Pay Yourself as a Sole Proprietor in Canada: Drawings, T2125

How do I pay myself as a sole proprietor in Canada?

A sole proprietor cannot pay themselves a deductible salary. You pay yourself by moving money out of the business, which is an owner's drawing (often called an owner's draw). The CRA says do not deduct salaries or drawings paid or payable to yourself, so nothing you pay yourself reduces the business's income.

A sole proprietorship has no separate legal status from its owner, so you are not your own employee: the pay does not go through payroll and no T4 is issued for it. A self-employed person pays both the employee and employer shares of CPP when filing the tax return on Schedule 8. A Quebec resident claims Quebec Pension Plan contributions on the Revenu Québec return instead.

That rule covers pay to yourself only. Reasonable pay to a spouse, common-law partner or child for work the business needs is a deductible salary; see paying family members.

In practice, a drawing is usually a transfer from the business account to your personal account. A regular transfer is easier to track than occasional withdrawals.

A case is not simple when:

• business and personal spending run through the same account or card;
• you took cash or paid personal bills from the business without a record;
• you used business property, such as goods you sell or a business vehicle, for personal purposes;
• you set nothing aside for tax, CPP or instalments;
• the books are months or years behind.

Gather bank and card statements, sales and expense records, the prior year's T2125 and any instalment notices from the CRA.

Do owner's drawings lower my business income or my tax?

No. Business income is the profit from the business, and the Income Tax Act bars a deduction for the taxpayer's personal or living expenses. You are taxed on net business income whether you leave it in the business or take it out. A cash drawing can exceed the year's profit without changing net income.

CPP is also based on net self-employment earnings, not on drawings (Government of Canada). The rates and ceilings are in how self-employed income is taxed.

How do I record an owner's drawing in my books?

Record a drawing in an owner's equity account, such as "Owner's drawings", never in an expense account. An equity account tracks what you have put into the business and taken out of it. An expense account lowers profit, and a drawing is not an expense.

1. Create an equity account for drawings and one for contributions (money or assets you put in).
2. Post every transfer to yourself, and every personal item the business paid, to drawings. A transfer to yourself is a debit to drawings and a credit to the business bank account.
3. Post a business purchase you paid with personal money to the matching expense or asset account, with the same amount as a contribution. If it settles a bill already recorded, clear that liability instead of recording the cost again.
4. Do not use a wages, salary, "owner pay" or payroll category for yourself. That understates profit on the T2125.
5. At year end, total the drawings account. The total feeds Part 9 of the T2125.

What counts as a drawing?

A drawing is any withdrawal of cash or other assets, or of the business's services, by you or your family. The CRA's T4002 guide says to include the cost or value of personal use of business assets or services in the year's drawings.

The CRA says to enter only the business part of an expense, because personal expenses cannot be deducted. For inventory, see cost of goods sold. For a GST/HST registrant, input tax credits follow the extent a purchase is for commercial use, so the personal share of a cost may not qualify. An individual registrant who takes goods or services bought for the business for personal or related-person use is also deemed to have made a supply at fair market value and collected the tax on it, even with no sale, unless an exception applies (Excise Tax Act, section 172). See GST/HST returns and input tax credits.

Taking a capital asset, such as equipment or a vehicle, out of business use is not a plain drawing. The Income Tax Act deems it sold at fair market value when the use changes, which can mean a capital gain or CCA recapture; see selling a business asset.

What does the T2125 ask about drawings and capital contributions?

Part 9 of the latest published Form T2125, "Details of equity", asks for three amounts (Form T2125). The CRA encourages T2125 for reporting business income and expenses.

A member of a partnership that files a partnership information return does not complete Part 9. Drawings are not an expense, so line 9932 does not change net income. It should still match your books. The CRA's T4002 guide explains each line.

A Quebec resident also reports business income to Revenu Québec. This page covers the federal rules.

Do I need a separate business bank account?

