Employees don’t seem to get any breaks. They usually have to follow bosses’ orders and they don’t get to share in the profits of the business at the end of the day.

And, when it comes to tax, the employee’s situation doesn’t get much better. Employees are very limited in the expenses they can deduct when calculating the tax they owe to the Canada Revenue Agency (CRA). Self-employed individuals have much more flexibility – they basically can deduct any reasonable expense incurred to earn income from their business.

If you are an employee, however, don’t despair. You can deduct some types of expenses. And, by structuring your employment arrangement with this in mind, you can reduce your tax bill.

This bulletin looks at the types of expenses you can deduct as an employee and the planning you should consider to maximize your deductions. Throughout the bulletin we’ll also discuss the differences in the rules for commission salespeople and the types of strategies they can use to maximize their deductible expenses. Finally, we’ll look at situations where special rules apply – these include artists, musicians, apprentice mechanics, and railway and transport employees.

This bulletin does not examine deductible expenses for self-employed individuals. If you are interested in this information, please see our bulletin: Self-Employment: Is it for you? or ask your BDO advisor for a hard copy.

When are expenses deductible?

Under Canadian tax rules, employees can only deduct expenses that are specifically allowed. Unlike individuals who run their own business, there is no general rule allowing employees to deduct any reasonable expense incurred to earn employment income. This makes tax minimization more challenging for employees.

For any employee to be able to deduct expenses, a basic test must always be met: the employee must be required by the contract of employment to pay his/her own expenses. This means that the employee needs to ensure that their employer signs Form T2200, Declaration of Conditions of Employment, certifying that this requirement indeed exists. Fortunately, however, this often isn’t a problem. Employers are usually more than happy to certify that employees are required by the terms of their employment to pay certain expenses, since this form helps the employee for tax purposes. (The form does not need to be filed with the CRA, but it should be kept by the employee in case of an audit by the CRA.)

Expenses of commissioned salespeople

The rules for commission salespeople are somewhat more generous. In addition to being allowed to deduct specific expenses, they can deduct any reasonable expense incurred to earn income (such as commissions) that is based on the amount of sales they generate.

To be able to deduct expenses as a salesperson, the following tests must be met:

• You must be required to pay your own expenses by virtue of your contract of employment;
• You must ordinarily be required to carry on the duties of your employment away from your employer’s business location (e.g. at customer locations);
• Your remuneration must be wholly or partly based on commissions or other amounts, such as bonuses, which are calculated by reference to the volume of sales made or contracts negotiated; and
• You are not in receipt of a tax-free travel allowance for your expenses.

If you are deducting expenses as a commission salesperson, there are a couple of points you should keep in mind. First, you can only deduct expenses to the extent of your commission income. If your expenses exceed this income, you will lose the ability to deduct any excess amounts. And, any excess can’t be transferred to another year to deduct against income earned then.

This leads to the second point: you can always deduct certain expenses as a regular employee against your salary. You only need to use the rules that allow you to deduct certain expenses as a commission salesperson if you couldn’t otherwise deduct them as a regular employee. A good example of an expense that is only deductible by a salesperson is meals and entertainment. Therefore, to minimize the likelihood that your expenses will exceed your commission income, you should always consider the rules for regular employees and then only use the rules for commission salespeople if expense deduction is higher.

What’s deductible?

Let’s review the specific expenses that are deductible. We’ve prepared a chart below outlining various expenses, comparing what’s deductible for regular employees and for commission salespeople. We’ve also added a column for self-employed individuals — keep in mind that they have the greatest flexibility in deducting expenses. Near the end of the bulletin we’ll briefly discuss the possibility of rearranging your affairs to become an independent contractor.

We discuss many of the items in more detail below. Be sure to read the commentary for each item to determine if a particular expense will be deductible for you. We’ve also included a separate section on home office expenses. The rules for this area are complicated and the type of expenses you can deduct vary depending on whether you are a regular employee, commission salesperson or an independent contractor.

Annual professional membership dues

Let’s say that you are an engineer working for a large company. Every year you have to pay fees to the provincial Professional Engineers Association to maintain your P.Eng. If your employer does not pay these fees, you can deduct them as an employment expense on your tax return. If your employer pays the fees on your behalf you can’t deduct them, but you won’t be taxed on this benefit either (as long as it was necessary that you maintain your professional status for your job). If your employer does include these fees as a taxable benefit on your T4 you can deduct this amount on your tax return.

