributions or withdrawals you made
Who needs to file a T2125?
If you run a sole proprietorship or you are part of a business partnership with five or fewer partners, the T2125 is for you. If you have more than five partners, you’ll need to file a T5013 Partnership Information Return filing requirements.
In addition to being a sole proprietor or partnership, you need to have earned income outside of your regular 9-to-5 employment. This includes anything from moonlighting as a freelance writer, running a full-time consulting business, or selling crafts out of the back of your van (if you’re doing the last one, you might want to consider setting up an online business). Even if your business isn’t registered, and even if you earned regular employment income in the same tax year, you still need to fill out the T2125.
Are you an employee or self-employed?
Individuals employed by someone else don’t need to fill out the T2125. The only exception is if you have side hustle income coming in from elsewhere.
You’re an employee if…
- Your employer determines your wages and hours
In a typical employment situation, the company you work for ultimately defines your wage or salary. It also determines where you work from when you need to be working and have the ability to fire you.
- You lack tool ownership
When you are an employee, your company most likely owns the tools you use. If you are an in-house graphic designer, it’s likely your employer pays for things like your Adobe membership. It’s also possible that your employer might also own your electronics like your phone or laptop.
However, this isn’t a surefire answer as there might be instances where an employee might own their own tools. You could still be an employee but use your own computer and phone for work purposes.
- You have little risk of profit or loss
There tends to be a low risk, low reward situation when it comes to employees (though that depends on your personal opinion of “reward”). Employees are guaranteed a wage or salary and don’t have to put up financial or other support that they could risk losing.
There’s a catch to this though—some companies provide their employees with stock options or ownership of a stake in the company. This means that an employee’s “reward” might be greater, but they still don’t have to throw any risks on the line.
- You’re well integrated into your company
Employees are most often integrated right into the company. This means they probably have a company issued email, and access to workspaces like Slack or ClickUp.
You’re a sole proprietor if…
- You control your wages and hours
Control looks at who decides what you earn, and when and how you work. When you are self-employed, you retain the right to decide how, when, and where you work. In many cases, you choose your own location, hours, and work standards.
That said, some modern companies with a remote-first approach can muddy the waters. This along with the fact that “work when you want” or “work when you work best” are becoming a more popular approach, means that some employees might have similar freedoms to a sole proprietor.
One quick litmus test is whether or not you have more than one client. If you are working for a single client, have set hours, and don’t determine your own work process, you are more likely to be considered an employee.
- You supply your own tools
Sole proprietors and contract workers usually supply their own tools. Chances are they’ll own the subscription for their graphic design program and supply their own computer.
That said, there are instances where a sole proprietor might use tools supplied by their client. A freelance blogger might access software provided by the client, such as SEO tools to research and add relevant keywords to an article
- You personally take on risk and reward
Those who are self-employed have an opportunity to make a profit, but they also run a risk of incurring losses due to things like bad debt, damaged equipment, and materials, or delays. Self-employed individuals also cover their own expenses, whereas employees typically don’t.
- You work independently of the larger company
While some sole proprietors might be integrated into a company — they might be welcomed into their Slack channel or use their collaboration tools — more often they are not. The standard contractor will use their own channels (email, client dashboards, communication apps) to communicate with clients, but won’t directly integrate into the company.
That said, contractors that take on a larger role might have a company email or hangout on the Slack channel and still be a sole proprietor.
How do I fill out a T2125?
The best way to complete your T2125 form is to have an accountant do it for you. This can help lower the risk of being audited, ensure everything is filled out correctly, and provide you with the best possible tax savings.
The basic idea of the T2125 is to input all the business and professional income you earn, and subtract any relevant expense to come up with your net business income or loss, depending on your earnings. Fill out every section as accurately as possible. It’s also important to make sure you have the paperwork to back it up.
How do I report income from multiple businesses?
You might be surprised to hear you can run multiple businesses from a single sole proprietorship. If you run a graphic design business during the day and moonlight as an income-earning podcast host in the evening, you need to fill out a separate T2125 form for each.
What is the difference between professional and business income?
The T2125 requires you to claim all professional and business income, but you might wonder what the difference is.
Professional income is earned as a member of a recognized profession—such as a lawyer, doctor, or accountant. Business income, on the other hand, is that earned through other activities, like your graphic design business.
These two types of income are taxed similarly today, though minor differences do remain, so it is important to identify which is which.
What business expenses can I deduct?
Sole proprietors who file a T2125 form can deduct certain small business expenses. There are three expense categories:
Cost of goods sold
The “cost of goods sold” is essentially any cost you incur to produce the end product you sell to a customer. This includes your inventory costs, returns, wages paid to employees, discounts, and money paid to contractors. Note these expenses have to be associated with selling goods or services.
General operational expenses
A general operating expense is any regular expense you incur while conducting regular business activity. This includes things such as marketing or advertising costs, salaries or wages, travel expenses, memberships or professional fees, and meals and entertainment.
This also includes “business use of” expenses. These are things like your motor vehicle expense or those associated with using a home office. You can often claim portions of your car insurance, maintenance costs and repairs, home insurance, and even your phone bill. It should be noted that you can’t always claim the whole expense, which is why it’s best to consult an accountant for advice.
Capital cost allowance
The “capital cost allowance” refers to the cost of things like equipment, furniture, tools, and buildings. These things depreciate over time, so they need to be split up and can’t be claimed all in one year.
How to file your T2125
When it comes to actually filing your T2125, you should file it with the rest of your T1 personal income tax documents. You can e-file it through Netfile, or you can get a professional tax preparer to file through the CRA’s e-file service.
When is the filing deadline for T2125 forms?
If you are self-employed, your T1 form and T2125 is due by June 15. That said, most professionals recommend you file your taxes prior to the April 30 deadline, because you will be charged interest on any taxes you owe starting April 30.
Getting ready for tax time
Whether you have to file a T2125 depends on the type of business you have. Regardless, all businesses have to prepare for tax season. Make sure to keep all of your receipts and invoices (it helps to have a good document management system), and using an accounting system can help make things easier when it comes to tax season.
This article offers general information only, is current as of the date of publication, and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by RBC Ventures Inc. or its affiliates.