The sole proprietors guide to: Taxes
Company of one? If you’re the only owner of your business and you haven’t formally incorporated, you are what’s known as a sole proprietor. If you work for yourself and your main source of income is generated from your business, you’re also considered self-employed.
Congratulations and welcome to being a self-employed sole proprietor! According to the Canada Revenue Agency (CRA), a sole proprietorship is the simplest kind of business structure. Well, simple until you bring one little word into the conversation — taxes.
In this article, we will break down everything you need to know about paying taxes as a sole proprietor. But first - you need to be sure you are registered for the necessary CRA programs and can legally operate under your chosen business name. For a helpful guide on how to do this, and to make sure you are doing it right; you can check out our article Step by step: how to register your Sole Proprietorship.
What taxes do sole proprietors need to know about?
As a business owner, you should be aware of your various tax obligations and how to ensure they are being met. If you have a bookkeeper or use an online bookkeeping service like Small-Books, this is something that for the most part will be taken care of for you, but it is a good idea to have a general understanding of the 3 different taxes and how they affect you and your business:
Personal and business income taxes (federal and provincial)
These determine your net tax owing — the amount you owe to the CRA for your taxable income after all of your qualified personal and business tax deductions.
Self-employment taxes
Canada Pension Plan/Québec Pension Plan (CPP/QPP) payments
Optional employment insurance (EI) payments
Goods and services tax (GST)
Plus any other provincial sales tax (PST) or harmonized sales tax (HST) as applicable to your business operations
We will go into each of these tax obligations in more detail below.
Paying Income Tax as a Sole Proprietor
What are you required to pay?
Paying income tax is nothing new; it is something we’ve all been doing since earning our first paycheck. The difference is, as a self-employed individual, no one is going to be taking the income tax off of your earnings on your behalf and submitting it to the CRA. This means it falls on you to remember to not only set this money aside and be prepared to pay it to the CRA at year end (or quarterly if you are required to pay in installments), but you must also file Form T2125 Statement of Business and Professional Activities as part of your personal T1 general tax return—the same return you use to file your personal income taxes.
As a sole proprietor, your personal income and business income are one in the same and the CRA sees it this way too. This means you will be taxed on the full amount of taxable NET income that your business earns, whether you withdraw it from your business or not. Your taxable net income means your total revenue less any tax-deductible business expenses (also called income tax credits).
The federal tax rates for Canadian income tax are listed below to give you an idea of how much income tax you will be required to pay:
You will owe 15% on the first $49,020 of taxable net income, plus
20.5% on the next $49,020 of taxable net income (on the portion of taxable income over 49,020 up to $98,040), plus
26% on the next $53,939 of taxable net income (on the portion of taxable income over $98,040 up to $151,978), plus
29% on the next $64,533 of taxable net income (on the portion of taxable income over 151,978 up to $216,511), plus
33% of taxable net income over $216,511
Remember: In addition to federal income taxes, you’re also subject to provincial income taxes which varies based on where you live in Canada.
When are you required to pay?
The filing deadline is later for individuals who are reporting self-employment on form T2125. The deadline for both filing and payment is usually April 30th for non-self-employed individuals, while your filing deadline as a sole proprietor is June 15 (or the next business day if this date falls on a weekend or holiday), but you are still required to make your total payment (or first quarterly payment if you are required to pay in installments) by April 30.
The 3 factors below will determine if you have to pay taxes in quarterly installments:
Being self-employed. Since you are earning income that doesn’t have things like income tax or employment tax payments regularly taken out, missing these deductions may leave you with a tax liability.
If you earned more than the threshold of $3,000 or more (or $1,800 or more in Québec) you would likely have to make quarterly payments.
You may also owe if you have outstanding amounts from passing the thresholds in the previous tax years.
These thresholds are applied based on the province or territory where you live.
If you received an installment reminder from the CRA.
If you have to pay your sole proprietorship taxes through quarterly payments, the quarterly due dates are March 15, June 15, September 15 and December 15. Just like the filing deadline, if the actual date falls on a weekend or holiday, your payment is due the next business day.
If you receive a reminder, the one sent in February is for the March and June payments, while the one sent in August is for the September and December payments.
Calculating Quarterly Installment Payments as a Self-Employed Sole Proprietor
According to the CRA, there are three options for calculating installment payments:
If your personal and business income are consistent from year to year, you can use the no-calculation method and the amounts are based on your most recent income tax return.
You can use a prior-year method if the current year is similar to the previous year.
Or you can opt to simply use the current tax year if this year is different than the year before.
Remember: If it’s your first year in business, you don’t have to start making payments until you hit the threshold of $3,000 in income tax ($1,800 or more in Québec).
Making the Most of Personal and Small Business Tax Deductions
Since you file your personal and business taxes together, you’ll want to make the most of any deductions for which you qualify.
On your personal income taxes, you can write off things like medical expenses, charitable donations, childcare and health insurance premiums. You can also receive a range of personal tax credits. Setting money aside in an RRSP or RESP also lowers your taxable income.
For your business income, common deductions include home office expenses, business-related mileage on your car, office supplies and equipment, as well as professional fees, like getting help from a bookkeeper. You can check out more common deductions available to most small businesses here: “Small business tax deductions: Expenses you should be claiming”.