The CRA's records guidance does not state that a separate bank account is required, but if the business operates under a name other than your own, you need one to process cheques payable to the business. Every personal item that runs through a shared account becomes a drawing you must find and total. A separate account makes that total a bank statement instead of a reconstruction.

Your records must show the date, amount and source of each receipt of income, a receipt or voucher for each expense, and a daily record of income and expenses. Keep them at least six years from the end of the last tax year they relate to; a late-filed return, an objection and GST/HST records have different periods (see how long to keep business records). More: doing your own books or hiring a bookkeeper.

With more than one account or card, give each its own account in your books and reconcile each one monthly. A transfer between your own accounts, or a payment of your own credit card, is neither income nor an expense. A customer payment that lands in a personal account is still business income, not a capital contribution.

I used the business account for personal costs, or paid business costs personally. Where does that go?

Personal costs paid by the business are drawings, and business purchases paid personally go to an expense, asset or existing liability account, funded by a contribution. Split any mixed cost first. For repayment and home-office questions, see business expenses paid personally.

How much should I leave in the business for tax and instalments?

Income tax and CPP are owed on net income, and GST/HST you collected is owed to the Crown, however much you drew. Instalments, if due, are advance payments toward that tax, not an extra amount.

You may have to pay instalments if your net tax owing is more than $3,000 ($1,800 for Quebec residents under the CRA's test) in the current year and in either of the two years before (CRA); Revenu Québec has its own instalment rules. If farming or fishing is your main source of income, the amount must exceed the threshold in the current year and in both of the two years before (Income Tax Act, section 156.1). Due dates and missed payments: tax instalment reminders.

Many owners track net income so far (sales less business expenses), estimate the year's tax, and move that share to a separate savings account each time they are paid.

Example

These examples are illustrative, use Canadian dollars and leave out GST/HST.

Amara moves the same amount every month

Amara, a Toronto designer, bills C$80,000 and has C$20,000 of business expenses. She moves C$3,000 a month to her personal account. Assume she received all her billings in cash.

Her net income on the T2125 is C$60,000. The C$36,000 she moved is drawings (line 9932), not an expense. She is taxed on C$60,000. The other C$24,000 of profit stays in the business; her tax and CPP on C$60,000 are paid from it or from other money.

Ben pays for a truck and groceries from one card

Ben, a contractor in Alberta, pays C$2,400 of truck insurance and C$6,000 of groceries from the business card. He used the truck 75% for business.

The business share of the insurance, C$1,800, is an expense. The other C$600 and the C$6,000 of groceries are drawings, C$6,600 in total.

Chloe takes C$50,000 and sets nothing aside

Chloe's net income for the year is C$70,000. She took C$50,000 out and set nothing aside.

The drawings do not reduce her C$70,000. Her tax and CPP are worked out on that figure. If all the profit was received in cash, the business holds about C$20,000, set against the tax and CPP due on C$70,000 when the balance is due. Whether that is enough depends on her province and credits. Her net tax owing may also pass the instalment threshold, so instalments may be due in later years; see tax instalment reminders.

Different for you?

• Your business and personal money share accounts, you took cash all year without tracking it, or the tax bill was larger than the cash you kept: bring statements, the prior T2125 and any instalment notices to bookkeeping.
• The books are months or years behind, or you have only bank statements and e-transfers: see catching up on overdue books or rebuilding books from bank statements.
• You already have a corporation, or are weighing one: pay comes out as salary or dividends, not drawings; see salary or dividends or sole proprietorship or corporation.
• Two people own the business: a partnership records draws per partner; see partnership or corporation.
• You are a US citizen or green-card holder with a Canadian sole proprietorship: see Schedule C from Canadian business books.
• You paid business costs personally or work from home: see business expenses paid personally.
• The CRA sent an instalment reminder or you missed one: see tax instalment reminders.
• You are deciding between doing the books yourself and hiring help: see doing your own books or hiring a bookkeeper.