Self-employed? Here's how to navigate the tax season labyrinth

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For self-employed Canadians, tax time is the point in the year where the benefits of working for themselves seem to come to a head. Not only are they on the hook for expenses an employed Canadian’s boss would pay, but they’re also tasked with handling the paperwork.

Yahoo Canada Finance took a look both styles of employment and how they differ when it comes to tax season.

An employed Canadian making $100,000 would pay $28,126.92 in taxes (both federal and provincial) including $2,564 in Canada Pension Plan and $836.19 in Employment Insurance. Their take-home: $71,873.08 according to numbers run by Bruce Ball, vice-president of tax for the Chartered Professional Accountants of Canada.

A self-employed Canadian – say a freelance designer or someone who made $100,000 consulting startups – would pay $29,109.86 in federal and provincial taxes combined plus CPP giving them $70,890.14 in take-home income. 

Different bottom lines

So why the discrepancy?

Tax rates are more or less the same, says Ball, the main difference lies in the CPP and EI. “If employed, your employer has to pay CPP on your behalf and you pay the other half as a source deduction.” An employee is then allowed to claim the amount deducted for credit purposes. That employment insurance they had deducted from their pay (maximum of $836.19 for 2017) is also eligible for a credit.

Unless someone who’s self-employed elects to pay EI, it doesn’t factor in to their tax bill. But CPP does.

“For a self-employed person, they have to pay the “employer” portion of CPP along with the employee portion,” he says, which totals $5,128.20. “They can use half to calculate a credit and the other half is a deduction from income.”

The end result is around $1,000 in the pocket of the employed person. Both sole-proprietors and employed Canadians can tap into any tax credits they’re eligible for but there are some significant differences in the way a self-employed Canadian files and the deductions they can claim.

The cost of being self-employed

Being able to claim expenses is one of the perks of being self-employed, says Katie Kaplan, CPA and a private client service tax partner in BDO’s Toronto office.

“As a freelancer, you may incur costs to travel somewhere to do something or you need a computer that you pay for because you don’t have an employer – all these costs you incur as a freelancer would be deductible against your income in a year,” she says. Of course spending $10,000 on office supplies, marketing themselves, using their car for work, traveling to conferences or 50 per cent of the cost to wine and dine clients, writes their income down to $90,000 so they’re not earning that $100,000.

“They would pay tax on the $90,000 because that’s really what they got to take home at the end of the day,” says Kaplan. “But if you look at the employee, their computer was paid for and given to them by their company and any costs they incurred – pens, pencils, paper, anything like that – were also paid for.”

Employees can make some deductions provided it’s agreed upon by their employer using a T2200 Declaration of Conditions of Employment form.

This can include tools for tradespersons, mechanics, apprentices, and forestry workers, work-related vehicle expenses, workspace-in-the-home expenses (internet/computers, office supplies, etc…) as well as meals and lodging expenses for transportation industry workers like long-haul truckers.

Commission-based employees can claim some food and beverage expenses as well as entertainment, vehicle and travel costs. Employed Canadians also get the Canada Employment Amount credit if they earn more than the value (which is around $1,100).

Settling up the tax bill

While both employed Canadians and self-employed Canadians need to settle up any tax owing by midnight on April 30, self-employed Canadians get an additional 45 days to file their taxes with the paperwork being due on June 15.

Most sole proprietors will opt to get it out of the way on the 30th but some take advantage of the extra time, says Ball. How they pay is different as well.

“Employees get their net pay and settle up at the end of the year,” he says. “If deductions are being done properly, they typically only owe to the extent they have other income other than employment and they may get a refund if they make an RRSP contribution or charitable donation.”

Business people however, need to leave money aside, often paying tax in quarterly instalments for the current year based on their previous years earnings. This can create some logistical challenges for the self-employed who may see a dip in income from year-to-year says Kaplan.

For instance, say a self-employed Canadian has a slow first two quarters so they project a lower income for the year but then they end up doing better in the last half of the year, making more income than the previous year. They’re going to owe more money in instalments and that money will be late which could lead to penalties and interest.

“If you don’t pay your instalments and you don’t pay on time by April 30 you could be paying instalment penalties, instalment interest, and arrears interest,” says Kaplan. “For most self-employed individuals this is very confusing.”

The Harmonized Sales Tax headache

Then there’s HST, another headache employed persons don’t need to worry about. But self-employed Canadians do.

“If your worldwide taxable sales are going to be in excess of $30,000 you’re required to register,” says Kaplan pointing out that the example of someone making $100,000 in Ontario would likely need to collect HST from Canadian clients.

“That is a separate business number registration, separate taxes that need to get filed and separate instalments that need to get paid throughout the year on that as well,” she says. “People don’t necessarily think of that – they think of themselves as I’m not a business, I’m just an individual, a sole proprietor doing this (but) you actually have triggered that threshold and are required to charge HST.”

While the tax bills are roughly the same, self employed Canadians end up paying for a lot of those benefits of working for themselves come tax time.

“When you look at the bigger picture and all the other things that need to be done for that self-employed person there’s a lot more administration and some cost relating to CPP that that individual is having to bear,” says Kaplan. “It is a tradeoff.”