Note (1) – Although the recent Supreme Court decision in the Gilford case did not rule out an interest deduction for employees, interest will remain non-deductible for most employees.

Union dues

Similarly, employees who are members of a union can deduct the annual union dues they are required to pay.

Salary paid to an assistant

In certain circumstances an employee can deduct the costs of hiring an assistant. An employee hiring their own assistant is unusual, however, because most assistants are hired directly by their employer who bears the costs. However, there are situations where it may make sense for an employee to hire their own assistant.

Let’s consider a mutual fund salesperson who is an employee of a financial planning firm. The person makes a small base salary but also earns sales commissions based on the dollar value of mutual funds sold in the year. The more time the individual has to meet clients and make sales, the higher their commissions will be. In this case, an assistant could be invaluable. The assistant could perform a lot of the administrative duties, freeing up the salesperson to do what they do best – make sales and therefore earn higher sales commissions.

If the employer won’t hire the assistant, the salesperson could hire the person instead and could deduct the cost of paying the person, including all related payroll costs (such as Canada Pension Plan contributions and Employment Insurance premiums).

It’s important to keep in mind that the amount you pay an assistant must be reasonable. This is extremely important to note if you want to hire a relative. You will only be allowed to deduct a reasonable salary for any services performed.

You should also note that this provision does not allow you to deduct amounts paid to someone to take care of your children to allow you to work. You can deduct these costs up to certain limits but only under the child care expense rules. These rules allow the lower income spouse to deduct expenses incurred up to two-thirds of their earned income to a maximum of $7,000 per child under 7 at the end of the year, $4,000 for a child between 7 and 16 at the end of the year, and $10,000 for each child having a severe and prolonged physical or mental impairment.

Supplies consumed in employment duties

You can deduct supplies you have to pay for that are consumed in your employment duties. These include items such as:

• Paper
• Office supplies
• Long distance telephone call charges
• Cellular phone airtime
• Internet charges based on usage.

Some people want to deduct expenses such as clothing under this provision. Generally speaking, clothing is a personal expense. However, an informal decision of the Tax Court of Canada does open the door for the deduction of specialty clothing such as a uniform. Provided that the clothing is not used personally, the court held that specialty clothing is a supply and it would be considered to be consumed as the clothing wears out. Although an informal decision does not represent a legal precedent, the reasoning used by the judge should be useful to other taxpayers.

Also, if your employer provides you with specialty clothing for work, an earlier court case states that the provision of this clothing does not represent a taxable benefit. The same rational applies to an allowance for the clothing and costs such as dry cleaning.

< This list is not exhaustive. For example, a medical practitioner who is required to buy his/her own medical supplies is allowed to deduct these costs as a supply.

Travelling expenses

Employees are allowed to deduct travelling expenses if they are required to pay these expenses under their contract of employment and they don’t receive a tax-free allowance for these expenses. These rules also allow employees to deduct automobile expenses.

A couple of points you should note. Most allowances you receive from your employer will be taxable, except for reasonable automobile allowances that are calculated by reference to the kilometres you drive for employment purposes. In certain circumstances, other reasonable allowances can be considered tax-free, such as allowances paid to cover travel expenses for salespeople, for clergy and for ordinary employees if they are required to travel away from the municipality in which they ordinarily report to work. Keep in mind that if these allowances are reasonable and therefore not taxable, you cannot deduct any of the travelling expenses that you incur.

The most common travelling expenses are for your automobile. Many employers require their employees to have a car and do not reimburse them on a tax-free basis for their expenses. We have produced a separate bulletin explaining what you can deduct for your car expenses and the records you need to keep, entitled, Automobile Expenses and Recordkeeping

Planning Point: - Most employers are willing to pay a reasonable amount per kilometre if you are required to use your car for employment purposes. What is reasonable is a question of fact but the CRA won’t likely challenge a per-kilometre allowance of 36 to 42 cents. Compare the amount you receive as a per-kilometre allowance to the amount of deductible automobile expenses you have. If the allowance is higher, don’t include it in your income and don’t deduct automobile expenses. The excess amount of the allowance over the deductible expenses will be tax-free. This will usually be the case if you drive an inexpensive or older car and therefore the amounts you can deduct for tax depreciation on the car (see below), as well as maintenance and fuel costs, are not very high.

Capital expenses

Capital expenses include any amount paid for a capital asset. For example, office furniture or equipment (such as a computer) are capital assets. Businesses (including self-employed individuals) can deduct the cost of capital assets through our tax depreciation system called capital cost allowance. Generally, as an ordinary employee or a salesperson you cannot deduct anything you pay for capital assets.

