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Income Tax for Self-Employed – What you should know

It’s not uncommon for self-employed people to find themselves in debt to the Canada Revenue Agency (CRA). When you are employed, your employer withholds the tax from your paycheque and remits it to the government. When you’re self-employed it’s easy to use tax money to fund your business and subsequently find yourself in trouble at the end of the year. 

Your Income Tax Obligations

In most cases, you must pay income tax if you earn or receive an income. Income from employment is one of the most common forms of income subject to income tax. If you are an employee, your employer will deduct income taxes, Canada Pension Plan (CPP), and Employment Insurance (EI) from your paycheque and forward it to the Canada Revenue Agency (CRA). 

The CRA factors the money it receives from your employer into the amount you owe in taxes at the end of the year. As a result, you may have to pay more income tax, or you could get a tax refund if you overpaid.

Income tax for the self-employed works differently. In effect, you can be described as both an employer and an employee. It is up to you to file your income tax return with the Canada Revenue Agency. If you are self-employed, you are responsible for several types of tax.

Starting a business can be an exciting prospect but make sure you have all the information you need before deciding how to register the company. This podcast explores the differences between sole-proprietorship and incorporation.

Income tax for self-employed and employees

In Canada, you pay both federal and provincial income tax. The tax you pay is a percentage of your income earned, less any deductions. Employees must file their tax returns by April 30 unless it falls on a weekend. Self-employed workers have until June 15. Late tax filings can be subject to penalties on any amount you owe.

According to the CRA, you will pay interest on any amounts owing after the due date. The interest is based on the CRA’s rates. It is a compound daily interest. In addition, there is a penalty of 5% for late tax filing. Finally, the CRA adds another 1% every month after the due date (to a maximum of 12 months) until they receive your tax return. It’s important to note that both interest rates and penalties can change.

Canada Pension Plan

Canada pension plan (CPP) payments are also based on your income. The employer pays part of the CPP premium if you are an employee. You pay the rest as a deduction from your paycheque.

You pay the employer’s and employee’s premiums when you are self-employed. If you’re self-employed, the maximum CPP contribution is $6,999.60 for 2022. That amount is increasing to $7,508.90 for 2023.

Employment insurance

Employment insurance (EI) is another premium employers and employees may have to pay. In an employer/employee relationship, the employer pays most of the premium, and the employee pays the balance. If you are self-employed, you pay benefits only if you opt into the EI program. Opting in allows you to access special benefits such as: 

  • Sickness. 
  • Maternity leave.
  • Parental leave. 
  • Family caregiver and compassionate care.

 You can opt-in by registering with the CEIC.

Goods and services tax, harmonized sales tax, and provincial sales tax

These taxes are referred to as GST, HST, and PST. The GST is a federal tax, but HST and PST can apply depending on your province or territory. These taxes will apply once you earn over $30,000 in either four consecutive quarters or during any consecutive three month period.

How to Manage Your Taxes

Dealing with your taxes can be complicated and time consuming. If you are self-employed, income tax is often more challenging than for employees. However,  there are ways to maximize your deductions and minimize stress. Setting aside money for taxes, and maximizing your deductions can reduce the income tax you have to pay.

Set money aside

One way to make sure you have money to pay any taxes owed is to set it aside on a regular basis. Transferring 20-30% of any income you receive can give you the funds you need to pay for any taxes you owe.

Deductions

As a business, you can deduct many expenses related to running your business, including:

  • Services you need to run your business, such as bookkeeping, accounting, legal fees, internet, cellphone, and telephone fees.
  • Utility costs.
  • Advertising fees.
  • Costs related to the start-up of your business.
  • Shipping costs.
  • Delivery fees.
  • Office expenses.
  • Vehicle, travel, and entertainment expenses.
  • Banking fees, membership dues, licensing fees.

Registered Retirement Savings Plan

If you have RRSP contribution room, you can contribute to your Registered Retirement Savings Plan (RRSP). One way to determine how much you can contribute is to check your Notice of Assessment from the previous year. RRSP contributions can be deducted from your income and reduce the tax you must pay.

Record keeping

Keeping records and receipts for everything you plan to deduct is essential. The CRA requires proof of deductions made for business purposes. Creating a system for organizing your receipts will be helpful if you are audited because the CRA will want to see them.

Bookkeeper

Hiring a bookkeeper knowledgeable about income taxes for the self-employed can be helpful. Bookkeepers provide many valuable services, including:

  • Making sure records are accurate.
  • Keeping track of your sales and taxes owed.
  • Working with your accountant for your tax preparation.
  • Filing remittances with the CRA, such as CRA installment payments.
  • Invoicing.
  • Reconciling reports.

Removing these tasks will free up your time so you can focus on your business.

Income Taxes as a Liability

Businesses are facing financial pressures for several reasons. Labour shortages, inflation, supply chain issues, and the lingering effects of the pandemic have increased operating costs. If you are facing a large income tax bill you cannot pay, help is available. 

Allan Marshall and Associates can provide you with options to find your best debt solution. Removing the financial stress of a tax burden can help you get back on track. Please contact Allan Marshall and Associates at 1-888-371-8900 for a free consultation to review your options.

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Glenn Steiner

Glenn Steiner is a Licensed Insolvency Trustee with Allan Marshall & Associates Inc. He has over 23 years as an LIT and 15 years in senior positions with the Office of the Superintendent of Bankruptcy.