So…I wrote this blog post about self-employed taxes in Canada over two years ago, mainly because I couldn’t find a resource quite like it when I first became self-employed in 2017. Fast-forward to 2020 and it’s still my most popular blog post! I still get emails and comments all the time about it, so I thought it was time for a bit of an update.
My Experience with Self-Employed Taxes in Canada
When I first wrote this blog post, I had just finished my first year of self-employment. For some backstory, I quit my corporate job in marketing in November 2016 and officially started working for myself in January 2017. It’s now May 2020, which means I’ve been successfully working for myself for 3 and a half years.
It’s crazy to see how fast time has flown by since that first year of self-employment. Looking back, in all honesty, I had no idea what I was getting myself into. Although I saved up about a year’s worth of living expenses into my Emergency Fund and had earned just over $30,000 from my side hustle in 2016 (which proved to myself I could earn a full-time living if I dedicated full-time hours to my business), I really didn’t have much of a plan. I don’t have a formal business background, I’ve never even taken a business class, and I’m completely self-taught when it comes to running a business. Luckily, you don’t need a business degree to be a successful business owner! I’m sure it helps, but it’s not essential.
You see, there are so many great free and reasonably priced courses and resources out there, anyone can learn this stuff if you have the self-discipline to do so! In retrospect, I probably knew more than I gave myself credit for. But what I will say is experience helps. The longer you run your business and continue to educate yourself, the easier it gets. I’m so much more organized and efficient now compared to that first year. Not to mention, I’ve almost tripled my business revenue!
And if you’re curious about what the heck my business actually consists of, I made a video that goes in-depth about it. But for the quick version, my business includes:
- Content creation (blog, podcast, videos, social media)
- Freelance writing
- Public speaking
- Selling digital products and courses
- Providing financial counselling services to individual/couple clients
- Running my Millennial Money Meetup® event series
Paying Taxes When You’re Self-Employed vs. an Employee
So, what’s the big difference between being an employee earning a paycheque at a company compared to being self-employed? Well, when you’re self-employed, that means that you become fully responsible for setting aside money to pay your income taxes and contribute to the Canada Pension Plan (CPP). It also means you have to pay that money directly to the government via your CRA My Account. When you’re an employee, your employer deals with all that for you by taking a percentage off your gross pay and submitting it to the government on your behalf.
That’s why when you’re an employee, you shouldn’t have a tax bill to pay after you file your taxes. If your employer took off the right amount of money from your pay, your tax bill should $0. Or, in most cases, they’ll have taken off too much and/or you’ll be eligible for some tax deductions and credits, thus providing you with a tax refund. A tax refund simply means you’ve overpaid on your taxes, so the government is paying you back. That’s right, a tax refund is not free money! It’s literally the government giving you back your own money.
When you’re self-employed, you’ll always have a tax bill to pay because you won’t have an employer doing all that work for you. Instead, when you become your own boss, you also become your own bookkeeper and accountant (unless you choose to hire someone to do that for you). Luckily, it’s not that complicated or much work to do on your own. Believe me, I’ve been doing my own bookkeeping for almost 4 years. The only thing I get help with is I hire a tax accountant to help me file my taxes every year (and she’s worth every penny!).
Looking for a Self-Employed Budget Spreadsheet?
How to Know If You’re Self-Employed
There are a ton of different terms for being self-employed, so I want to start with clearing some things up. If you’re a freelancer, if you’re a small business owner, or even if you have a side hustle, all of those would fall under the umbrella of self-employed. Self-employed simply means you are earning income by yourself, outside of an employer.
That being said, there are a few exceptions in which you aren’t self-employed but still need to set aside money for income taxes. For instance, if you earn cash tips from your job, that is considered taxable income. Not only do you need to claim that cash as income when filing your taxes, but you also need to pay tax on it. The same goes for if you do any cash gigs. For instance, if you’re a musician and get paid for your performance in cash, that cash is considered taxable income that you need to claim and pay taxes on. If you do not claim any cash you earn as income on your taxes, that is considered tax evasion and is illegal.
Another example would be if you are a hired contract worker for a company. In some instances, the company will pay you regularly as if you are a normal employee, but they won’t take any tax or CPP off your paycheque. In this case, you may not be self-employed in the traditional sense, but you would be in the sense that you have to save a percentage of your pay for tax time.
And since I mentioned side hustles, if you work a full-time job for a company, but in your spare time you have a side hustle, it’s on you to save a percentage of your side hustle income for tax time as well. I remember the first year I earned money from my blog, I had no idea I had to do this! When I filed my taxes, I was hit with a bill of a few hundred dollars and I felt like such an idiot. So no matter what your side hustle is (running an Etsy store, consulting, freelance writing, Uber driving), remember that you need to save some money for income taxes and CPP contributions.
For more info, check out this article on the government’s website about tax obligations for self-employed individuals.