There is one main exception. An employee can deduct capital cost allowance (CCA) on his/her car if they are eligible to deduct automobile expenses. However, there are limits on the amount of CCA you can claim on your automobile. The rules are complex, but basically you cannot deduct CCA on any purchase price greater than $30,000 plus applicable GST and provincial sales tax (PST) for purchases after 2000. See our Automobile Expenses and RecordkeepingBulletin for limits for purchases before 2001.

If the cost of your automobile is less than the limits above, it is considered a “class 10” asset. Your purchase price (including sales tax) is added to a pool of costs with any other class 10 assets you own. Each year you are entitled to claim up to 30% of the pool’s balance as CCA (only 15% on assets in the year of purchase). Any amount claimed in one year reduces the pool balance for the next year’s calculation. If the cost of your car exceeds the limits, the maximum deductible amount will go into its own separate CCA class, known as class 10.1, which is eligible for the same CCA deductions.

If you sell a car in the year you may have a gain or loss, depending on whether the proceeds are greater or less than the pool’s remaining balance. The rules are complicated so we suggest you discuss the consequences with your BDO advisor.

Similar rules also allow employees to deduct CCA on an aircraft, if they are required to own a plane and use it in their employment duties.

Finally, note that special rules for musicians and apprentice mechanics may allow for additional deductions for certain capital expenses (see the Special Situations section later in the bulletin).

Rental costs of equipment/telephone lines

Ordinary employees cannot deduct the cost of renting equipment, such as a computer or office equipment. The CRA does not consider the rental payment to be a supply consumed in the course of performing employment duties and therefore it’s not deductible. The same rationale also means that an employee can’t deduct the monthly cost of renting a telephone line or cellular phone – even if the only reason for the line or phone was for employment purposes.

The fact that these rental costs are not deductible for ordinary employees is often misunderstood. This is probably due to the fact that commission salespersons can deduct these expenses against their commission income. Remember that salespeople have more flexibility in what they can deduct – they can deduct rental payments under the rule that allows them to deduct any reasonable expense incurred to earn commission income provided it is not a capital payment.

Planning Point - ordinary employees: Ordinary employees should avoid paying for the cost of equipment they need for employment purposes. Instead, you should have your employer purchase or rent the equipment you need. Your employer can deduct these costs as a business expense – there will be no tax consequences for you as long as you don’t use the equipment for personal purposes. If you do, you will be taxed on the value of the personal use.

Planning Point - commission salespeople: If you are a salesperson and you have to provide your own equipment for your job, such as a computer or cell phone, you should always lease this equipment. If you buy the equipment you cannot deduct the cost as CCA. If you lease the equipment, however, you can deduct the lease payments as an expense incurred to earn commissions.

Interest expense

You generally can’t deduct interest expense, whether you are an ordinary employee or a commission salesperson as interest is generally payment of capital. Although a recent decision of the Supreme Court did not rule out the possibility that interest could be an income expenditure, it will generally be a capital payment based on the Supreme Court’s rationale. An exception to this rule is interest on a car loan – you can deduct a prorated portion of this interest expense as a car expense.

Planning Point: - Don’t borrow to fund your employment expenses (unless you’re borrowing to buy a car and you can deduct automobile expenses). Use cash for these expenses whenever possible and borrow for other purposes if the interest will be tax deductible. For example, you can deduct interest expense if you borrow to make an investment.

Meals & entertainment

Ordinary employees had better hope their employer reimburses them for that business lunch. If they don’t, they can’t deduct anything as an employment expense.

Commission salespeople, however, have more flexibility. Meal and entertainment expenses are deductible against their commission income. However, only 50% of the cost is deductible.

Office rent/Home office expenses

As an employee you can deduct the cost of renting an office if your employer requires you to pay for your own space to work. This isn’t very common, however. It is more common for individuals to work for their employers out of a home office. You can deduct the cost of maintaining a home office as long as you were required to provide your own place of work and you pass one of the following two tests:

• Your home office is the principal place of your employment. Basically, this means that you work more than 50% of the time from your home office. This can be a difficult test to meet for some employees who have home offices. For example, a commission salesperson might use a home office to carry out administrative duties. If they are usually on the road at customer sites, however, they likely won’t meet the 50% test and therefore aren’t eligible to deduct home office expenses.
• Your home office is used exclusively for employment purposes and is used on a regular or continuous basis for meeting clients, customers or patients. This test is designed primarily for individuals such as doctors, chiropractors and massage therapists — they might have an office where they usually work away from their home but they might also see clients or patients at home. These individuals can deduct home office expenses as long as they use the office space exclusively in their employment duties (in other words, the office is not part of their living space).

