As a Canadian small business owner, having a strong comprehension of how your income is treated by tax laws is crucial.
One of the main components of this is understanding the type of income you make, as it is essential for accurate tax filing and effective tax planning. However, the distinction between various classifications of income isn’t always obvious. This is especially true when it comes to capital gains and business income.
So let’s dive in and gain some knowledge.
A business’ capital is the money it has on hand to cover both its ongoing expenses and potential future expansion. Working capital, debt, equity, and trade capital are the four main categories of capital.
When a capital asset is sold, and its value increases, this is referred to as a capital gain. By and large, a capital gain happens when you sell an asset for more money than you paid for it initially. Almost every asset that you own, whether acquired for investments or personal use, is considered to be a capital asset. When you sell an asset you can realize capital gains by deducting the purchase price from the sale price. In certain situations, the Internal Revenue Service (IRS) taxes individuals on their capital gains.
This is true for shares of mutual funds, exchange-traded funds (ETFs), stocks, bonds, and other financial instruments, as well as for rental properties, vacation homes, and machinery and equipment for your business. On the flip side, when you sell an asset for less than you paid when you first bought it, it is considered a capital loss.
*Only half of all capital gains are taxed in Canada. This does not necessarily mean that you are taxed at a set rate. It is taxed at your marginal tax rate and is part of your yearly taxable income. Only when you sell an asset for a profit do capital gains apply.
To compare the tax brackets for each province and territory in Canada visit here.
For the purposes of tax filing and planning, business income is categorized as ordinary income and is a sort of earned income. Business income includes all earnings derived from an entity’s activities. It is a business’ net profit or loss which is determined by subtracting revenue from all of its sources from operating expenses.
It is important to distinguish between transactions involving your personal life and those involving your business because, whereas capital gains are only partially included in income, business income is fully included.
The individual circumstances of each taxpayer will determine whether they would rather generate capital gains or business income. Although one taxpayer might find it advantageous to maximize the amount of losses that are available to them by claiming business losses, another taxpayer might want to reduce their taxable income by claiming capital income. In most cases, taxpayers would prefer to earn capital gains over business income.
Agency, C. R. (2022, January 18). Capital Gains - 2021. Canada.ca. Retrieved August 2022, from https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4037/capital-gains.html#P306_32909
Business income vs. capital gains. HTK Academy. (n.d.). Retrieved August 2022, from https://htkacademy.com/business-income-vs-capital-gains/#:~:text=Business%20Income%20vs.-,Capital%20Gains,included%20in%20income%20at%2050%25.
Di Verdi, S., & Dallaire, J. (2022, May 20). Capital gains tax in Canada, explained. MoneySense. Retrieved August 2022, from https://www.moneysense.ca/save/taxes/capital-gains-tax-explained/
Introduction to business income vs. capital gains. TaxPage.com. (2021, October 25). Retrieved August 2022, from https://taxpage.com/articles-and-tips/a-canadian-tax-lawyers-introduction-to-business-income-vs-capital-gains/
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