Claiming a Business Loss – Losing Money Never Felt So Good

So a couple weeks ago I sat down to get our tax situation figured out for 2011. We decided to go with a chartered account to file all of the paperwork for us. It actually worked out pretty well since he needed a website made for him and one of us (I’ll leave it up to you to guess) is pretty good at doing that sort of thing. As a bonus for future years, we found out that since we are now a registered business, we can deduct the costs of having someone do our books, from the revenue of the business itself. If we assume our marginal tax rate is somewhere around 35-40%, this basically means that the tax preparation really only costs us less than 2/3 of the sticker price. Anyway, I had done my own taxes in the past (I still recommend trying your hand at this process if your return is fairly straight forward), but I wanted someone who was sure they knew what they were doing since we had to include business-related stuff this time around.

I had never really paid attention to all the deductions that businesses were allowed to make since it never affected me before. I was vaguely aware that my dad “wrote-off” quite a few things with his lumber business when I was young, but I didn’t really understand just how extensive tax deductions can be for a business. Now I should say right up front that I am definitely no tax expert, I don’t play one on TV (or on my blog) and I didn’t even stay at a Holiday Inn Express last night, so take my opinions and thoughts for what they are worth.

Running A Blog Costs More Than I Thought

claiming a business loss

After adding up all our revenues and immediate costs related to the business (stuff like hosting, design help, contract work, software, internet costs etc.) I thought we would likely break even for 2011; however, after learning all the expenses I was allowed to claim against our revenues, I was never so happy to report that I had “lost” quite a bit of a money. So for our first year in business, we are claiming a business loss! The main aspect of these deductions that I was not aware of was all of the home expenses that we are able to deduct. The basic idea is that if you conduct more than 50% of your business from home, you are allowed to claim many different business costs such as rent, mortgage (sans interest), home insurance costs, utilities from your taxes. The percentage of these costs you are allowed to deduct is based on the square footage of your home office as a percentage of the overall square footage in your house. Now I know why so many people try to create fraudulent businesses – they could be quite lucrative!

Now hopefully this will be the only year that we claim a loss for our business. I definitely plan on our business making substantially more in 2012. One of the only large benefits to being a registered general partnership business is that you can deduct business losses from your other income. In the case of JB and I, we both have pretty decent jobs and fairly high marginal tax rates. Every dollar that we lost in 2011 on our business is 30 cents or so of savings in our pockets come tax return time. Now if we were incorporated, that is another ball of wax, and the tax treatment would be much different.

To Deduct, or Not To Deduct – That Is The Question

The flip side claiming this loss of course, is that the government takes a closer look at you and your tax situation and that infamous term comes into play – tax audit. I have only heard terrible things about this scenario, but I think we have a small enough business that it should be pretty simple even if “our number comes up.” Also, from what I heard and read, the chances of you having an audit done go up dramatically if your business continues to incur losses for several years running. This makes sense, as otherwise I’m sure lawyers would be advising everyone to open a random business so that they could subtract home costs from income taxes. That being said, I have to believe that initial start-up costs in your original year, and your meagre initial revenues would probably be looked at different than a company posting large losses for its 4th straight year or something along those lines. I guess we’ll find out soon… maybe you’ll soon be treated to a post about the joys of being audited!

Any other tips from people who have owned small businesses for a while or went through the audit process?

About Teacher Man

TM is a self-professed nerd about all things related to personal finance. He can be found writing for My University Money, Young and Thrifty, and Canadian Personal Finance Blog. TM blogs in order to continue his quest for lifelong learning and hopefully to help others along the way.

18 Responses to Claiming a Business Loss – Losing Money Never Felt So Good

  1. Ramona says:

    CRA refers to it as “expectation of profit”. Side businesses that generate losses several years in a row can be targeted and deemed a hobby, rather than a business, and therefore expenses won’t be deductible.

    Smart idea to have your taxes done professionally with the business. Hopefully in addition to preparing accurate taxes, they’ll offer good advice as well.

  2. Thad P says:

    Great reminder that a blog is a business. Need to remember that next year when doing my taxes!

  3. PK says:

    I also think a lot of that audit talk is a scare tactic, heh. I’m not suggesting inventing deductions that you can’t justify, but you should definitely claim every dollar that is justifiable. I know people who won’t claim a home office deduction because of the increased audit risk that comes with doing that…

    … basically they are increasing their own tax rate. Silly!

    • Teacher Man says:

      Yah, I have heard some audit horror stories over the years, but my dad ran his own business for 30+ years, and claimed home deductions and many other things. They were all very legit, and he would have been fine in an audit, but he was never looked at. I figure we are pretty small potatoes overall.

  4. Okay, so I know pretty much nothing about business taxes. So thanks for sharing this, now I know that reporting a loss (or just having one in general) isn’t necessarily a bad thing. It’s weird how this tax stuff works out. :-)

  5. I think it all depends on the income declared that you’re claiming a loss on. If it’s less than $5000, I have a hard time imagining the CRA doesn’t have bigger fish to go after!

    • Teacher Man says:

      That’s what I figure too man. It also makes blogging pretty attractive as a side gig, because realistically, you can make quite a bit of income before you even exceed your basic deductions for having a home business.

  6. My dad – who is a CPA, CFP, etc, and does my taxes – says that the self-employed are also likely to get audited if they see a huge increase in their earnings from one year to the next! This year, I was able to use my Schedule A form to decrease my taxable income by more than a third – it was the difference between owing the IRS and getting a small refund!

    • Teacher Man says:

      Interesting, an increase in earnings would trigger an audit. I would guess that most people claiming that much of an increase wouldn’t be fraudulent. Congrats on actually making the tax system work for you!

  7. This gives me some hope. When J$ (Budgets are Sexy) was saying he will have to pay quite a bit of tax, I congratulated him because this meant he has made quite a bit as well. His reponse was to pray for me…and let’s just say that his prayers work. It looks like we’ll have to pay tax on side hustles (blog is very insignificant part of the income). So, thank you for reminding me about all the expenses that need to be counted – this may make the situation a bit better (I still want to pay loads of tax but…).

    • Teacher Man says:

      We are a partnership here at MUM, but I would say the company would have to make at least 5-6K in profit in a year before we would even begin to pay tax. There are so many little expenses that are directly business related, and then because it’s a home business we have plenty of home deductions as well. Any professional fees, or trips to conferences for PF or anything like that are fairly safe from everything I’ve read (in Canada anyway). In any case, we are pretty young guys with not a lot of deductions, so with high marginal tax rates, any savings is really nice for us!

  8. Office-in-home expenses are legit as long as you really do have a separate room for your business and use it only for that purpose. You need to be aware that you cannot create or increase a business loss by claiming office-in-home expenses. You can, however, include these expenses even if you are in a loss position but they will have to be carried forward to use in a year when you do have a positive net income. Just remember to keep ALL your receipts in case the CRA does come knocking!

  9. I have had an accountant for a few years now and it’s some of the best money my business spends.

  10. Steve White says:

    I’m a CA student just finished another busy season. Came upon your blog through hearing of your taking over the other one. Congrats on the new endeavor.

    Just one small correction: you can deduct only a percentage of the interest on your mortgage as a home office expense, and not the principal.

    Good article though. Thanks for sharing with everyone.

    • Teacher Man says:

      Right, sorry Steve I thought I had made that a little clearer. Yes, only the square footage percentage of your house that gets used for your small business (for us, only 15% offices), and only the interest on your mortgage.

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