When you’re self-employed, you have different tax responsibilities than a traditional employee. Essentially, the Canada Revenue Agency (CRA) considers you to be a small-business owner, and as such, you need to withhold your own payroll taxes and meet key tax filing obligations. Don’t worry: The process may be easier than you think.
What Does It Mean to Be Self-Employed?
The phrase self-employment covers a variety of different pursuits. If you’re a freelance photographer with a busy studio, you’re clearly self-employed. Similarly, if you run a small cafe and employ a few workers, you may also be self-employed. What if you buy old furniture, refurbish it, and sell it online? Or how about if you keep a few chickens and sell their eggs? These activities might be hobbies, but for tax purposes, the CRA considers any hobbies that turn a profit to be businesses.
To see if you turned a profit, simply subtract your expenses from your revenue. To continue with the chicken example, imagine you spent $100 on chicken food throughout the year, and you earned $80 selling eggs. You don’t have a profit, so you aren’t self-employed.
That said, there certainly are cases where you can lose money and still be considered self-employed. For instance, if you have a business where you earn money most years but lose money one year, you’re still self-employed. When this happens, you should file your tax return as usual. Then, you can subtract the loss from your current year’s earnings, or you can roll the loss to a future year and deduct it then.
Types of Businesses
In Canada, businesses fall into three main categories: sole proprietorship, partnerships, and corporations. The type of business you have plays into whether you’re self-employed. A sole proprietorship is when you’re the sole owner of a company. All the profits are yours, but you’re also responsible for all the business’ debts and obligations. If you’re a freelancer, an independent contractor, or the sole owner of an unincorporated business, you’re a sole proprietor. All of the profits earned from your business constitute your income, and you must pay the personal tax rate on that income.
A partnership is when two or more people run an unincorporated business together. This business structure is just like a sole proprietorship, but with more people. You can split up the partnership however you like. For instance, two people can each own 50% of the partnership, two people can own 25% each while a third partner owns the other half, or you can take another approach. You must report the partnership’s profits as your own income based on your share in the partnership. If the partnership earns $500,000 and you own half, for example, you report $250,000 as self-employment income.
With a general partnership, you and your partners are responsible for the company’s debts and obligations. There are also limited-liability partnerships where the partners do not take personal responsibility for all the partnership’s debts, but generally, only doctors, lawyers, and similar professionals can use that business structure. On top of that, there are limited partnerships where one or more partners invests in the business but aren’t involved in its day-to-day operations. With these business structures, you’re also considered to be self-employed, but your income tax-filing process is going to be slightly different than someone who’s a sole proprietor.
Finally, there are corporations. You can register your corporation with the federal government or a provincial government, but in both cases, when you incorporate a business, you’re making it into a standalone entity that’s separate from yourself. In other words, you’re not personally liable for the debts and obligations of your corporation. You’re also not considered to be self-employed. Instead, you’re an owner of the corporation. The corporation must file its own tax return, declaring its own profits. Then, you file your own personal tax return where you report any income or dividends received from the corporation.
Do You Need to File Taxes?
As of 2018, you have to file a tax return if your self-employment income exceeds $3,500. This is the threshold where Canada Pension Plan premiums (CPP) apply, and it’s updated annually based on inflation. You also need to file if you’re paying Employment Insurance (EI) premiums. If you don’t have to file your tax return based on these requirements, you may want to file if any of the following apply:
- You want to claim the working income tax benefit.
- You received working income tax benefits advance payments during the tax year.
- You sold property and incurred a capital gain.
- You want to claim a refund.
- You want to claim the goods and services tax (GST)/harmonized sales tax (HST) credit.
- You receive Canada child benefit payments.
- You’ve incurred a noncapital loss that you want to apply in future years.
You also need to file a return if the CRA requests that you file, or if you think you owe income tax for any reason.
What Forms Do You Need to File?
When you’re self-employed, you can use Form T2125 (Statement of Business or Professional Activities) to calculate your self-employment income. This form is the easiest and most effective way to get the CRA the detailed information about your business. On Form T2125, you briefly describe your business’ products or services, and if you own any websites, you list those as well. To calculate your taxable self-employment income, you note your business income. That includes gross sales, commissions, fees, or any other amounts you’ve collected from your customers. If you sell goods, this form also helps you figure out your cost of goods sold (COGS) and your gross profits. Essentially, this section adds together your opening inventory, purchases made during the year, direct wage costs, and subcontracts. Then, you subtract your closing inventory to get your COGS, and finally, you subtract that amount from your business revenue to determine your business income.