There is an important point to note. As long as you work primarily out of your home office, which means more than 50% of the time, you don’t have to use your home office exclusively for your job. The office can be combined with personal living space. What you have to do is prorate the expenses related to your home office between its use for employment and personal purposes. If you use it 60% of the time for your job and 40% for something else, then only 60% of the expenses related to the maintenance of the home office is deductible.

What expenses can you deduct?

As an employee you can deduct the cost of renting an office. If you own the space in which the office is located (i.e. it’s a home office that meets one of the two tests), you can only deduct the expenses of the office that are considered to be “supplies consumed in your employment activities.”

How will these rules apply to you?

Let’s first consider the situation where you rent your living space and it contains a home office. You’ll be able to deduct a portion of your rent as a cost of renting an office. If you have to pay for utilities or minor repairs, you can also deduct these expenses as supplies consumed in your employment duties.

For example, assume you rent a two bedroom apartment for $900 a month and you use the second bedroom as a home office. You also have to pay $100 a month for utilities in addition to your rent. The office is 25% of the total apartment and you use it 80% of the time for work. You will be able to deduct $200 a month for home office expenses – this is calculated in the chart below:

Now let’s assume you own a house in which you have a home office that you use for employment purposes. You can deduct the portion of your utilities and maintenance costs that relate to the business use of your home office as supplies consumed in your employment. However, the deductible portion of these expenses is probably not significant.

What about other costs you pay for your home, such as property taxes, insurance and mortgage interest? As an ordinary employee, you are not allowed to deduct these expenses as there is no provision in our tax law that allows this. In particular, these expenses are not considered supplies consumed in your employment duties and therefore are not deductible (the CRA does consider such items as basic repairs and utilities to be supplies).

Commission salespeople have a bit more flexibility in what they can deduct. Remember that they can deduct any reasonable expense they incur to earn commission income. Because of this provision, they are allowed to deduct a portion of their property taxes and house insurance that relates to their home office. However, they also cannot deduct any of their mortgage interest, since employees generally cannot deduct capital expenses, such as interest. The office expenses chart above shows what expenses are deductible for a home office, comparing an ordinary employee, commission salesperson and self-employed individual. As the chart shows, self-employed individuals have the most flexibility in what they can deduct.

These differences probably seem unfair to you. You’re right! Employees who rent a home office have much more flexibility in the expenses they can deduct (since they can deduct office rent, they can effectively deduct all the costs that are built into the rent such as property taxes, insurance and interest). And commission salespeople and self-employed individuals are able to deduct more expenses for a home office if they own their own home as compared with an ordinary employee.

Planning to maximize tax breaks

If you’re an employee, you are limited in what you can do to maximize your tax breaks. However, there are some measures you could consider.

Become a salesperson

Are you involved in sales? Do you often negotiate contracts on your employer’s behalf? If you do, consider renegotiating your salary package so that at least some of your income is based on the revenue you produce. This could be as simple as receiving a year-end bonus that is based on the sales you are responsible for. If you can rearrange your affairs, you’ll be eligible to deduct expenses as a commission salesperson. Make sure your employer reports your commission or bonus separately as a commission on your T4 – otherwise the CRA will likely question your expense deductions as a commission salesperson.

You’ll have to assess whether this makes sense for you. Are you willing to accept the risk that part of your remuneration package will be based on the sales you produce? Also, consider the amount of expenses you currently have to pay that would become deductible if you became a commission salesperson. If you would have minimal deductible expenses anyway, it’s probably not worthwhile. For example, you could increase the amount of deductible home office expenses, deduct the rental costs of any equipment you have to pay for and deduct business meals and entertainment if part of your remuneration is based on sales.

Become an independent contractor

Self-employed individuals have the most flexibility in deducting expenses. It may be possible to rearrange your work arrangement so that you will be considered to be self-employed rather than an employee.

A few words of caution: You can’t just state that you’re an independent contractor to be treated that way for tax purposes. There is a series of tests used by the CRA in determining whether you are self-employed or are an employee. For example, the CRA looks at who controls the work – whether you have the flexibility to determine when and how you do the work, whether you are required to work between certain hours, etc. It also checks whether your remuneration is fixed or whether you have the ability to earn as much money as possible. You should always consult with your BDO advisor before attempting to become an independent contractor.

