Self-employment has some exciting benefits, including a flexible schedule and the freedom to select your projects. It also comes with big responsibilities, especially at tax time. When you’re self-employed, the burden of reporting, filing, and paying taxes falls entirely to you. If you want to streamline the process, it’s a good idea to get familiar with the Canadian Revenue Association’s (CRA) required self-employment tax forms. With that understanding, you can organize your finances, keep great records, and make tax filing a breeze.
Who Needs to File Self-Employment Taxes?
When you’re self-employed, your business income is part of your personal tax return. That means that you pay the personal income tax rate rather than a corporate tax rate. The CRA considers you to be self-employed if your business is:
- A sole proprietorship
- An unincorporated partnership
- An unincorporated limited liability partnership
- An unincorporated general partnership
If you’ve incorporated your business, you’re no longer self-employed. Instead, you work for the corporation.
Finding Self-Employment Income With Form T4A
When you work for an employer, you receive a T4 slip at tax time. This slip tells you how much you earned throughout the year and provides you with the number you need to fill out your T1 return.
When you’re self-employed, things are a bit different. If you’re an independent contractor, look out for Form T4A, the Statement of Pension, Retirement, Annuity, and Other Income. Each of your clients should send you this form at the end of the year. T4A slips include the total dollar amount for each job. To figure out your total income, simply add the amounts from each slip.
What Happens if You Don’t Receive Form T4A?
Don’t worry — Not all self-employed people receive a T4A slip. If you’re selling products directly to consumers, for example, your customers won’t send you a T4A slip. Clients can forget to send the T4A to independent contractors, or you might lose the form after it arrives.
Regardless, the CRA expects you to file and pay self-employment taxes. That’s why it’s important to keep accurate records. Throughout the year, you can track the income for each job or sale using a program such as QuickBooks Online. You can also scan in receipts, invoices, and other proof of income. When tax time rolls around, simply run a report to find out your total income.
Calculating Gross and Net Self-Employment Income Using Form T2125
As a self-employed person, you need to fill out Form T2125, the Statement of Business or Professional Activities. This form helps you calculate your gross income, which is the total amount of money you brought in during the year. It also helps you figure out your business expenses, which you can deduct from your gross income to lower your taxable income so you pay less in income taxes. When you’re self-employed, these deductions can have a big impact on your bottom line.
On Form T2125, expect to provide the following details:
- Information about your business, including a description of your products and services
- Income that comes from internet business activities, such as affiliate sales or ad traffic revenue
- Business or professional income
- Goods and Services Tax (GST)/Harmonized Sales Tax (HST) you paid
- Costs paid while making and selling goods
- Business expenses
- Expenses you paid while running a business from home
- Information about your business partners (where applicable)
After you complete Form T2125, you know your net and gross incomes for the year. Use these numbers to fill out your T1 tax return. You should fill out a separate T2125 for each business you run. If you sell crafts on Etsy and also provide writing services, for example, you should fill out two different T2125 forms.
How to File a T2125 Form
Deducting Legal Fees With the T2125
The CRA allows small business owners and self-employed individuals to write off business expenses, and this includes legal fees. You may report legal fees on line 8860 of Form T2125, Statement of Business and Professional Activities. These expenses may include legal fees you incur for advisement purposes, as well as legal fees paid to appeal assessments related to your income tax, Canada Pension Plan contributions, and Employment Insurance premiums.
In some cases, you must report legal fees on other parts of your T2125. For example, imagine you’re a landlord and you incur legal fees for drafting leases. You may report those costs on line 8860, as usual. However, if you incur legal fees while buying a property, you must include those fees as part of the cost of obtaining the property.
Handling Deductions for Inventory
If you operate a business as a sole proprietor or in an unincorporated partnership, you need to report your business income annually using Form T2125 Statement of Business or Professional Activities. This extensive form requires many calculations, including one that is often misunderstood: inventory. Here is what you need to know to make sure you comply with the Income Tax Act when reporting your inventory.
Inventory and the Cost of Goods Sold
From an accounting perspective, inventory can be described as both an asset and an expense. It’s an asset because you own the actual physical goods, which have value. It’s also an expense because you spend money to acquire the goods.
Annually, you are entitled to deduct the portion of the money you spend to acquire the goods you actually sell. This is called the “cost of goods sold,” and you must calculate it and report it on your T2125 form.
To calculate your cost of goods sold, you need to know three essential elements:
- The value of your inventory at the start of your fiscal period
- The value of your inventory at the end of your fiscal period
- The cost of your purchases during the fiscal period.
To get that information, do an actual stock count at the end of each fiscal period, or use a perpetual inventory system. In all cases, keep detailed records of your inventory at the end of each count. If this is your first year of reporting business income, you need to choose a method for valuing your inventory. In subsequent years, you must continue to use the same method, so choose carefully.
Filling out Form T2125
The inventory portion of Form T2125 is in Part 4, or lines 8300 to 8500. Enter your opening inventory amount at line 8300 and your closing inventory amount at line 8500. On line 8320, enter the amount of purchases made during the year. Your purchases should include the cost of the goods themselves as well as incidental costs such as delivery, freight, and express charges. Conversely, subtract any discounts you may have received.
