Freelancing, full time or as a side-gig, is a very attractive way for people to generate income for themselves. With a lot of freelancing websites such as Fiverr and Upwork, more and more Canadians are using these platforms to make extra bucks.
From an income tax point of view, is doing a side-gig good for you or not?
It gives oneself the freedom to work at one’s own pace, with a diverse group of people, not necessarily indulging in the same kind of repetitive work and at the same time by not ‘formally’ incorporating a business. Yes, not incorporation! We’ll talk about it later. In all cases, no doubt, it is conveniently a middle ground between the traditional Job and Entrepreneurship.
Freelancing is a form of self-employment (UNLESS your corporation is offering it on these platforms) so we are going to focus on a freelancer whether having a side-gig or going full throttle. Here are a couple of key points that are really important for any freelancer in Canada to know.
What forms are required to file Income Tax Return by Freelancers in Canada?
As we mentioned above, Freelancing work is a form of self-employed, therefore, all the forms as applicable to any unincorporated business are used. Essentially, T1 (Individual income tax and benefit return in Canada) and form T2125 to report your business income. T2125 is a statement of business and professional activities where you can report all income and expenses related to your self-employment, freelance business or any other unincorporated business. If you are providing freelance services in addition to another home-based business, keep in mind to prepare separate T2125 for each business.
Bear in mind, the Excise taxation act also makes any person to register for HST/GST if they meet a certain threshold of income. You can always opt to register on a voluntary basis to claim back Input tax credits for the sales taxes you paid in Canada for the business expenses. Self-employed people tend to confuse HST as an additional tax on them, NO, this is not your money. You are simply collecting on behalf of the government. So make sure that you put aside this money. If you are providing the services online to customers who reside outside Canada, you will be using a zero percent tax rate depending on the kind of services.
You can use any personal income tax preparer in Canada or read from the online guides available at CRA’s website to prepare these forms. If you are having complex transactions involved, it’s better to consult a professional tax preparer in that case. You can do your own taxes as well, no rocket science if you have a simple tax situation.
There is no employer to deduct or withhold income tax on your freelancing income
In an employment situation, your employer deducts or withholds income taxes from your paycheck. At the end of the year, the cumulative amount of this withholding is reported on T4 by the employer. When you file your income tax return, you usually pay the difference only, i.e. a refund or a payment. However, for your freelancing business, the money received by you is the gross revenue and the taxes are not withheld. Hence people with self-employment income usually end up owing taxes to the government at the filing of their personal taxes rather than getting a refund. Every tax situation is different depending on the circumstances of each taxpayer. How much a freelancer is going to pay to CRA at the end of the year depends on multiple tax situations.
You are entitled to income tax deductions for the business expenses
Earning revenues would be impossible without incurring certain expenses. You are entitled to deduct all the expenses required to generate that business income. Keep in mind that a deduction gives income tax reduction at the highest personal marginal rate. There are certain restrictions and rules related to different types of business expenses. If you are a freelancer, you are not an employee of your self-employment business, therefore, you cannot issue yourself a salary. Also, there is a requirement for the maintenance of records for six years.
Expenses are further categorized into Capital and Current Expenses. Current expenses are deducted fully in one year whereas capital expenses are distributed over a period of time. The latter includes long term assets that benefit you for a period of more than one year. For tax purposes, this is called the Capital Cost Allowance (CCA). The most common current expenses that can be deducted are Rent, Professional Fees, Meals, Supplies, Telephone, etc. Make sure you are aware of what is for your personal use and what is for freelance use as you cannot combine the two to lower your taxes. You can also claim home-office expenses and vehicle use for the business.
A statement of business or professional income may require the service of a professional accountant to determine the right amount of deductions.
Freelancer needs to pay self-employment taxes too
A certain percentage of your income is deducted and contributed to the Canada Pension Plan. In the case of employment, your employer matches the same amount and remit to the CRA. In the case of a self-employed person, both the employee and employer portion needs to be paid by the self-employed person. In short, a freelancer or self-employed person has to pay 2X of CPP. The percentage is 5.1% for 2019 (5.25% for 2020), for any income above $3500 but below $57,400 ($58,700 for 2020). Now, for a freelancer, they need to know that they are both the employer and employee (an awesome perk for some people) and that is why they have a CPP payable to the CRA which is 10.2%
Self-employed persons may be entitled to Canada Workers Benefit (CWB)
This benefit was started in 2007 and previously known as Working Income tax benefit. Now it is called Canada Workers Benefits and reported on Line 45300 (2019) on the personal income tax return. You must be eligible to receive this benefit for your freelancing business.
Beware of Tax Brackets in Canada
Canada has marginal tax rates for different brackets of income. Having a higher income does not mean that your “whole income” is going to be taxed at higher rates. Only the dollars above the threshold are taxed at the marginal rates for that tax bracket. A freelancer must be aware of these marginal tax rates. If you are having a salary and doing online work as a side-gig, your net income from this business will be taxed at the highest marginal rate for your income. The situation is different if you are a low bracket income tax individual.
Having a higher income does not mean that you are always going to pay higher taxes. There are many tax planning options for self-employed persons to reduce their income taxes, for example, RRSP contributions or Charitable donations.
The above-mentioned information will hopefully increase your personal income tax knowledge. The CRA website is a great place to check out more detailed info about freelance taxes or any other tax topic in general. If you are looking for an individual tax preparation service or tax planning advice, you can always reach to us.
Disclaimer: This post is for general purposes aimed at self-employed individuals who are working as Freelancers. At no point of time, it can be considered tax advice and the readers are cautioned to make any decision based on the reading of this post.
Maroof HS CPA Professional Corporation provides comprehensive tax services in Canada to individuals and businesses. You can reach us to discuss your personal tax situation, income tax return preparation, income tax planning, complicated tax issues related to Canadian and US Taxes.