Not all income is created the same and the CRA requires that different types of income are reported differently. It is very important that you understand the differences between the types of income and how they are reported to the CRA. The type of income earned can significantly change the treatment from a tax perspective. For instance different expenses can be deducted against business income than employment income. We will discuss the most common forms of income, and how they are reported on a personal tax return (also known as your T1).
Employment income is any income earned as an employee. When you work for a business or entity and receive compensation from that entity, you have earned employment income. Employment income includes income earned from salaries, wages, gratuities, other income inclusions (such as taxable benefits) and stock option benefits. Employment income reported on a calendar basis and is taxed on a cash basis meaning only amounts received are taxed. Typically employment income is reported (by the employer) on a T4 Statement of Remuneration Paid slip, which is included in your personal tax return as employment income.
Business income is any income earned by a business. The CRA considers business income to be any income earned in a:
Any income you receive in connection with the business is considered taxable.
- manufacture or undertaking of any kind,
- adventure or concern in nature of trade,
- or any other activity carried for profit, with evidence of an intention to produce profit.
Note that business income does not include employment income (discussed above). Also generally speaking, business income does not include any rental income (or property income). All income generated from renting space and providing basic services should be reported separately as rental income.
Business income is reported on the accrual basis of accounting. Simply put this means that income and expenses must be recorded when incurred, not when the cash is received/paid. For example, if you complete a project before the current year end, however the customer has 30 days to pay you for that project; it would be considered income in the current period. The same stands true for expenses. If you receive goods or services before the current year end, but have two weeks to pay for them, they would be considered expenses in the current period, regardless of when they are paid.
Business income is reported on a personal tax return using the T2125 Statement of Business or Professional Activities form. This form is used to summarize the total revenues or gross income, then deduct all cost of goods sold and business expenses to come to the businesses net income. Note that reporting for some expenses (for instance CCA, eligible business use of home expenses and vehicle expenses) require you to prepare additional forms. In addition to the T2125, if there are additional reporting requirements if your business collects and remits GST and/or has Employees.
In most situations, where the business is operated as a partnership between a number of partners, the net income for the business is distributed between partners based on the agreed income distribution or ownership. This is calculated on the T2125 form Statement of Business or Professional Activities form discussed above.
Generally, a partnership does not pay income tax on the income it earns and will not file an income tax return, which is different than a corporation (discussed below). Instead, as mentioned above each partner files an income tax return to report their share of the partnership's net income or loss. This requirement for each partner to report their share of the partnership's net income is the same whether the share of income was received in cash or as a credit to one of the partnership's capital accounts, or basically an increase to their right/ownership in the partnership.
There are certain criteria (generally larger partnerships) that may require a Partnership Information Return (Form T5013).
From a tax perspective, a corporation is treated as a legal entity, separate from the individuals owning it and is required to report and file a corporate income tax return (or T2). The corporation will pay taxes much the same as an individual, however the rules, rates and requirements for reporting and paying income tax for a corporation are much different than those set out for individuals.
After the corporation has paid corporate, the income earned from the corporation can only be paid out to individuals (or shareholders) through dividends. Dividends are then taxed as investment income on the personal level.
See the topics on Corporate tax for more information on considerations for incorporation as well as filing and reporting corporate income.