Are you a service-based sole proprietor or non-incorporated business owner who earns business income in Canada? Then you'll need to know Form T2125.
Canada Tax: Your Guide to the T2125 Form
The T2125, also known as the "Statement of Business or Professional Activities", is a key tax form used by self-employed individuals in Canada, including freelancers, contractors, and small business owners. It is submitted as part of your personal tax return (T1) to report your business income and expenses. Here’s a detailed guide to help you understand and complete the T2125 form.
Purpose and Importance of the T2125 Form
The T2125 Form is essential for individuals running a business or earning self-employment income. It helps taxpayers accurately report their financial activities, claim deductions, and determine the taxes owed to the Canada Revenue Agency (CRA).
Who Needs to File a T2125?
The T2125 form is used to report income and expenses related to any business, freelance, or professional activity in Canada. It helps the Canada Revenue Agency (CRA) determine how much net income (or loss) you earned from your self-employment activities during the tax year.
You need to fill out the T2125 if you:
- Are you self-employed as a sole proprietor or in a partnership?
- Earn income from freelancing, contract work, or any business activity.
- Earn money from providing professional services (e.g., doctors, lawyers, consultants).
If you have any business and professional income at all—even if it’s an unregistered side hustle for fun—you still have to fill out Form T2125 when you complete your T1 Canadian tax return. Just remember, if CRA considers your side hustle a hobby, the number of expenses you can claim is limited to your total income from your side hustle. In other words, you can’t create a business loss that you use to reduce your other sources of income.
However, there are some exceptions on how to report your income depending on your business structure or industry. Instead, file using the following forms:
- T5013 if you are in a partnership with more than 5 members
- T2121 if you earned your business income through fishing
- T2042 if you earned your business income through farming
What’s the Difference Between Professional Income and Business Income?
Business income is generally any revenue earned by selling products or services. The exception is when you earn income and are in a profession that has a governing body. Like CPAs, lawyers, engineers, doctors, and other healthcare professionals. Professional sole proprietors or partnerships with less than 5 members will report their revenue in the professional income section of the T2125. Everyone else will report their revenue in the business income section of the T2125.
Working Under Contract for a Client: Employee or a Sole Proprietorship?
This is a tricky question. How the CRA classifies you depends on how, where, and when you work.
You Are Considered an Employee If…
Your employer sets the hours you work, controls the pace of your work, sets your salary, supervises you, and assesses the quality of your work. In this case, the work you do under this contract would be considered employment. It would be best to get a T4 for this job and not include any of this income on a T2125. If you feel you are an employee based on these criteria but do not get CPP, EI, or tax deducted from the contract payments you receive, talk to your client about setting up your contract correctly.
You Are Considered a Sole Proprietorship If…
You decide and control where you work, how long/often you work, and how you conduct your duties. You supply your own equipment and tools, you incur business costs and advertising costs, and manage the cost of renting or purchasing.
As part of this contract work, you could make a profit or incur a loss and are expected to cover your own general operating expenses and operating costs. You also incorporate the duties of this work into your other business or professional activities. If this sounds like your contract terms, you are most definitely a sole proprietor and will need to report income from it on a T2125.
Do I Need to Fill Out Form T2125 for Income Earned Outside of Canada?
Yes. If you have American or other international clients, you may be required to fill out tax documents like Form W-8BEN, which ensures you aren’t taxed in the U.S. as well as Canada.
When reporting your business’ gross and net income to the CRA here at home, you still need to include anything you earned through services or sales from international clients on Form T2125.
Did you get paid in bitcoin instead? Cryptocurrency counts, too, and you’ve got to report that business income on Form T2125. You may also have capital gains or losses to report if you sold any of your bitcoin during the year.
What If I Bartered Some of My Services? Do I Need to Include That Income on Form T2125?
Yes. It’s not unusual for some professionals to provide their services in exchange for products or services from their clients. Think of an IT specialist who manages the website of a restaurant in exchange for monthly meals or a plumber who gets a manicure/pedicure to take care of the leak in a spa’s bathroom. These are called barter payments.
Even though no money is exchanged hands, you still have to report the value of the services you provided as income. For example, if the cost of managing the restaurant’s website is $1,000/year, that’s what you would include as income on Form T2125.
Do I Include My Business Expenses on Form T2125?
Yes. The purpose of the form is to help you calculate your net business income (i.e., what’s left after you’ve subtracted your business expenses from the money you’ve earned).
Form T2125 will prompt you to enter your self-employment income and expenses. Be prepared with information about both.
