Before you get started: Understanding taxes as a self-employed Canadian.
As a self-employed individual, your tax return will mostly look the same as if you had an employer. Here’s the main difference: instead of getting a T4 form that reports all the employment income you earned and the taxes your employer sent to the Canada Revenue Agency (CRA) for you, you’ll need to report your self-employment income on a specific tax form, the T2125. You’ll also need to send in any tax you owe yourself, along with Canada Pension Plan or Quebec Pension Plan premiums (lots more on this below).
How do you report your self-employment income?
You use the T2125 form, also known as the “Statement of Business or Professional Activities,” to report how much self-employment income you earned and the expenses you paid to support your business. Then, any tax owing is calculated on your net income — the amount of income left over after you subtract all your expenses.. You’ll also need to send in any tax you owe yourself, along with Canada Pension Plan or Quebec Pension Plan premiums (lots more on this below).
What expenses can you claim?
The T2125 form provides a good guide to the kinds of expenses you can deduct as a creator. Here are the main sections showing what you can claim:
Part 4: Net income (loss) before adjustments, on page 3, lists the categories of expenses you might have, from advertising to office expenses to interest and bank charges.
Part 7: Calculating business-use-of-home expenses is where you add up all of your housing-related expenses, like heat, electricity, and rent or property taxes that you can claim if you used part of your living space to run your business. For example, If you used 15 percent of your living space as a home office, you’d claim 15 percent of your yearly expenses related to heating, insuring, and electrifying that space. And if you painted that space (and didn’t use the paint anywhere else), you could claim 100 percent of the paint costs.
💡 Tip: To calculate the part you can deduct, the CRA says to use a reasonable basis, “such as the area of the workspace divided by the total area of your home.”Chart A: Motor vehicle expenses is where you include all of your car-related expenses like gas or electricity, maintenance, and insurance. Just like claiming a part of your housing expenses as business expenses, you can claim a portion of your vehicle expenses that relates to the kilometres you drove in 2020 to make money in your business.
Area A: Calculation of capital cost allowance (CCA) claim is where you report any capital expenses. This can be a bit tricky to understand, but “capital” purchases are things that provide a “lasting benefit” to your business — so you don’t write off the full cost of that purchase in the year you bought it. Instead, you claim a bit of the total expense each year, depending on what capital cost allowance category the item fits into, until there’s nothing left of the original cost to claim. The amount you claim is called the “capital cost allowance,” or CCA. Keep in mind that CCA usually only applies to more expensive items.
💡 Tip: What kind of items require you to claim a capital cost allowance? Think computers, furniture, and — if you have a food-related business — kitchen equipment.
Understanding Canada Pension Plan (CPP) premiums if you’re self-employed
When you’re an employee, you pay into the Canada Pension Plan (or the Quebec Pension Plan, if you’re working in Quebec) automatically, as your employer deducts the required premiums from your paycheque and sends them in for you. There’s an “employer portion” that your employer pays as a payroll tax, and an “employee portion” that you pay as an employee — that second portion is the amount you see reported on your T4.
When you’re self-employed, you need to pay both of those portions yourself, and there’s no automatic way to do so. This means that when you file your tax return, the amount of your CPP or QPP required contributions is calculated and added to the amount of tax owing, giving you one bill you pay all at once. (You don’t have to figure out your CPP or QPP premiums separately, or make a separate payment.)
Step 1: Getting ready to file
Before you’re ready to file your tax return, there are two main tasks you need to complete as a creator: adding up all of your creator income, and all of your business expenses.
Then you’ll add those two pieces of information to everything else you need to file your taxes — charitable donation receipts, moving expenses, childcare expenses, medical expenses, RRSP contributions, and so on — and report your self-employment income and expenses on your personal tax return.
How should you calculate your income?
If you use professional bookkeeping software, like FreshBooks, your software will be able to tally up your total self-employment earnings for 2020. But using a spreadsheet like Excel or a Google Sheet is fine, too.
As a self-employed individual, you might earn commissions, fees, or sales revenue from goods you sell. Whatever form your self-employment income takes, you report it in Part 3A of the T2125 form.
If you charge HST or GST, you also report those amounts here, but they’re subtracted out to give you something called your “adjusted gross sales” — or your total sales, minus any GST or HST you collected.
How should you calculate your expenses?
