If you're a self-employed Canadian, you might be paying more income tax than you need to. Reducing self-employed taxes in Canada requires a solid understanding of tax deductions, credits, and planning strategies.
As a self-employed individual in Canada, managing your taxes effectively is crucial for maximizing your income and ensuring compliance with the tax laws. Understanding the intricacies of self-employment taxation, identifying deductible expenses, implementing tax planning strategies, and leveraging available tax credits and benefits are key steps in reducing your tax liability.
Understanding Self-Employment Taxes in Canada
The Basics of Self-Employment Taxation
Self-employment taxes in Canada can feel like navigating a maze, but fear not! Understanding the basics is key. As a self-employed individual, you're responsible for both the employer and employee portions of CPP (Canada Pension Plan) and EI (Employment Insurance) contributions. Yep, it's a double whammy.
Differences Between Employment Income and Self-Employment Income
Unlike traditional employees who have taxes deducted from their paychecks, self-employed folks need to set aside money for taxes themselves. The key difference lies in the fact that self-employment income is generally not subject to tax deductions at source.
You're in charge of your own tax destiny.
What Are Self-Employed Taxes—and Who Needs to Pay Them?
Before we dive into strategies for reducing your self-employed taxes, let’s quickly cover some self-employment tax basics.
Self-employed tax is how self-employed individuals (i.e., sole proprietors or partners in a partnership) pay income tax and make CPP contributions. If this tax seems higher than what you paid as an employee, that’s because it is. Employers and employees typically split these taxes in Canada, but a self-employed person is on the hook for the whole thing.
Anyone who has income after deducting all their business expenses from their self-employment income is required to pay tax on that income (so if you have a side hustle that’s helping pay your expenses, you may be on the hook). To calculate how much you owe for tax purposes on your net self-employment income, you’ll need to file a Schedule T2125 (Statement of Business or Professional Activities) with your income tax return.
Your income tax rate is the same as you pay on your employment income. The difference is that you must pay both the employer’s and the employee’s portion of CPP. Self-employed individuals in Canada owe the Canada Revenue Agency (CRA) 11.4% of their income, to a maximum of $7,508.90 in 2023 and $7,735 in 2024.
How to Minimize Your Self-Employed Taxes in Canada
1. Increase Business Expenses
While it may seem counterintuitive, investing more in your business can be a savvy strategy to reduce your tax obligations. Here’s why:
Self-employed tax is based on net income. And because business expenses reduce your net income, they also reduce your tax owed.
That doesn’t mean you should spend money just for the sake of reducing self-employment taxes. If you do, you run the risk of spending more out of pocket than if you just paid tax on that business income.
But do think about the timing of necessary expenses. If you have the choice to spend money on December 31 or January 1, choose December 31 to take advantage of your tax deduction as soon as possible.
Eligible Business Expenses
- Home Office Expenses: If you use part of your home for business, you can deduct a portion of your rent, mortgage interest, property taxes, utilities, and maintenance costs.
- Vehicle Expenses: If you use a vehicle for business, you can claim fuel, maintenance, insurance, and lease payments (or depreciation if you own it). Keep accurate records of business vs. personal use mileage.
- Supplies and Equipment: Deduct the cost of office supplies, tools, or other equipment necessary for your business.
- Professional Fees and Insurance: Account for legal fees, accounting services, and professional liability insurance as deductible expenses.
Just make sure you’re tracking all of your expenses. If you’re claiming something as a business expense for tax purposes, you need to document it. Want to simplify the process? Partner with a professional accountant to manage this task for you.
2. Look for Common Self-Employed Tax Deductions
Deductions are another way to lower your taxable income—which, in turn, will reduce your self-employment tax.
There are several deductions you can claim as a self-employed individual:
- Did you take out a loan to start your business? You can claim a deduction for the interest paid on that business loan.
- Do you use your car to meet clients regularly? You may qualify for vehicle expenses and/or a deduction based on your mileage.
- Do you pay for meals while traveling for business or take clients out to lunch? You can deduct 50% of the cost of business meals.
- Do you work from home? Claim the business use-of-home deduction on your taxes.
The point is there are plenty of deductions available for self-employed individuals—and if you want to lower your taxes, you should look for (and claim) as many deductions as possible.
3. Deduct a Portion of Your Canada Pension Plan (CPP) to Reduce Taxable Income
As a self-employed person, you’re required to contribute to both the employer and employee portions of CPP. While this is an additional cost, it provides benefits in the form of retirement, disability, and survivor benefits. Consider these contributions part of your retirement planning.
You can deduct the employer’s portion of CPP. This deduction happens after calculating the CPP but before calculating your income taxes. Make sure to report this in the appropriate section of your tax return).
In addition, you can claim a personal tax credit for the employee’s portion of the CPP you pay, even though, technically, you aren’t an employee. While this doesn’t lower your self-employed taxes, it does reduce the total amount you’ll pay to the CRA come tax time. And really, isn’t saving money what it’s all about?
4. Take Advantage of Tax Credits
Tax credits and deductions often get lumped together. But if you’re not taking advantage of both, you’re missing out on a solid opportunity to lower your self-employed taxes.
What, exactly, is the difference between tax credits and deductions? Tax deductions lower your taxable income. For every dollar you deduct, your taxes are cut by a percentage of that deduction, which is based on your marginal tax bracket. So, for example, if you’re in the 15% tax bracket, your tax is cut by 15 cents for every dollar you deduct.
Tax credits, on the other hand, lower your actual tax dollar for dollar. So, if you have a tax credit of $500, that credit will actually lower your taxes by $500. If you’re eligible for them, tax credits can dramatically reduce the amount you owe in taxes.
