Understanding Taxation When You Are Newly Self-Employed

In recent years, self-employment has grown in popularity across Canada, with many individuals embracing entrepreneurship as a path to professional independence. The Canadian government provides many tax write-offs to Canadians, which may be desirable. However, the process of paying taxes and writing off expenses can be confusing for a newly self-employed entrepreneur. If you are newly self-employed, one of the most crucial aspects of your business to understand is taxation requirements as outlined by the Canadian Revenue Agency (CRA).

Navigating the tax landscape may seem overwhelming at first, so it’s essential to ensure your business complies with all regulations and avoids costly penalties. To ensure your entrepreneurial venture is aligned well before tax season, it is important to consider essential steps such as business registration, General Sales Tax (GST)/Harmonized Sales Tax (HST) registration, and other critical record-keeping initiatives.

Getting Started:

Business Structure and Registration

When you’re starting out, deciding between operating as a Business Name Registration such as a Sole Proprietor, General Partnership or incorporating your business is one of the most important decisions you’ll make. Each structure comes with different tax implications:

Sole Proprietorship or General Partnership: In these structures, the business and owner (or owners) are considered the same legal entity. You report business income on your personal tax return, and any profits are taxed at your personal income tax rate. If a General Partnership is registered, it is assumed that the revenues are split evenly, unless otherwise indicated to the CRA.

A Sole Proprietorship tends to be a popular option for smaller, low-risk businesses where you are the sole operator and owner. The tax process tends to be simpler, and there are fewer regulatory requirements when it comes to record-keeping. However, as the sole operator, all liability lies with you, including debts and obligations of the business. Raising capital can also pose a challenge, as lenders may hesitate due to the unlimited liability clause, hindering overall economic growth.

Lastly, the workload cannot be understated. While you are your own boss, many sole proprietors start as a one-man show, meaning long hours, heavy workloads, and requiring simultaneous skills in marketing, sales, accounting, money and finance, and customer service.

The same can often be said about a General Partnership between two or more individuals. The taxable income is split between the partners at their individual personal tax rates. The issue related to raising capital remains difficult for this unincorporated business set-up. It is recommended to obtain a partnership agreement when entering a General Partnership to avoid confusion, misgivings and conflicts with partners over time.

Incorporation: A corporation is a distinct legal entity separate from its owners. It is owned by shareholders who enjoy limited liability, meaning they are not personally liable for the corporation’s debts or obligations. In Canada, corporations are registered with either the federal or provincial government and must adhere to specific laws and regulations.

Incorporation can solve some of the pitfalls of a Business Name Registration, although it comes with its own set of important responsibilities and considerations. Starting with the main advantage, many Canadian entrepreneurs turn to incorporation to relieve some of the liabilities associated with owning a business. As a separate legal entity, a corporation can shield all shareholders to a certain degree. In contrast to a Sole Proprietorship or General Partnership, with an incorporated company, income from the business can be split between the corporation and its shareholders, which may provide a lower overall tax rate. Corporations are also more attractive to investors as the shareholders can issue shares of stock to investors.

Business Name

Once you have decided on the structure of your business, you will want to register your business name, which is a key legal requirement in Canada. A misconception is that sole proprietors do not need a registered business name. If you are a Sole Proprietor using a business name that differs from your legal name, you will need to register said business name. An example of this is using your personal name. For instance, Jane Smith does not require registration, but “Jane Smith Pottery” or any other use of words outside of your first and last name does require registration. A sole proprietorship cannot be confused with a business that has more than one person. Using wording such as group, associates, or identifying more than one person, such as Smith and Jones, is not available.

If you register a General Partnership, the individual name is not applicable as there are two or more individuals involved in the business. All General Partnerships will need to register a business name.

It is important to note that when registering a business name as a Sole Proprietorship or General Partnership, there is no protection from others using the same business name. If branding is a top priority for your business, incorporation is the only business setup that provides name protection within the jurisdiction of incorporation.

Federal Business Number (BN) Registration

When you register a Sole Proprietorship, General Partnership or Incorporation, a Business Number (BN) is auto-assigned to the business upon registration. The tax account is available to add GST/HST and payroll when required. As soon as your revenue exceeds $30,000 in four consecutive calendar quarters, you are required to set up a GST/HST account, or if you employ others, a payroll account is mandatory.

The BN number is a unique number issued by the CRA to identify your business in its dealings with the CRA, HST Registration and Compliance.

The Harmonized Sales Tax (HST) is a value-added tax that applies to most goods and services sold in Canada. If your business earns more than $30,000 in gross revenue over four consecutive calendar quarters, you’re required to register for HST. If the business does not have revenues topping $30,000.00, you can opt into the HST program if you wish, or wait until the threshold is met.

HST Registration and Filing Process

Registering for HST can be done online through the CRA website. Once registered, you’ll need to charge HST on taxable sales and remit it to the government. You’ll also be responsible for filing HST returns, which typically happen quarterly or annually, depending on your business size. It’s essential to keep accurate records of your sales and HST collected to make filing as seamless as possible.

Essential Tax Filings and Deadlines

Personal Income Tax vs. Corporate Tax

As a Sole Proprietor or General Partnership, you report your business income on your personal income tax return. If you’re incorporated, your business files its own corporate tax return, and you will only pay personal tax on the income you have taken from the corporation. The key difference is that corporate tax rates tend to be lower, particularly for small businesses.