You’ll have to consider a number of things to determine if this is a viable option for you. Will you have significant expenses that will now be deductible? Are you prepared to give up some of the perks of employment, such as dental and health plans? Do you want the protection of employment insurance, which is only available to employees and not independent contractors? And finally, is it even possible to change your relationship with your current employer so that you are an independent contractor?

For more information read our bulletin Self-Employment: Is it for you? or ask your BDO advisor for a hard copy.

Special situations

For certain types of employees there are special rules that allow them to deduct other expenses in addition to the ones described above. The special rules are an attempt by the government to recognize the special nature of these jobs and the fact that certain expenses may have to be incurred by the employee and should be allowed as a deduction from employment income.

Musicians

Musicians usually have to buy their own musical instruments. They can deduct the cost of instruments using the tax depreciation rules called capital cost allowance (CCA). Most instruments are classified as class 8 – the purchase price (including sales tax) is added to a pool of costs with any other class 8 assets. Each year, a deduction of 20% of the pool’s balance is allowed (10% can be claimed on assets added to the class in the year of purchase).

Artists

Artists who earn employment income from an artistic activity can deduct additional expenses from their employment income. Artistic activities include:

• creating paintings, prints, etchings, drawings, sculptures or similar works of art;
• composing a dramatic, musical or literary work;
• performing a dramatic or musical work as an actor, dancer, singer or musician; or
• carrying out an artistic activity in respect of which the taxpayer is a member of a professional artists association that is certified by the Minister of Canadian Heritage.

The expenses that can be deducted are limited to the lesser of:

• $1,000; and
• 20% of employment income from artistic activities, less any amounts claimed as CCA on automobiles or musical instruments.

Transport employees

Individuals who work for employers whose principal business is the transport of passengers, goods or both, can deduct reasonable expenses for meals and lodging if their employer does not reimburse them for these costs. Only costs incurred while travelling away from the municipality where the individual reports to work can be deducted. Although unfair, these rules do not apply for full-time transport drivers of companies which are not in the transport business.

Railway employees

Similar to transport employees, individuals who are employees of a railway company can deduct expenses for meals and lodging to the extent they are not reimbursed by their employer for these costs. Only costs incurred while away from their ordinary place of residence are eligible to be deducted.

Apprentice mechanics

An eligible apprentice mechanic is allowed to deduct the cost of eligible tools purchased. The deduction allowed is equal to the cost of tools purchased less the greater of 5% of employment income as an eligible apprentice mechanic or $1,000. The allowable amount deducted can’t exceed an individual’s net income (from all sources). An unclaimed amount can be carried forward.

Documentation of expenses

If you are deducting expenses for tax purposes, documenting your expenses is crucial. If you keep track of your expenses in an organized fashion, not only will this save you time when you prepare your tax return (and money on your accountant’s bill), it will also help ensure that you are prepared should the CRA decide to review your return.

Receipts are crucial for all of your expenses. If you’re a salesperson and you are deducting meals and entertainment expenses, it’s a good idea to write on the receipt who you took to lunch and why. Automobile expenses, in particular, have to be properly documented. It’s extremely important to keep a logbook of your driving to support the number of kilometres you drive for business purposes. Your BDO advisor can provide you with a BDO logbook you can use to keep track of your driving.

GST rebates

When you incur expenses you also pay GST on some of the expenses. If your employer reimburses you and is registered for the GST, your employer is eligible to recover the GST.

If you don’t get reimbursed and are eligible to deduct the expenses for tax purposes, it only makes sense that you can recover the GST as well. You do this by requesting a GST rebate when you file your personal tax return. The rebate is 7/107ths of your deductible expenses (including CCA) less expenses on which you did not incur GST. In Nova Scotia, New Brunswick and Newfoundland, the HST rebate factor is 15/115, and in Québec, the QST rebate factor is 7.5/107.5. Examples of expenses on which you won’t have incurred GST are insurance and interest on a car loan. The rebate is claimed by filing CRA Form GST 370. Note that you don’t qualify for the rebate if your employer is not a registrant or if you work for a listed financial institution. Finally, the rebates are taxable in the year of receipt for expense claims and reduces the balance for CCA purposes where a rebate is claimed on CCA.

Conclusion

Employees are very limited in what they can deduct for tax purposes. However, with a little planning and care they can take advantage of the deductions that are available to them. If you have any questions, talk to your BDO advisor today.