There are a variety of tax credits available to small business owners, for example:
- Investment Tax Credit (ITC): If you spent substantial funds on scientific research and experimental development (SR&ED), you might be eligible for ITCs on qualified expenditures. ITCs can be used to reduce your tax owing, create a cash refund, or do both. Unused SR&ED ITCs can be carried back 3 years and forward 20 years.
- Employee and Partner GST/HST Rebate: You may be eligible for this rebate on goods and services tax (GST) and harmonized sales tax (HST) if you paid expenses as a partner that were not deducted from your partnership revenue. Most of the time, this is related to business use of your personal vehicle, but it can be any expenses you paid that still need to be claimed on your T2125. Ensure you or your partnership is registered for GST/HST before taking advantage of this credit.
- Canada Workers’ Benefit: Depending on your income, you (or an eligible spouse or dependent) may qualify for this tax credit of up to $1,000 per year.
- Air Quality Improvement Tax Credit: This 25% refundable tax credit is available to eligible businesses that made qualifying expenditures to improve air quality in certain locations.
Not every available tax credit will be relevant to you and your business—but the potential for significant savings makes this a strategy worth investigating.
5. Take Advantage of the Lifetime Capital Gains Exemption (LCGE)
If you sell shares of a small business corporation or farming/fishing property, you may qualify for the LCGE, which exempts a portion of your capital gains from taxes.
6. Health Spending Account (HSA)
If you’re self-employed and have health-related expenses, consider setting up a Health Spending Account (HSA). It allows you to pay for medical expenses with pre-tax income, reducing your taxable income.
Because contributions aren’t taxable to you as an employee, the money you put into your HSA will lower your taxable income. HSAs can also roll over from year to year, so you can continue carrying those tax-free savings.
If you’re not sure if you qualify, talk to your insurance company to determine if your business qualifies for an HSA.
7. Income Splitting with a Spousal RRSP
Contribute to a spousal RRSP if your spouse is in a lower tax bracket. This helps spread retirement income more evenly, reducing your overall family tax liability during retirement.
8. Invest in a Registered Retirement Savings Plan (RRSP)
Contributing to a Registered Retirement Savings Plan (RRSP) reduces your taxable income. This is especially helpful in years when you have higher earnings. You can carry forward unused contribution room for future years.
There are a million reasons why investing in your retirement is a good idea (the least of which is having money to retire with). But if you need an added incentive to start stashing cash away, contributions to eligible investment accounts are tax-deductible. They won’t reduce your CPP contribution amounts, but they do reduce your federal and provincial income taxes.
Keep in mind that there’s no one-size-fits-all solution to retirement planning. The type of account (or accounts) that are going to make the most sense for you depends on your investment goals, savings strategy, and how much you plan to contribute each year.
Talk to an expert financial advisor if you’re unsure how to best plan (and save) for retirement.
9. Claim Apprenticeship Job Creation Tax Credit
If your business hires apprentices, you could be eligible for this credit, which provides a non-refundable tax credit equal to 10% of the eligible salaries and wages.
10. Navigating GST/HST Obligations for Self-Employed Individuals
Understanding GST/HST Registration Requirements for Self-Employed Workers
If your self-employed business earns more than $30,000 in annual revenue, you may need to register for the Goods and Services Tax/Harmonized Sales Tax (GST/HST). Familiarize yourself with the rules and thresholds to ensure compliance with Canada Revenue Agency (CRA) regulations. By understanding your obligations regarding GST/HST registration, you can avoid penalties and maintain good standing with the tax authorities.
Claiming Input Tax Credits to Offset GST/HST
Paid As a self-employed individual collecting GST/HST on your goods or services, you can also benefit from claiming Input Tax Credits (ITCs) to offset the GST/HST you've paid on business expenses. By keeping detailed records of your input tax expenses, you can reduce the amount of GST/HST you owe come tax time. Maximizing your ITC claims is a savvy way to manage your tax liability and improve your bottom line.
11. Consider Incorporation
How you structure your business can impact how much you pay in income tax. One of the best business structures to help reduce this amount is a corporation.
Is it time to take your business to the next level? Depending on your income, incorporating can be a smart move. Corporations often have access to more tax planning strategies and may pay a lower tax rate on their first $500,000 of active business income. This is a big-picture decision; however, it might be worth exploring if your business is growing.
When you incorporate your business, you become an employee and shareholder of your company. You pay yourself as an employee and have the option to distribute any additional income to yourself (and any other shareholders) or leave your money in the business.
So, how does this lower self-employed tax?
With a corporation, the money you pay to yourself as a salary is subject to employment taxes and CPP, deducted from your paycheques, just as it is for any other employee. Any additional income, which is paid out as a dividend, is not. Dividend income is taxed at a lower rate on your personal tax return because your corporation shares the tax burden with you. In contrast, any income you leave in your corporation is taxed at the small business rate for corporations (assuming your company qualifies for this reduced tax rate).
12. Seeking Professional Tax Advice for Self-Employed Tax Optimization
The Benefits of Consulting with a Tax Professional
While managing your self-employed taxes can feel overwhelming, seeking advice from a tax professional can be a game-changer. A tax expert can provide valuable insights into tax optimization strategies, help you navigate complex regulations, and ensure you are maximizing your deductions and credits. Investing in professional advice may result in significant tax savings and give you peace of mind knowing your finances are in good hands.
Tips for Finding the Right Tax Advisor for Your Self-Employed Business
When selecting a tax accountant for your self-employed business, look for someone with experience working with self-employed individuals and small businesses. Consider their credentials, reputation, and fees to ensure they are the right fit for your needs. Personal recommendations, online reviews, and interviews can help you assess potential tax advisors effectively. Remember, finding the right tax professional can make a world of difference in optimizing your self-employed taxes and financial well-being.
Smooth Sailing Ahead
Connect with Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.