Tax Filing Deadlines

For any Business Name Registration, personal tax returns are due by April 30 of each year, but if you’re reporting self-employment income, you have until June 15 to file. Corporations, on the other hand, must file their tax returns within six months after their fiscal year-end. The fiscal year-end is the finish of a company's 12-month business cycle, which can vary. However, deadlines are important to be aware of, as missing deadlines can result in penalties and interest charges, so staying on top of these dates is critical. The corporate tax date filing can vary from the personal tax filing requirement of April 30th, making it easier to manage between the two tax account filing requirements.

GST/HST Remittance

After you’ve collected HST and reduced the business income by expenses, you must remit it to the government by the deadlines set by the CRA, typically quarterly. Again, late remittances can incur penalties, so it’s important to stay compliant.

Payroll Deductions

If you hire employees, you’ll also have payroll tax obligations. This includes deducting Canada Pension Plan (CPP), Employment Insurance (EI), and income tax from their wages and remitting these amounts to the CRA. Payroll is remitted every month based on the previous month's employment records.

Record Keeping and Accounting

The CRA requires you to keep detailed records of all your business transactions for at least six years. This means every receipt, invoice, bank statement, and financial record should be saved, either digitally or in hard copy, so you’re ready to back up any claims.

Imagine this: You’re preparing your taxes and need to claim a deduction for the office supplies you bought six months ago. If you’ve been diligent in keeping every receipt, the process is a breeze, and you can include the missed expense in a later tax filing. If you do not keep diligent records, you might miss out on valuable deductions.

And remember, it’s not just about tax season. If the CRA ever decides to audit your business, having clean, organized records is critical. For example, if your business was randomly selected for an audit, they might ask to see records of your expenses, such as that business lunch you deducted or the office equipment you purchased. Having these records handy will make an audit far less daunting.

Choosing an Accounting System

Investing in good accounting software can simplify your tax preparation. Software like QuickBooks or FreshBooks can help track income, expenses, and even HST collections, making it easier to file returns and manage your business finances. For businesses that need to charge and remit HST, accounting software makes this process much simpler by automatically tracking what you owe and when. It can even integrate with your bank accounts to categorize transactions, saving you countless hours of manual entry. In the digital age, accounting software is a no-brainer.

Engaging a Tax Professional

Even if you’re confident handling your business’s finances, engaging a tax accountant at least once a year to review your financials and tax returns is a smart move. They can help identify deductions or credits you may have overlooked and ensure your tax filing is accurate and compliant with the latest regulations. For example, if you’ve recently moved provinces, or expanded your business to new markets, tax rules can differ, and a professional can guide you through these changes.

Common Tax Deductions For Self-Employed Individuals

Business expenses can range from supplies and physical materials to travel and meals for yourself and others. Additionally, marketing and advertising fall under this larger umbrella, so it’s important to keep careful track.

Home office deductions can include mortgage interest or rent, property taxes, utility bills, home maintenance and repairs, and even insurance. The deductible amount will be based on the proportion of your home used for business activities.

Vehicle expense deductions are like home deductions in that you can write off a portion of insurance, maintenance costs, leasing payments or depreciation costs, and even fuel costs and parking fees.

It is important to portion out the required room in your home and your time in the vehicle that is reasonable for a tax write-off. If you have a 7-room house and only one room is used for an office along with some use for a bathroom and kitchen, the office expense should equal the amount of space your business utilizes within the home. The same is to be considered for your vehicle. For instance, if you spend one day a week going to clients or delivering merchandise, the vehicle expense should be 1/7th of the vehicle costs overall.

Planning for the Future:

Taxes and Business Growth

When your business starts gaining traction, the excitement of growth can sometimes overshadow important tax considerations. As your revenue increases, so do your tax obligations. Expanding your business might mean hiring employees, investing in new equipment, or even opening a second location. This may even prompt you to switch from a Sole Proprietorship or General Partnership to a corporation. If you’re consistently earning a significant income, incorporating could allow you to take advantage of Canada’s lower corporate tax rates—especially for small businesses. For example, in Ontario, the corporate tax rate on the first $500,000 of active business income is only 12.2%, much lower than personal income tax rates. However, as aforementioned, it is important to consider all the pros and cons of incorporation and consult a tax professional when needed to ensure your ducks are in line.

No matter the size of your business, staying on top of tax regulations is crucial for long-term success. A proactive approach to ongoing compliance involves scheduling regular check-ins with your accountant or tax advisor, especially after any major business changes like hiring staff, purchasing large equipment, or entering new contracts. These professionals can help you identify any new tax obligations and make sure you’re taking full advantage of the deductions, credits, or exemptions that apply to your business.

Final Thoughts From A Business Pro

Understanding taxation is a critical component of success for any newly self-employed individual. From selecting the right business structure to staying compliant with GST/HST and tax filing requirements, there are many factors to consider. But it does not have to be rocket science. Professional registration and incorporation services can offer support to help new businesses navigate these requirements, and accountants are always valuable resources in dealing with taxes. When in doubt, seek the consultation of a professional to ensure you’re making the best decisions for your business’s financial health and setting yourself up for continued growth.

About Laura Harvey: As the proud owner of Ontario Business Central Inc., Laura's journey is one of dedication, passion, and an unwavering commitment to nurturing the entrepreneurial landscape in Canada. With over three decades of experience as a corporate specialist coupled with over 25 years of entrepreneurial ventures, Laura brings a wealth of knowledge and insight to her role. Her expertise is not just theoretical; it's built on the real-life challenges and triumphs of navigating the business world.

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