On line 8340, indicate the direct wage costs (remuneration) you pay to employees who work directly in the manufacture of your goods. Do not include indirect wages such as administrative salaries or a salary paid to yourself or a partner. On line 8360, enter the costs of outside contractors (as opposed to employees) you hire to perform tasks related to the goods you sold. Finally, on line 8450, enter any other direct costs you incur as part of producing or acquiring your inventory.
Add lines 8320, 8340, 8360, and 8450 to your opening inventory amount (line 8300). The sum is your total cost of inventory. From that amount, subtract the value of your closing inventory (line 8500). The remainder is your annual cost of goods sold for the year. This is the amount you can deduct from your gross business income to arrive at your gross profit. The secret to making inventory calculations simple is keeping detailed and timely records. When you use those, you’re better able to fill out Form T2125 accurately and efficiently.
If you run a partnership, you should also fill out Form T2125, but only note your portion of the business income and expenses. For example, say you own 50% of the partnership. During the year, your partnership collected $400,000 in income. You note half that amount ($200,000) on your form. Then, say you had $10,000 in business expenses. Again, you just note half that amount ($5,000).
Partnership Information Return – T5013
In some situations, you need to file a T5013 (Partnership Information Return) in addition to Form T2125. This happens when:
- Your partnership has more than $5 million in worldwide assets.
- The absolute value of worldwide revenue plus worldwide expenses exceeds $2 million.
- Your partnership is tiered, meaning one or more of the partners is a partnership.
- One or more partners is a trust or corporation.
- The partnership invested in flowed-through shares of a corporation that incurred Canadian resource expenses and renounced those expenses to your partnership.
- The Minister of Natural Resources requests a partnership return.
On top of those forms, you also need to file your your T1 (General Income Tax and Benefit Return). The federal form varies slightly depending on which province you’re in, and if you reside in Québec, you need to file the Income Tax Return from Revenu Québec. You import numbers from Form T2125 to your general income tax return.
Where to Report Self-Employment Income on the T1 Return
Once you’ve completed Form T2125, you’re ready to complete your T1 return, the personal income tax return. As a self-employed person, your business income is the same as your personal income, so you’re required to fill out one return.
Place your gross income, which you calculate in part 3C of Form T2125, in lines 162-166 of Form T1. Your net income, which you calculate in part 5 of Form T2125, goes into lines 135-139 of Form T1. If you are also employed at a traditional job, you need to report your standard income on line 101 of the T1 return.
Do You Need to File a GST/HST Return Form?
Is your business making more than $30,000 per year? If so, the government requires you to register for a GST/HST number, collect GST/HST, and file the appropriate return. You can file your GST/HST return using Form GST34. The CRA mails you this form, either by email or traditional mail.
The deadlines for GST/HST returns vary depending on how frequently you pay.
- Monthly: File and pay by August 31
- Quarterly: File and pay by April 30
- Annual: File and pay by November 30
- Annual with a fiscal year that ends on December 31: Pay by April 20, file by June 15
In most cases, the government prefers that you file GST/HST returns online. Once you file your first online return, the CRA sends future forms by email to streamline the process.
Canada and Québec Pension Plan Contributions for the Self-Employed
The CPP is a retirement-pension program. All workers over the age of 18 are required to make CPP contributions, and then, receive a pension based on their contributions if they retire or become disabled. If you die, your dependants may also receive payments from the CPP.
As of 2019, you have to pay CPP premiums on all income over $3,500 and up to $53,900. When you have an employer, you contribute 4.95% of your wages, and your employer matches that amount. But when you’re self-employed, you’re your own boss so you cover both portions. In other words, you contribute 10.20% of your income. Because the contributions only apply to a certain range of your income, your maximum annual contribution can only be up to $5,497.80.
Residents of Québec have their own program. If you reside in Québec, you pay Québec Pension Plan contributions. As of 2019, QPP also applies to all earnings between $3,500 and $57,400. Although these amounts are the same, the rate is a bit higher. In Québec, you must pay 10.80% of your income.
Employment Insurance for Self-Employed People
CPP and QPP premiums are compulsory, but when you’re self-employed, you get to decide whether you want to pay Employment Insurance (EI) premiums. EI offers maternity, parental, and sickness benefits, and you can also apply for benefits if you need to provide care to a terminally ill patient or a critically injured child or adult.
As a self-employed individual, you can forgo these benefits, or you can opt to register with the Canada Employment Insurance Commission. To qualify, you must be self-employed and a citizen or permanent resident of Canada. As of 2018, EI premiums are $1.66 for every $100 you earn, up to an annual maximum of $585.22. If you register as a self-employed person, you can’t claim any benefits until you’ve paid in for at least 12 months.
Again, the situation is different in Québec. If you live in Québec, you’re automatically entitled to maternity, paternity, and parental benefits through the Québec Parental Insurance Plan. If you want to get additional benefits in case you become ill or need to take care of another person, you can choose to enrol in the EI program. As of 2018, your premiums are $1.30 for every $100 of earnings, up to $672.10 per year.