Paying Self-Employment Taxes
Along with your income tax, self-employed individuals are also required to contribute to CPP and may also choose to make EI contributions (the EI program for self-employed individuals is only for special benefits and is voluntary). To learn more, check out this article: Voluntary EI for self-employed individuals and other (better) alternatives.
Both EI and CPP are calculated and remitted on your income tax return.
Paying into CPP
With very few exceptions, every person over the age of 18 who works in Canada outside of Quebec and earns more than a minimum amount ($3,500 per year) must contribute to the Canada Pension Plan (CPP). When you have an employer, you only pay half the required contributions, and your employer pays for the other half. It is also automatically deducted from your pay. But, as a self-employed individual, you are required to make the whole contribution yourself.
So, what does that look like in terms of how much you will need to pay into CPP as a sole proprietor?
If you earn more than $3,500 during the year, you must make CPP payments on your self-employment income up to a maximum amount that’s set each January. For 2022, this amount is $6,999.60.
While CPP contributions are split between the employee and the employer in a traditional I’m-the-boss-and- you’re-the-employee setup, when you’re the boss and the employee you pay the full 9.9%.
The employee contributions are like the deductions you’d receive if you were getting a traditional paycheck — affecting your personal income levels and reporting.
Your employer contributions are a business expense that’s factored into your business earnings and expenses.
Depending on how much you paid in CPP employer contributions, you may be able to claim a tax deduction on these amounts.
Paying into EI (voluntary)
When you’re someone’s employee, your employer withholds your employee EI amount and contributes the employer amount (1.4% of the employee’s) on your behalf.
Just like CPP, when you’re self-employed, you are responsible for making all of the payments yourself (the employee’s and the employer’s).
If you’re self-employed, enrollment in EI is voluntary.
Again, depending on how much you pay in employer contributions, you may be able to claim a tax deduction on these amounts.
What Sole Proprietors Need to Know About Collecting sales tax
What is sales tax?
Sales tax can be broken into two distinct categories; federal sales tax and provincial sales tax (or harmonized sales tax which is a mix of the two). The federal sales tax is called Goods and Services sales tax (GST) and it is a tax that most small businesses (other than “small suppliers”) are required to collect on behalf of the government for goods and services sold in Canada. The goods and services tax (GST) is a value-added tax of 5%, levied on most goods and services sold for domestic consumption. But, like all such taxes, there are few exceptions even under GST where goods or services are exempt from tax liability. Such exemptions on specified goods or services are granted by the government based on certain conditions. Hence, while determining the tax liability under GST, one needs to check for not only the goods or services that are chargeable to GST, but one also needs to look into the goods or services that are exempt from tax.
Provincial sales tax (PST) is different for each province and determined based on the province you do business in, or in the case of e-commerce/remote business: where your customer is located. For a detailed guide on the different provincial sales taxes and how to know which sales tax to charge, check out our article: Provincial Sales Tax and the place of supply rules.
Currently, five provinces (Ontario, New Brunswick, Nova Scotia, Newfoundland & Labrador, Prince Edward Island) no longer have a provincial sales tax - they have merged their provincial sales tax with the federal GST and now charge a single Harmonized Sales Tax (HST). For Ontario, this means you would charge a total of 13% (5% GST plus 8% PST) on any qualifying goods and services.
When do you need to collect sales tax?
In general, the rule is that if your total gross sales meet or exceed $30,000, you must charge GST/HST. Gross sales are the total qualifying goods or services sold, without taking into consideration any expenses incurred to produce them.
Note: Once you hit this threshold, you’re responsible for collecting, reporting and remitting these taxes no more than 30 days later. If you’re making quarterly payments, you will also need to account for GST/HST in the applicable quarter.
In order to do collect and remit these taxes, you have to register for a GST/HST number. Once you set up your GST/HST account, you’ll also want to keep track of your effective date and subsequent filing deadlines.
When filing your returns, in addition to documenting how much you collected, be sure to also calculate and claim any GST/HST amounts you paid as a business in order to lower your overall tax bill.
If You’re Late Paying Any of Your Self-Employed Sole Proprietor Taxes…
In general, if you make a late payment to the CRA, you will incur interest and fines. If you’re late or underpay an installment payment, interest is compounded daily. Additional penalties can be up to $1,000 or a percentage of the difference in the interest between the amounts you paid and should have paid.
For GST/HST there are several scenarios for penalties and fines depending on the mistake you make. For instance, if you fail to file after you’ve received a demand to do so, it’s an immediate $250 fine. Interest also accrues on late or underpayments.
If your bookkeeping is out of date, it can make your tax filing and payments to the CRA late, costing you even more in interest and penalties. Small-Books offers back-dated bookkeeping packages to get you caught up and help you to avoid these unnecessary fees. Or you can check out our article on how to get your bookkeeping up to date - fast.
Have more questions about your specific tax situation?
Small-Books can help!
Depending on your individual needs, it can be very cost-effective to work with a professional in small business taxes, like us here at Small-Books. Hiring an online bookkeeper can provide you with clear guidance on what sales tax you should be charging, how to make installment payments to the CRA, and of course, how to maximize your tax savings.
The information in this post does not constitute or replace the need for professional bookkeeping, accounting or tax advice. Small-Books has gathered this information from several sources and has done its best to ensure accuracy. Any errors or omissions will be corrected in a timely manner. As tax laws are constantly changing, it's important to ensure that you have the most accurate and up-to-date information.