Regardless of whether you sell goods, you need to note all of your business expenses. As a general rule of thumb, you can write off any expenses incurred in the pursuit of profit. That includes expenses such as advertising, meals and entertainment, office rent, salaries paid to employees, and any other qualifying business expenses. You cannot include any personal expenses.
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).
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.
As mentioned above, you need to note your business expenses when filing your self-employed income tax returns. If you don’t include all your expenses, your business income will look higher than it actually is, and as a result, you’ll face a higher tax liability.
So that you don’t overlook any expenses, you want to be vigilant about tracking them. To simplify the process, you may want to look into an app that lets you snap photographs of your receipts and instantly upload them into your accounting records. Also, consider checking out QuickBooks Online. This cloud-based software gives you a convenient spot to track income and expenses, and it can also help with payroll deductions, GST/HST calculations, and other financial aspects of running your own business. Then, when tax time comes around, you have all the information you need to file your return at your fingertips. The CRA also requires you to keep all records and receipts for at least six years: Once you file your return, you shouldn’t throw anything out. If you get audited, those details are essential.
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 2018, you have to pay CPP premiums on all income over $3,500 and up to $55,900. 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 9.90% of your income. Because the contributions only apply to a certain range of your income, your maximum annual contribution can only be up to $5,187.60.
Residents of Québec have their own program. If you reside in Québec, you pay Québec Pension Plan contributions. As of 2018, QPP also applies to all earnings between $3,500 and $55,900. 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 2018, federal income tax rates are:
- 15% of the first $46,605 of taxable income
- 20.5% of the next $46.603 of taxable income
- 26% of the next $51,281 of taxable income
- 29% of the next $61,353 of taxable income
- 33% of all taxable income over $205,842
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 $11,635. 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 instalments (quarterly payments) throughout the year. You only need to make instalment 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 instalment 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 instalments 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 instalments during your second year of business. If you don’t make the instalment payments, you may face penalties and interest.
Your income-tax return is due by April 30 every year. If you aren’t required to make instalment payments, your income tax is also due on that day. Otherwise, instalment payments are due on March 15, June 15, Sept. 15, and Dec. 15 every year. If the due date is on a weekend or public holiday, it moves to the following business day. Due to the seasonal nature of their business, farmers and fishers only have to make one instalment payment by the last day of the year.
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 instalment 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.
Goods and Services Tax
After you figure out income taxes, CPP contributions, and EI premiums, you still need to think about goods and services tax (GST). The GST is a federal tax on goods and services, and as of 2018, the rate is 5%.
In British Columbia and Saskatchewan, you also have to assess provincial sales tax (PST): That’s 7% in British Columbia and 6% in Saskatchewan. In Manitoba, you have to collect 8% retail sales tax (RST), and in Québec, you need to collect 9.975% Québec sales tax (QST). New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, and Prince Edward Island use a harmonized sales tax (HST). HST is a combination of the federal GST and the provincial sales tax, and it’s 15% in all of these provinces.
Luckily, you don’t have to worry about GST, HST, or PST if you’re a small supplier; you’re considered a small supplier if your yearly revenue is less than $30,000. If you exceed that threshold in a single calendar year, you have to register and start making GST/HST payments within 29 days. This amount refers to revenue, and it doesn’t take into account your expenses. Additionally, if you’re in a partnership, you need to count all of the partnership’s revenue, not just your portion. Once you register, you should assess GST/HST on the sales of all nonexempt goods and services. For instance, if you make $100,000 in sales and the HST rate in your province is 15%, you should collect $15,000 and remit that amount to the government. To figure out how much you owe, you can file Form GST34. If you deal with QST, you should file Form RC7200. Once you’re registered, you can do it all online through the CRA website.
Still Have Questions?
If you still have questions, you’re not alone; this is a lot of information to digest. If you have questions on tax filing or how to file taxes online, check out the CRA website. The agency publishes a lot of information on self-employment deductions, income tax rates, and related information. You may also want to look through the small business centre on the QuickBooks site. It also hosts a variety of tips and tricks to make small-business accounting as easy as possible. Then, you may want to talk with an accountant who can handle all the numbers for you and do your tax prep, or just consult with you and provide a few tips to help you get started. Most importantly, make sure you’re using the right tech tools. QuickBooks has an app just for freelancers, contractors, and sole proprietors. Track expenses, mileage, and invoices all in one simple app.