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I was asked, the other day, on Twitter whether or not software costs and app costs are tax deductible if running a business from “home”. The short answer is yes, if such costs can be directly attributable to running the business.

Most businesses are not corporations, but instead small sole proprietorships or partnerships (think of a small mechanic’s shop or a cornershop). It makes no sense to incorporate as the businesses are rather small and one of the big downsides is the issue of double-taxation. For a small business there are several issues to look at when deciding to incorporate – incorporation will protect your personal assets such as the family home if the business goes bankrupt. The downside is that the corporation becomes a legal entity, a person so to speak, and it needs to pay income tax. And the double taxation comes from the fact that the employees also have to pay income tax.

But returning to the original premise of what is tax deductible if you are running a sole proprietorship, what can you deduct?

There are several things to consider:

  • any costs directly attributable to the running of the business are for the most part tax deductible
  • if you are running your business from your home you can deduct a portion of your mortgage payments (the interest only, not any payments on the principle)
  • you can deduct a portion of your utilities. This becomes a rather grey area, as you are also living in this home, so how much of your gas/oil, telephone, internet can you deduct? It depends really. You need to work out the proportion. If you work 8hrs a day at the business, 5 days a week, that’s 40hrs. There’s 168hrs in a week, so that is 23.8% of your costs you can deduct for utilities.
  • With regards to the interest on the mortgage (if there is one) it would be based upon square footage. If you have a home office that is dedicated towards your business, then you’d take the square footage of that space and determine the proportion.
  • Cars are an issue as well. The argument could be made that the car you use is also being used for personal reasons. How do you work out what you can deduct? Most Tax Authorities (CRA, IRS, HMRC) will have tables determining how much you can deduct for “wear and tear” – in Canada it is something like $0.50 for the first 5,000km and then it drops down to something like $0.32 per km. Then you need to work out how much you drove for personal reasons – which should be easy by checking what your mileage life to date was at the beginning of the year and at the end of the year, and if you track how much you’ve driven for business purposes for the year you can easily work out the proportions to be used for the calculations
  • Gas receipts are easier, as you can collect your receipts.

So these examples above are with regards to how to split business related expenses from personal expenses. Other costs such as advertising & promotion, specialised software/apps, and office supplies can easily be determined.

One area most sole proprietors screw up on is having a single bank account for personal and business. Always separate the two. Same goes for credit cards – never mix business and personal.