While it’s probably pretty easy for you to add up all of your self-employment revenue, finding the expenses you can claim likely isn’t as straightforward — and that’s even when you know exactly what you’re looking for.
If you’re using professional bookkeeping software, you’ll be able to get it to add up and sort all of your expenses by expense category. You’ll need to set the software up to recognize the expense categories you use first, and you’ll need to link it to your bank or credit union and credit card accounts so it can work in the background to pull the info you need.
But if you don’t have or don’t want bookkeeping software, a simple spreadsheet for adding up your expenses also does the trick. Here’s where Benji can help, as it automatically scans your bank and credit card accounts for eligible expenses (and the cost of Benji is an eligible expense you can write off, too!). Benji also has lists of the typical expenses you might have if you’re a content creator, developer, designer, and more.
If you’re not using Benji or professional bookkeeping software, in order to create your spreadsheet of expenses you’ll need to comb through all of the places where records of your spending might be hiding: cash receipts, credit card slips, and bank records.
Enter all of the details In your spreadsheet: the date, the kind of expense, the vendor, the total amount, and the GST or HST broken out if you’re registered for GST or HST and you need to add up your “input tax credits” for a GST or HST return. Recording this much info might seem like overkill, but you’ll want it close at hand if CRA has questions about your spending.
Step 2: Filing your tax return
OK! You’ve taken the time to get up to speed on what you can and can’t claim, you’ve organized your receipts and added up your income, you’ve collected all of the other information you need to prepare your personal tax return, and you’re ready to file. Now what?
You have two options: prepare your tax return and file it yourself, or work with a professional tax preparer who can take the task on for you.
Preparing your tax return yourself
If you decide to prepare your tax return yourself, there are lots of tax preparation software solutions (some are even free!) that will simplify the job for you. One option to consider is Wealthsimple Tax, a pay-what-you-like (even zero) offering that’s available even if you don’t have a WealthSimple account.
Of course, if you want to be really old school, you can also prepare your tax return using paper forms which you then mail in. For most people, software’s the way to go: the CRA says only 16 percent of tax filers sent in paper returns in 2019.
Working with a tax professional
If you decide to work with a tax pro, you might use a Chartered Professional Accountant (CPA) who offers personal tax preparation services, a tax-prep agency, or an individual who offers tax-preparation services but who isn’t a CPA. The CRA certifies tax professionals to offer electronic filing of tax returns to ensure they meet standards like secure storage of client information, for example.
A tax professional will prepare your return using the information you provide and then submit it to the CRA on your behalf. Note: you’re still responsible for verifying that the return as filed is accurate and complete, even if someone else prepared it for you.
Tax filing and payment FAQs
Whether you choose to get professional help or go it alone, there are two basic steps to getting your taxes done: entering all of your information into the tax software or paper forms, and submitting your completed return to CRA by the deadline.
What’s the deadline for submitting your tax return to the Canada Revenue Agency?
Here’s where self-employed individuals get a bit of a break: if you are reporting self-employment income on a T2125 as part of your tax return, your return is due on June 15th — instead of the “regular” date of April 30th for people without self-employment income. This applies to you even if you also have T4 (employment) income — and it applies to your spouse or common-law partner’s tax return, too, even if they’re not reporting any self-employment income.
However, any taxes you owe are still due by April 30th, meaning that for many self-employed individuals, you’ll probably still want to prepare and file your taxes by the April 30th deadline.
What happens if you miss the deadline?
If you don’t file your tax return by the due date, the CRA will assess a late-filing penalty. It’s calculated as five percent of your tax bill, plus interest. Note: this means that if you don’t owe anything, you won’t be charged a penalty.
If you owe taxes, how do you pay them?
There are basically two ways to pay your tax bill: by mailing a cheque, or by transferring the funds electronically. You can pay electronically by credit card, PayPal, by setting up a pre-authorized debit, or by e-transfer. You can also make an electronic payment in-person at your local Canada Post outlet or your bank or credit union.
What if you can’t pay your tax bill in full?
Especially if you’re a newly self-employed, estimating your tax bill and setting aside funds in advance can be challenging. This is doubly so for 2020, a year like no other when you might have a mix of employment, unemployment, CERB, CRB and self-employment income.
If you can’t pay the full amount of your tax (and CPP or QPP premiums) owing, CRA asks you to make a payment arrangement with them. Even though CRA might get a “bad rap” as a tax collection agency, they know that many Canadians face unexpected expenses or income gaps at tax time, especially in the year we’ve just been through. If you can’t make the full required payment, you’ll be charged interest on any overdue amount at the CRA’s “prescribed rate,” which is currently 5 percent.
