Blog Posts, Tax

Self-Employment Tax Guide

Updated: December 29, 2022

Being self-employed has many benefits. You get additional flexibility and you essentially work for yourself.  However, taxes for individuals who are self-employed individuals can be confusing since they are different than those for full-time employees.

We created this mini-guide as a reference manual for those of you who are self-employed and need to file taxes.

If you have questions about your specific situation, we recommend you speak to a qualified tax professional.

This guide is split into two main sections:

  • The first section called “Start Here” is meant to address general topics you need to know about filing taxes as someone who is self-employed.
  • The second section called “Deductions” will address important tax deductions you should keep in mind when filing your taxes.

Who is this guide for?

This guide is for individuals who are freelancers, independent contractors, consultants, influencers, artists, creatives, and anyone else who considers themselves to be “self-employed.”

If you’re not someone who receives a T4 slip from an employer, you’re most likely self-employed.

Section #1 Start Here

GST/HST

By far the most common question we get from clients who are self-employed is: “Should I charge HST?”. As with all questions in accounting, the short answer is “it depends”.

In our blog post about GST/HST, we state that anyone in Canada that sells goods or services worth more than $30,000/year is required to collect HST. However, some categories of goods/services don’t require you to charge HST.

The critical thing to remember about HST as a self-employed individual is:

  • You need to determine whether or not you’re required to charge HST for your goods or services. There is a chart that details which goods and services are exempt from the tax.
  • If you are required to charge HST, you must register for HST with the CRA and get an HST number to be able to charge to your customers. Also, you need to include this information in your invoices along with your GST/HST number.
  • Make sure that you file your HST return and pay the HST required as required by the CRA and by the due dates.

If you haven’t passed the income threshold, but think you may in the following months. You need to take a look at the rule that will let you know at what point you need to start collecting the tax. It’s not complicated, but our blog post will give you more details. Also, you can go on the CRA website for the official details.

Installments

Most individuals who are self-employed believe that you only have to pay taxes when you file your tax return. This is an incorrect assumption. The CRA requires self-employed individuals to pay taxes throughout the year if their business income is above a certain threshold.

What does this mean? It means if you paid more than $3,000 (or $1,800 in Quebec) in taxes last year as a self-employed individual, you are required to make quarterly tax payments to the government throughout the year (CRA: who has to pay). Let’s look at a quick example to understand what this means:

Jane is a self-employed photographer and paid $6,000 in taxes in 2020.

Since Jane paid more than $3,000 in taxes last year, this means that she will be required to pay taxes in installments for 2021. These installments are calculated using her tax bill from last year of $6,000 and dividing this number by 4 which is equal to: $1,500.

Hence, for 2021 Jane is required to pay $1,500 four times a year and when she files her taxes, there will be a “true-up adjustment” in order to make sure that the amount she’s paid of $6,000 is adjusted for the actual taxes she owes for the year.

Why do you have to pay taxes in installments? Because the government doesn’t want to wait for its money! You have to pay the government your taxes owing throughout the year and not just when you file your taxes during tax season. This is similar to most employed individuals. When you work for an employer, taxes are deducted from your paycheque immediately. You don’t wait until you have to file your taxes to pay taxes. In a similar fashion, quarterly installment payments require self-employed individuals to pay taxes throughout the year.

Think of it this way. Since you are your own employer, you need to pay taxes in the same way as if you worked for another employer.

Profit and Loss Statement

If you’re self-employed and provide services to one or multiple clients, you should consider the expenses you’ve incurred to provide those services to your clients. These expenses are deductible from your taxable income and can help you save a significant amount of money.

Hence, before you file your income tax it’s vital that you develop a profit and loss statement for your business income. Let’s look at an example:

In 2021, Jane had a self-employment income of $60,000 and she has expenses for the following:

  • Admin: $5,000
  • Office: $750
  • Software: $1,000

This is how her profit and loss statement would be calculated for 2021:

It starts with your sales or revenue (i.e. the amount you’ve earned during the year) minus all of your business expenses. Business expenses are items you’ve purchased to generate revenue (ex. office supplies, software subscriptions). Personal expenses (ex. clothes or meals) don’t qualify.