How to Calculate Taxes
In addition to calculating your CPP contributions and EI premiums, you also need to calculate your income tax. Income-tax rates vary based on how much you earn. As of 2019, federal income tax rates are:
- 15% of the first $47,630 of taxable income
- 20.5% of the next $47,629 of taxable income
- 26% of the next $53,404 of taxable income
- 29% of the next $63,895 of taxable income
- 33% of all taxable income over $214,368
Then, you have to pay provincial income tax, and those rates vary based on your income and your province.
As you may have noticed, the amounts are based on your taxable income. That’s not the same as your business income. To explain, imagine you reported $100,000 in revenue on Form T2125 and $20,000 in business expenses. When you subtract your expenses from your revenue, you have $80,000 in self-employment income. But that’s still not your taxable income. When you port that income over to your T1 General Income Tax return, you get to claim a basic personal amount.
As of 2018, that’s $12,069. Then, depending on your situation, you may be able to claim some additional deductions as well, and when you subtract those amounts from your income, you get your taxable income. To continue with this example, say that all your deductions add up to $15,000. When you subtract that amount from $80,000, you have your taxable income of $65,000. Income tax only applies to that amount.
How Much to Set Aside for Taxes
With so many numbers, it can be hard to estimate how much you should set aside for taxes. Typically, it’s easier to estimate your taxes after you’ve been in business a year. When you file your first self-employment tax return, add up all your federal and provincial income tax. Then, divide that amount by your income. For this calculation, just use your regular business income. Don’t use your taxable income.
To illustrate, imagine your income was $80,000 and your total federal and provincial income tax was $16,000. When you divide your income tax bill by your income, the result is 0.2. In other words, your effective tax rate is 20% of your income. If you anticipate making about the same amount during your second year of business, you should set aside 20% of your profits for taxes.
Remember, this amount only covers your income tax. You have to set aside money separately for EI premiums and CPP/QPP contributions. Of course, this number will change as your income fluctuates and as tax rates change. Some self-employed people may only need to set aside 2 or 3% of their profits, while others may need to set aside a third or more.
Sometimes, the CRA requires self-employed people to pay their income tax in installments (quarterly payments) throughout the year. You only need to make installment payments if you anticipate owing over $3,000 and you owed over $3,000 in one of the previous two years. In Québec, you have to make installment payments if your income tax due exceeds $1,800. Usually, during your first year of business, you can do your income-tax filing and pay all your taxes for the year at once. But typically, after that point, you need to pay your income tax in installments throughout the year.
For example, say it’s your first year of business and you owe $5,000 in income tax. You can pay that amount when you file your annual tax return. Now, imagine that during your second year of business, you also anticipate owing $5,000 in income tax. You have to pay that amount in installments during your second year of business. If you don’t make the installment payments, you may face penalties and interest.
Deadlines for Filing Self-Employment Tax Forms
Most Canadians need to file their taxes by April 30 of each year. If you’re a full-time, self-employed professional, you’re eligible for an extension and can file your taxes up until June 15. However, you should still pay any taxes you owe by April 30. If you work for another company as a traditional employee, even part-time, you need to file your T1 return by April 30. If you prefer to file online, you can do so beginning on February 26.
Your clients have until the last day of February to send out T4A slips for the preceding year. These forms can be sent by email, if you have agreed to electronic delivery. Otherwise, clients send T4A slips through traditional mail or in person.
Government Tax Resources for Self-Employed People
The government offers a variety of resources to help you file your self-employment taxes. For basic information about filing your Canadian taxes, look to the “Doing Your Taxes” government guide. This guide provides step-by-step assistance for filing income tax and benefit returns. It can also tell you if you’re eligible for a free tax clinic that provides help with filing.
Guide T4002 helps you work through Form T2125. This is especially useful in determining the difference between business and professional income. It also helps you understand special tax circumstances that apply if your business is fishing or farming. Need to figure out how to pay your taxes? The Make a Payment tool helps you determine the best method for your business.
How to File Your Self-Employed Tax Return
To file your tax return, you can work through these steps:
- Gather your financial information (accounting records, receipts, etc.).
- Find the forms you need to file.
- Fill out the information requested on the forms.
- Alternatively, use tax-prep software. You provide the information, and the software fills out the forms.
- Remit your forms to the CRA.
- Pay any amounts due.
- File your records and receipts in a safe place in case of an audit.
- Determine if you need to make installment payments next year.
- Start planning and getting organized for the next tax season.
If you’re wondering how to file taxes online, you can use tax prep software or file through the NETFILE system. To file online, you have to be a resident of Canada, and you can’t have filed bankruptcy in the current tax year or the previous year.
Pro Tip: QuickBooks Self-employed makes tracking your income and expenses a breeze come tax time.
Filing your taxes might seem intimidating as a self-employed person, but there’s no need to worry. As long as you track your expenses and fill in all your self-employed tax forms carefully, you can maximize your deductions and stay compliant with CRA rules. The QuickBooks Self-Employed app helps freelancers, contractors, and sole proprietors track and manage your business on the go. Download the app today.