What should you do with all the receipts you’ve saved?
If you filed your taxes electronically — which most people do — then you don’t submit any paperwork to the CRA for review. But, as we said above, it’s still important to hang on to the documents (receipts, slips, bank statements, and so on) you used to prepare your taxes because the CRA might ask to see them as part of their review of your tax return.
After you’ve filed: What to expect from the Canada Revenue Agency
Once your tax return is completed and filed with the CRA, it’s out of your hands. Often, the CRA tax review process can feel like a “black box.” As part of your overall tax empowerment process, it’s good to have an idea of what CRA will do with your return once you file it.
Canada’s tax system operates on what’s called a “self-assessment” basis. That means individuals calculate their income, credits, and deductions on their own, using the tax forms supplied by the CRA, and then submit the completed forms to the CRA for their review and assessment. You’ll know when the CRA has reviewed and assessed the tax return you filed when you get a CRA Notice of Assessment mailed to you or available in your online “My Account” with the CRA.
In other countries around the world, the tax authorities take different approaches. For example, at least 36 countries — including Germany, Japan, and the United Kingdom — use a “return-free” tax system, meaning individuals don’t have to file tax returns at all. Instead, the tax system is simple enough that the government, not individuals, reconciles the taxes you might owe at the end of the year, and your role is to check their calculations, not to undertake them yourself.
In Canada, however, we have a two-step system that starts with you and ends with the CRA. Here are the steps CRA goes through in assessing tax returns as they’re submitted:
Pre- and post-assessment reviews: Both before and after your tax return is assessed, it may be reviewed by the CRA. For example, you might have missed a tax slip or entered a number incorrectly — it happens! Although people often refer to these kinds of CRA reviews as “audits,” technically they aren’t audits, but “reviews.”
To help ensure your tax return is completed accurately and assessed fairly, the CRA undertakes various kinds of reviews throughout the year. As part of these reviews, you may be asked to send in documents — such as medical or moving expense receipts, for example.Assessment of your tax return: Once the CRA has completed its assessment of your tax return as filed, they will issue a “Notice of Assessment” that confirms the amounts you’ve reported in your tax return, including any adjustments they’ve made, and the tax bill you need to pay or the refund they will send to you.
The adjustments CRA makes to your tax return might correct available RRSP room, adjust the amount of income reported on a tax slip, or add information from a tax slip that’s been missed. Not every return will be adjusted, and if you disagree with an adjustment, you can request that the CRA review your return again, or provide more information to support your return as filed (more on this below).Audit of your tax return: The CRA audits individual tax returns throughout the year. The difference between a “review” and an audit is that a review typically focuses on a single area of your tax return, to confirm or adjust one area of your taxes as filed, and it is carried out electronically or by mail.
An audit, in contrast, involves a “close examination” of not just your tax return, but all of the information you relied on in preparing your return. This means a physical, in-person examination of your books and records by a CRA auditor, either at your home or business, or at a CRA office.
Generally, the CRA selects a tax return for an audit because they’ve identified “risk factors” that may apply to your return, such as a large variation in income or expenses from year to year, or expenses that vary significantly from the norm for tax filers in similar situations.
Once an audit is complete, you’ll receive a notice from the CRA that says no changes are required to your tax return, or changes are required and you’ll receive either a refund or a notice of an additional amount owing.
What this all means is that once your tax return is filed, you’ll interact with the CRA who will either accept your return as filed or adjust it for you, ask for more information as part of their review processes, or, in a small number of cases, undertake a formal audit of your return including reviewing your financial records.
Throughout these interactions, you can rely on a Taxpayer Bill of Rights that sets out the standards and expectations for CRA conduct with tax filers — helping to ensure the tax system is fair, accountable, and accessible for all Canadians.
Final words
This guide walks you the essentials of what you can expect as a self-employed individual when you’re filing a Canadian tax return, whether it's your first time or your twentieth time.
No matter what option you choose for preparing and submitting your taxes – going it alone or working with a pro – our goal has been to empower you to better understand how the Canadian tax system works when you have self-employment income.
With this knowledge in hand, we hope you can get your taxes done more easily, so you can focus on what really matters to you: building an enduring business.