What You’re Required to Pay as a Self-Employed Individual
Okay, with all of that knowledge in your head now, let’s talk about what you’re on the hook to pay to the government come tax time. When you’re self-employed, and you’re operating your business as a sole proprietorship, you must pay:
- Personal income tax on your business’ earnings minus business expenses
- Contributions to the Canada Pension Plan (CPP)
- Contributions to Employment Insurance (EI) voluntary
How to Calculate How Much You’ll Owe If You’re Self-Employed
Let’s talk specifics here. You may think that you have to pay tax on every dollar your business earns, but that’s actually not the case. You’re only required to pay income tax on your business’ earnings after business expenses. Moreover, you can lower your average tax rate and thus your tax bill even more by taking advantage of other personal tax deductions and tax credits, such as claiming some of your RRSP contributions as deductions.
Let’s say you’re a self-employed web designer in Ontario and you earned $100,000 in business revenue. Business revenue is the total amount of income your business generated by selling goods and/or services. Business revenue does not include any sales tax collected (that’s completely separate).
You spent $30,000 on business expenses and operating costs.
That leaves you with $70,000 in business earnings after expenses. Using SimpleTax’s free calculator, you’ll find that your average tax rate would be 26.66%, and you should set aside $18,662 to pay your federal and provincial taxes and your CPP premiums.
Now, let’s say you also contributed $10,000 to your RRSP which you claim as a tax deduction.
As you can see, your RRSP deduction lowered your average tax rate to 22.42%, thus decreasing your tax bill to only $15,697.
Although this calculator is great, I would suggest just using it as a reference point to determine a percentage you should be putting aside for income taxes and CPP. You may owe less, you may owe more. But it’s important that throughout the year you keep track of your business revenue and expenses, and adjust your tax savings if necessary.
Moreover, having been doing this for several years now, I personally always aim to save more than I need to. I never want to find myself in a situation where I owe more than I have saved, and am forced to dip into my personal Emergency Fund to pay part of my tax bill. So, if I was in the example above, I’d probably round up those average tax rates to 28% or 25% just to be safe.
In my experience, I’ve found it better to be safe than sorry. Plus, if you over save, there’s your “tax refund” (sort of). If you save more than you need to for taxes, then you have extra money to play with. Or, you can be boring like me and just put that extra money into the following year’s tax savings account.
How to Calculate Your CPP Contributions
Personally, I just use the SimpleTax calculator to ensure I’m saving enough for income taxes and my Canada Pension Plan contributions, but if you’re curious how the math works, here goes!
For your CPP premiums, you are required to pay these if you are 18 or older and earn more than $3,500/year. It’s also interesting to note that if you are an employee, you only pay half of your CPP premiums (5.25%) and your employer pays the other half. When you’re self-employed, you aren’t so lucky and have to pay the full 10.5%. This percentage is calculated on your net income (business revenue minus business expenses, tax deductions, federal tax and provincial tax). For more specific info about CPP contributions, check out this great resource on Canada.ca.
Luckily, there is a ceiling for CPP premiums. The maximum amount a self-employed individual can contribute to CPP is $5,796/year as of 2020. Since CPP contribution amounts change every year, to keep up to date check out this CPP contribution rates, maximums and exemptions page on the government’s website.
How to Calculate Your EI Contributions
I want to make it clear that contributing to the EI program is not mandatory when you’re self-employed. It is 100% voluntary. However, by not contributing to EI, that means you are ineligible to take advantage of all the benefits EI has to offer, such as maternity/parental leave or being a caregiver to a family member who is ill or injured. Then again, it may not be worth it to you and instead you may prefer to just have a very cushy Emergency Fund.
But if you are interested in it, here’s how much it costs. For self-employed individuals, as of 2020, the EI rate is 1.58%. This means that for every $100 you earn, you need to pay $1.58, to a maximum of $856.36/year (or maximum insurable earnings of $54,200). And for insurable earnings, this refers to your gross salary, or your business revenue after you’ve deducted business expenses but before you’ve paid income tax and CPP.
Using my earlier example:
You earned $100,000 in business revenue
You spent $30,000 on business expenses and operating costs
You’re left with $70,000 in business earnings after expenses
$70,000 x 1.58% = $1,106
Since $1,106 exceeds the maximum EI contribution amount, you would then just pay the maximum amount of $856.36 for EI. To play around with different scenarios, you can check out this free EI calculator.
To learn more, visit this page about EI special benefits for self-employed individuals on the government’s website.
This has been a major post, so if you actually read it all, word for word, you are a rock star! Not only that, now you’re way more informed than most self-employed people. High-fives all around for that!
But again, if you’ve got to do your self-employed taxes in Canada and are still confused about things, feel free to email me or leave your question in the comments and I’ll try my best to help you find an answer or solution.
I will be coming out with more blog posts and videos on other self-employed finance topics, so to keep in the loop make sure to subscribe to my email newsletter.
Is it your first time filing self-employed taxes in Canada? What are your concerns or questions? Let me know if you can’t find the answers here and I can write a follow-up blog post!