Congratulations on starting your entrepreneurial journey! Let’s take a look at what it means to be self-employed, when you owe personal income taxes, and when your personal income tax return has to be filed with the Canada Revenue Agency.
Employee vs. Self-Employed
As a new business owner that is starting a sole proprietorship (meaning your business is not initially incorporated), you should first ensure you understand how your pay and income taxes as an owner will look different than when you may have been an employee of another organization.
Employee – Tax Paid via Source Deductions
If you were ever an employee, you may be used to receiving a net pay cheque (what you earned less what you needed to pay into CPP, EI, and income taxes). At tax time, you likely had very little tax liability (if any), because your employer handled remitting these source deductions to the Canada Revenue Agency throughout the year on your behalf.
Self-Employed – No Tax Paid via Source Deductions
As a self-employed business owner, no one is regularly remitting source deductions to the Canada Revenue Agency on your behalf. Tax-free income, score! Well – not quite. You will have to pay income tax when you file your personal income tax return. Then, eventually, you will have to remit quarterly income tax instalments throughout the year to the Canada Revenue Agency (due March 15th, June 15th, September 15th, and December 15th) rather than making a lump-sum once a year payment. When does this happen? Well, if you previously did not have over $3,000 of net tax owing at tax time, then you won’t be into this quarterly tax instalment requirement initially.
You will eventually have to pay personal income tax by quarterly instalments for the tax year if 1) your net owing in the current year is more than $3,000, AND 2) if your net tax owing in either the last year OR second last year is more than $3,000.
Put Money Aside!
Thus, it’s particularly important that you put some commission income that you earn aside in your first year (or two) for income taxes. The last thing you want to have happen is that you’ve spent all your income tax money that should have been earmarked for the Canada Revenue Agency and are now being kept up at night fretting about a large tax bill. Dealing with the collections department of the Canada Revenue Agency is not fun, and the non-deductible interest that accrues on arrears is steep.
How Much?
How much should you put aside, you might ask? Well, we are taxed progressively in Canada (meaning the first “bracket” of income is taxed at a certain percentage, then the income in the next “bracket” is taxed at a higher rate, and so forth). The final amount of personal income taxes you effectively pay will depend on your personal situation. All of your personal sources of taxable income in any given year are aggregated and then your taxable income is reduced by eligible deductions (expenses incurred to earn the commission income, RRSP, etc). Your tax liability is then calculated based on progressive tax rates. This tax liability can then be further reduced by various personal tax credits you may be entitled to depending on your circumstances.
An accountant can help you with a more accurate estimate based on your specific situation, but a good starting point ballpark might be at 25% of your net business income (that is, your total business income you earn less eligible deductible expenses incurred to earn that income).
Filing Deadline – Extension
The default personal income tax filing deadline for most taxpayers is April 30th following the tax year being filed. However, if you OR your spouse are self-employed, then both of your personal tax returns are eligible for the extended filing deadline of June 15th.
This extension occurs as the government “kindly” gives you more time to compile the information needed to prepare your T2125, “Statement of Business Activities” – the schedule that reports of your commission income and expenses for the year. If you haven’t been tracking your income and expenses during the year, then it can be quite the task to tally and categorize all of the receipts. Of course, my suggestion is going to be get organized sooner and to do this during the year so that it’s not such an arduous task at tax time.
It’s generally advantageous to prepare the spouse’s return at the same time to ensure that the tax returns are optimized, hence the extension to your spouse as well.
If you have a balance owing and file after the deadline, then the Canada Revenue Agency will assess a late filing penalty. Make sure you file on time!
Payment Deadline Not Extended!
It’s important to note, however, that while the filing deadline is extended, the Canada Revenue Agency is not so “kind” with the payment deadline. The Canada Revenue Agency will start charging you arrears interest on any unpaid amounts after April 30th.