How Do I Fill Out Form T2125?
Form T2125 is a 7-page document broken up into 9 sections that can be found on the CRA’s website or provided by any tax professional. Tax filing software will also have the form and guide you through filling it out.
Below is a step-by-step explanation of each section. Note that not all sections will apply to every sole proprietor, so you may leave some blank.
What Does the T2125 Form Include?
The T2125 form is divided into several sections, each of which helps you calculate your income, expenses, and ultimately, the net profit or loss from your business. Here's a breakdown of the sections:
1: Identification
Here’s where you enter your basic information, including:
- Name
- Social Insurance Number (SIN)
- Business name, address, and business number (which is often the same as your GST/HST number)
- Identifying information about your business, such as your main product or service (e.g., graphic design, plumbing, etc.) and industry code
2: Internet Business Activities
You only need to fill out this section if you have a website that generates income. You’ll simply enter the relevant URL(s) and the percentage of gross income generated from the web pages and websites.
3: Income Types and Cost of Goods Sold
This is the section where you declare income. It’s split into 4 parts:
- 3A, Business Income: Fill in this part only if you have business (not professional) income. You’ll also enter how much GST/HST you collected.
- 3B, Professional Income: Fill in this part only if you have professional income. If you just have business income, leave this part blank and fill in 3A. You’ll also enter how much GST/HST you collected.
- 3C, Gross Business or Professional Income: Use the adjusted gross totals you calculated in 3A or 3B, plus include any reserves deducted from the previous year and any other income.
- 3D, Cost of Goods Sold and Gross Profit: Here’s where you enter your business income and subtract expenses like inventory, wages, subcontracts, and other costs directly related to selling your goods or services (a.k.a. costs of goods sold).
4: Net Income (Loss) Before Adjustments
This is where you report all of the expenses you incurred while running your business in the previous year by category. One important section is the capital cost allowance, which includes buildings, furniture, and equipment you use in your business or professional activities that depreciate over time. Form T2125 will help you keep track of your capital cost allowance year over year.
5: Your Net Income (Loss)
Use this section to calculate your final net income or loss for the year. There’s also a section about business partnership income, which you don’t need to answer if you’re a sole proprietor.
6: Other Amounts Deductible from Your Share of the Net Partnership Income (Loss)
Do you have other business expenses that didn’t fit into the categories of Part 4 or Part 5? Here’s where you claim expenses that don’t suit those categories.
7: Calculating Business-Use-Of-Home Expenses
Use this section to enter and calculate how much of your home expenses your business uses, such as heat, electricity, insurance, maintenance costs, etc. These can be deducted from your business income.
8: Details of Other Partners
If you’re in a business partnership, this is where you enter personal and contact information for your other partners. If you’re a sole proprietor, you can leave this section blank.
9: Details of Equity
This is where you report any debts your business owed at the end of the tax year and any personal contributions or withdrawals you made to or from the business, including purchasing your own equipment, building, and motor vehicle expenses.
Gathering Information: What You’ll Need to fill Form T2125
Before diving headfirst into filling out the T2125, you've got to gather the right materials. Here’s a checklist to ensure you're prepared:
- Income Records: Collect all your invoices, receipts, and any other proof of income. Every dollar counts!
- Expense Receipts: Keep track of your business-related expenses. This could include office supplies, travel costs, or even a portion of your home expenses if you work from home.
- Previous Tax Returns: If you've filed before, having last year's returns handy can give you a solid reference point.
- Business Identification: If you have a registered business name, have those documents ready. They’re essential for filling out the T2125 correctly.
How to File the T2125 Form?
You can file the T2125 form electronically or by paper as part of your T1 tax return. Most people use online tax software to file their returns and input the required information.
Key Considerations:
- Keep Good Records: To claim expenses, you must have receipts and records of business income and expenses. The CRA may ask for proof during an audit.
- Separate Personal and Business Finances: It’s a good practice to keep personal and business finances separate by using separate bank accounts and credit cards for business activities.
- Claiming Home Office Expenses: Ensure you calculate the proper percentage of your home used for business. The CRA may request this information.
- Filing Deadlines: If you’re self-employed, your tax return is due by June 15, but any taxes owing must be paid by April 30 to avoid interest charges.
Wrap Up:
The T2125 form is essential for any self-employed individual or small business owner in Canada. By accurately reporting your income and claiming all eligible business expenses, you can reduce your taxable income and potentially save on taxes. To ensure compliance and take full advantage of deductions, keep meticulous records of your business activities and consult a tax professional if necessary.
Connect with Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.