If you’re a Schitt’s Creek fan, you might remember this scene. Me deeming it immediately recognizable may or may not be due to how excited I get when accounting-related terms make their way to mainstream.

Before you continue further on this post, please watch this YouTube video of the scene I am referencing and ask yourself: Am I a David (Dan Levy) or am I a Johnny (Eugene Levy)?

I love this scene because you are going to lean towards relating to one character or the other. Either you’re David, and think that having a business opens up a whole bunch more shopping opportunities for you, or you’re Johnny who can’t believe that some people don’t know what a tax deduction is. Most likely, you’re somewhere in the middle of David and Johnny, where you know that things can be ‘written off’, but aren’t really sure of the mechanics of this. So let me break it down for you.

To calculate a business’s taxable income (read: the amount of income they have to pay tax on) you take their total sales and subtract their business expenses. These business expenses are otherwise known as tax deductions, deductions, tax write-offs or simply, write-offs. The more expenses you “write off”, the more your taxable income is reduced and therefore the lower your tax bill.

We all want to pay as little tax as possible, but of course there are rules that must be abided by to ensure that everyone is paying their fair share.

What is an allowable write off?

Well, certainly not any of the items David proposes to “write off” in the above clip. In order to deduct expenses from your business’s income, they have to be legitimate expenses you incurred to earn that income. The expense must be attributable to the revenues it helped earn, and must be reasonable in the eyes of the tax man. (The word reasonable will make quite a few appearances in this article.)

It is very important when assessing whether something is an allowable deduction to determine if the expense benefitted your business, or whether it benefitted you personally. If you have a personal benefit from the expense - even just a little bit - it enters into a grey zone of allowable expenses. There will be some instances when you will have an expense that is a business expense, but there is a personal benefit there as well. An example of this would be a company vehicle that you also use for personal purposes. The company can write off the car payments or amortization of the car, but the person benefitting from the use of the car will also have a taxable benefit assessed to them - meaning their personal taxes will increase to represent the benefit they received.

Allowable deductions must also be reasonable

There’s that word again. Once you’ve determined that an item is a legitimate expense and can be deducted from your revenue to arrive at your taxable income, there are still more considerations to be made. The amount deducted in the various expense categories have to be in reasonable amounts, or they can raise some red flags for the CRA during an audit.

Reasonable: A company with annual revenues of $1M spend $50-$80k on advertising in a given year.

Unreasonable: A company with annual revenues of $50k spend $50k on advertising in a given year.

If your company is reporting losses year after year, or veryyyyy little profit compared to your sales, you are welcoming the CRA to come and audit your operations and the expenses you are deducting. Your business has a reasonable expectation of being profitable, and if it isn’t - you will face certain scrutiny.

Expense categories often ‘taken advantage of’

Certain expense categories, just by their nature, can seem like an attractive place to write off personal expenses. I assure you, however, that the CRA (or any tax authority, really) is very aware of this and therefore pays special interest to these categories during an audit. I will go through some common categories and what you can do to ensure that you are on side with the tax man as you put items through your business.

Big Ticket Items

Wanna write off that brand new car you just bought? Dream on!

First of all, ANY item that is purchased for your business which has a useful life of over a year and costs above a certain threshold (commonly, $1000) cannot simply be deducted in full from your business income. These items are considered Capital Assets which are depreciated over their useful life. The depreciation amount in each period is an allowable deduction, but there are separate tax rules for how these capital asset purchases affect your tax filings. More detail can be found here. If your business includes the purchase of large quantities of equipment, you’ll want to consult with an accounting professional to properly set up how this is reflected in your books.

Meals & Entertainment (M&E)

The CRA allows a business to deduct 50% of the M&E costs it incurs. Examples of these would be restaurant meals or tickets to a sporting event with a client. Dinner and a movie with your spouse cannot be deducted. You already (hopefully) know that you must retain receipts for any and all business expenses, so a good practice here is to ensure that anything being deducted under M&E very clearly includes on your receipt those who attended the meal or event so that the tax authority can be reassured that this expenditure was, in fact, made to help further the business in the form of wining and dining a client or potential client.

Marketing & Advertising

Of course you need to spend money on marketing and advertising for your business, how else will people know you exist and what you can offer them? You absolutely are allowed to spend a reasonable amount in this category. There’s that word again! What would be considered an unreasonable expenditure in this category? If you held parties open to the public every night of the week under the guise of “marketing event”. Your business is not there to subsidize your party hardy lifestyle, so please keep that in mind when booking things to these accounts. This falls in line with the M&E category listed above.

In Summary

Many people are total Davids when it comes to knowledge about write-offs, and that is ok. But if this is your situation and you are running a business, it might be time to consult with an accountant to help you.

For a complete list of what can and cannot legally be deducted from your business income to arrive at your taxable income, please see this page. Notice that the language used can be vague at times, and that there aren’t very many hard numbers telling you what is allowed. This is simply because one size does not fit all. A reasonable expense for a large corporation might be completely unreasonable for a smaller business. There is a lot of room for interpretation of these rules.

It is much better for you to learn the rules and apply them in a forward-thinking manner, than having the tax authorities come in and make that determination for themselves as judge, jury and (sometimes) executioner.

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I LOVE banishing the “finance scaries” by teaching entrepreneurs in an easy-to-understand way. If you’re reading this, you might benefit from my FREE Financial Health Check, which will assess how you’re doing with the financial management of your business, and provide you with customized resources that will hopefully resonate with you.