Income Calculations - Unreported Income | Income Tax Lawyers Canada
 
 
Income Calculations for Employees and Independent Contractors
 
A worker can either be classified as an employee or as an independent contractor. Each designation brings with it its own rules for the calculation of income, expenses, deductions and overall tax payable. The distinction is also important when calculating any deductions from taxable income for the year. A key distinction is that an employee’s income is calculated as employment income, while an independent contractor’s work is computed as business income. There are various other key differences between an employee and an independent contractor:
 
Difference in…
 
Employee
 
Independent Contractor
 
 
Payment and Withholding of Tax
 
Employer must withhold and remit a certain amount from each payment made to an employee (s. 153)
  No such obligation, although may be required to make periodic installments (s. 156)
Basis of Measurement
 
Income recognized when received (cash basis)
 
Income recognized when earned (accrual basis)
Reporting Period: Taxation Year
 
Calendar year (s. 249)
  Fiscal year of the business (s. 249.1)
Scope of Deductions
 
May deduct the limited amount of expenses authorized in s. 8
 
Wider scope to deduct income-earning expenses under ss. 9 and 20
 
Employee and Commissioned Salesperson
 
The CRA only taxes gross income from employment. This means that, unless a deduction is specifically listed in the Income Tax Act, it cannot be used to reduce taxable income for that year. The major deductions that are allowed by the CRA are found in s. 8 of the Income Tax Act (Act). However, before deducting expenses, an employee must calculate his or her income using the rules found in ss. 5 and 6 of the Act.
 
Inclusions in Employment Income
 
An employee begins by looking at s. 5 of the Act, which includes salaries and wages as income for the year. Similarly, voluntary payments made in consideration of services rendered in the course of the employment are also included in the calculation of income.
The employee must also consider certain fringe benefit additions to income under s. 6 of the Act, the most important one being a benefit “of any kind whatever”. Some examples of fringe benefits include: board and lodging, awards for achievement, cash gifts from the employer, non-merit-based scholarships given to the children of the
 
1.Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, s. 8 [Act].
2.Ibid., s. 6(1)(a).
employee, certain work-related relocation costs, and allowances given to the employee by the employer for certain expenses.
 
Some specific benefits are excluded from being added to a taxpayer’s income, including:
 
  • Merchandise discounts to employees of a retailer
  • Use of an employer’s recreational facility
  • Merit-based scholarships given to the children of the employee
  • Counseling services in respect of the mental and physical health of the employee or as required by re-employment of the      taxpayer
  • Business trips for the primary purpose of benefiting the employer
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    If the inclusion of a benefit is in dispute, the courts of Canada generally apply a 3-part test to see if a “benefit” should be added to an employee’s income:
     
    1. Was there a material acquisition conferring an economic benefit on the taxpayer?
    2. Was this advantage conferred for the benefit of the employer?
    3. Was this advantage conferred in respect of, in the course of, or by virtue of the employment relationship?
     
    Salesperson Deductions
     
    A salesperson can deduct certain expenses from gross income if all of the following criteria are met:
     
    1. Employed to sell property or negotiate contracts for the employer;
    2. Must pay his or her own business-related expenses;
    3. Usually carries out job duties away from the employer’s regular place of business;
    4. Is remunerated by commissions related to the volume of sales.
     
    The maximum amount a salesperson can deduct per year is the amount of commission income he or she receives during that year.
     
    Employee Deductions
     
    Once employees calculate their income (including additions from ss. 5 and 6), they can deduct certain items from this income in order to lower their tax payable. These deductions are found mainly in s. 8 of the Act. Some major deductions include:
     
  • Traveling expenses, if traveling is required in the ordinary course of employment, the employee pays for this cost and there     is no allowance to cover it;
  • Motor vehicle expenses, if the employee is required to pay for this cost while conducting business away from the home office    and there is no given an allowance to cover this expense;
  • Certain professional membership fees to maintain the status of a “professional” recognized by law;
  • Legal fees incurred in establishing a right to a salary or wages, as well as to collect any such amount that is owed to the     employee;
  • Costs of supplies that are consumed in the direct operation or performance of duties of employment;
  • Food costs with certain limitations on the manner in which they are incurred.
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    Salesperson Deductions
     
    Under s. 8(1)(f) of the Act, sales people can claim certain deductions so long as they work on a commission basis, are not in receipt of an allowance that covers these costs, and are required to pay their own expenses for these regularly-incurred costs.
     
    Limits on Deductions
     
    The ability of salespersons or employees to deduct expenses from their income depends on two criteria:
     
    1. The authority to deduct this amount - usually found in the Act, and
    2. The reasonableness of the amount declared
     
    Under ss. 8(10) of the Act, before an employee is entitled to any deductions a specific form is required to be filled. If these forms are not filled out, the deductions will not be recognized by the CRA.
     
    Independent Contractor
     
    Inclusions in Independent Contractor Income
     
    Income earned by an independent contractor is considered income from a business. The main rule for computation of this income is found in s. 9 of the Act. This income is calculated by subtracting costs from revenues for the taxation year. To determine these variables, an independent contractor must consult s. 10 – 37 of the Act, which set out methods of computation for specific items. Generally, however, in calculating income for the year, well-accepted business practices can be used unless the calculation is accounted for or prohibited by some provision of the Act. As well, s. 12 of the Act includes specific revenues to be included, such as:
     
  • Amounts received for goods and services to be rendered in the future;
  • Amounts receivable for services rendered;
  • Interest income;
  • Dividend income;
  • Income from partnerships.
  •  
    Deductions from Independent Contractor Income
     
    Several key sections (namely ss. 18, 20, 62, 63 and 67.1) of the Act affect the deduction of certain expenses from the calculation of business income, such as:
     
  • Expenses incurred for the purpose of earning income;
  • Capital cost allowance;
  • Interest payments on certain investments;
  • Certain moving expenses;
  • Certain childcare expenses;
  • 50% of food and beverage expenditures for meals of a business nature;
  • Membership fees to social clubs for the purpose of business networking.
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    Similarly, some deductions are forbidden, such as:
     
  • Capital expenditures;
  • Personal or living expenses.
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    The issue of childcare expenses remains a much-discussed topic, without concrete resolution coming from the courts.
     
     
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