If you’re using a bookkeeping software like QuickBooks Online or Xero, this will be pretty easy to create. You can also build your profit and loss statement in excel, but its much more streamlined with accounting software.

CPP

If you’re self-employed and have a net income (revenue less expenses) of over $3,500 you’re required by the CRA to make CPP contributions.

As a self-employed individual, you will be required to contribute both the employee and employer portion of the CPP payment. The amount you owe is calculated based on your net income.

As an example, if we take a look at Jane’s example above where she has Net Income of $53,250, her CPP contributions can be calculated using this CPP Table from the CRA:

EI

Self-employed individuals don’t have to make contributions to employee insurance.

However, you can voluntarily register to pay EI premiums. Why would you do this?

Paying EI would allow you to take advantage of government benefits offered through EI for maternity, parental, or caregivers. The full list of benefits can be found here.

You should note that in order to receive any benefits under EI, you must have paid premiums for a 12-month period before you can collect any benefits. If being able to rely on EI is important for you, then you need to make sure that you factor that into your budget.

How much do you have to pay?

In 2021, for every $100 earned, you contribute $1.58 in EI up to a maximum of $889.54

Quebec has its own parental insurance program. In 2021, for every $100 earned, you contribute $1.18 in EI up to a maximum of $664.34.

Section #2 Deductions

Deductible expenses for self-employed individuals can make working for yourself more attractive than earning income as an employee from a tax perspective.

In section #1 of this post, we discussed how most expenses that can be deducted from income earned as a self-employed individual have to be incurred to generate sales or revenue.

In this section, we will discuss other expenses that can also be allocated to a self-employed individual’s profit and loss statement to calculate net income for tax purposes.

Meal and Entertainment

Client lunches and dinners can be included as part of your business expenses. However, the CRA dictates that only 50% of the cost of the meal can be deducted.

The most practical advice we give business owners is to expense these meals as incurred at 100%. When it comes time to file your taxes, your accountant will take 50% of this amount to ensure that only the tax-deductible portion of meals and entertainment is shown on your profit and loss statement.

Home Office Expenses

Most corporations lease office space where their employees and team can work. This lease cost is added to the business deductions of the corporation.

Most self-employed individuals work from a home office. Similar to corporations, self-employed individuals can deduct the equivalent of rent as home office expenses on their profit and loss statement to determine net income for income tax purposes. However, the deduction you take is prorated by the square footage of your home office space. Expenses that can be deducted are as follows:

  • Rent
  • Property insurance
  • Property Taxes
  • Mortgage interest
  • Utilities (heat and light)

Let’s take a look at an example to understand how this works:

Jane is self-employed and uses her home office to earn income. Her expenses for 2020 are as follows:

  • Rent: $24,000/year
  • Property Insurance: $1,000/year
  • Property Taxes: $4,500/year
  • Utilities $960/year

Car and Vehicle Expenses

A common question we get from self-employed individuals is whether or not car expenses can be deducted.

The deduction for vehicle expenses works the same way as home office expenses whereby only the business portion of your vehicle expenses can be deducted. This is measured by calculating the kilometers you drive for personal use and business use and thereafter prorating the expense accordingly.

Car expenses have other limitations imposed by the CRA which we will explore in our next blog post. The critical aspect of the deduction is to be clear of when your car or vehicle is used strictly for business purposes.

Travel

If you’re going to be traveling for business purposes outside your usual area of business to meet clients or for other business purposes, these costs will qualify as deductions on your profit and loss statement.

We would note, however, that commuting expenses incurred (i.e. to and from work) do not qualify as eligible deductions.

In a similar way to vehicle expenses, whatever travel expenses you deduct have to be strictly for business purposes.

Professional Fees

If you’re a qualified professional and pay professional fees to maintain a certification (ex. accountants pay fees to maintain their CPA designation), such fees qualify as deductions on your profit and loss statement.

Education expenses

If you’re a qualified professional and pay fees for courses to maintain your designation or further your professional development, such fees qualify as deductions on your profit and loss statement. In addition, any interest on loans you’ve taken to pursue such courses can be deducted.

These deductions are a great incentive to help you continue developing your skill and improving your self-employed taxes payments.

Let us help you. Do you have questions? Email us: info@verticalcpa.ca

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax circumstances and/or objectives.

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