Welcome to Virtual Heights Accounting—your trusted partner in navigating Canadian taxation. In today’s blog, we’ll break down the differences between self-employment and contract work in Canada and share key insights to help you file your taxes efficiently.
Understanding Self-Employed and Contract Work
Before diving into tax requirements, you must understand how self-employment differs from contract work.
- Self-Employed
Self-employed individuals operate their own businesses or work as freelancers. They manage their operations, find clients, and handle all aspects of their work independently.
- Contract Work
Contract workers take on specific projects or work for fixed periods under a contract. These contracts outline clear deliverables and timelines. These include what we refer to as gig workers.
Does This Distinction Matter for Taxes?
No, it doesn’t. Whether you identify as a business owner or a contract worker (as long as you’re not an employee), you must file a T2125 Statement of Business or Professional Activities with your personal tax return. You’ll pay the same taxes and contribute to both employer and self-employed CPP.
We can’t emphasize this enough: For tax purposes, the CRA makes no distinction between a sole proprietor and a contract worker.
Choosing a Business Structure
Most self-employed individuals start as unincorporated sole proprietors. However, you should consider whether incorporating makes sense for your business.
Sole Proprietorship
As a sole proprietor, you report business income on your personal tax return. You only need to account for revenue and expenses, making the financial side less complex. A simple Excel sheet may be enough to track expenses, but you must keep receipts and invoices.
Incorporation
Incorporating creates a separate legal entity for your business. This means you must file a corporate tax return and report the business’s assets, liabilities, and equity on a Balance Sheet (GIFI 100).
Before deciding to incorporate, consult a professional. Incorporating may benefit businesses looking to grow significantly. Since small business corporations in Canada pay a lower tax rate than individuals, incorporating allows you to reinvest more funds into your business. You can use these savings to hire employees or purchase equipment.
Income Reporting
Unincorporated sole proprietors and contract workers must report income on the T2125 form, detailing revenue, expenses, and net income. Keeping accurate records is crucial.
You must report all revenue earned and deduct eligible business expenses to determine taxes owed or refunds due.
Deductions and Expenses
Deductions and Expenses
As a self-employed individual, you can deduct various business expenses, including:
- Advertising
- Meals
- Office supplies
- Equipment
- Travel
The T2125 Schedule groups expenses into categories. You can track these expenses in an Excel sheet or use accounting software like Xero (Starter package) or Wave for basic reporting. To streamline bookkeeping, consider using a dedicated business bank account and credit card.
Eg: Expense groupings on the T2125 (note we do not show cost of goods sold in this picture which may also be applicable)
Home Office Deductions
Home office expenses may also be eligible if you do not rent an office external to your home and instead use a home office to run your business. In order to deduct home office expenses the space must be at least one of the following:
- Your principal place of business; AND/OR
- You use the space only to earn business income and you use it on a regular and ongoing basis to meet your clients, customers, or patients.
Eg. Home office expense groupings
GST/HST Considerations
The Canada Revenue Agency allows businesses to stay unregistered for GST/HST until their business reaches a certain size. This reduces the administrative burden for side businesses and growing businesses. Once your revenue exceeds $30,000 annually (or four consecutive quarters), you must register for and collect GST/HST. If you sell services to clients in other countries, check out this blog for guidance on charging GST/HST for remote work.
Further, if you own multiple businesses, you must apply the $30,000 small supplier threshold collectively. GST/HST rules consider all your businesses as related, meaning you can’t avoid registration by spreading revenue across multiple businesses. For example, if your combined revenue exceeds $30,000, even if each business falls below the threshold individually, you must register for GST/HST for all your businesses.
Conclusion
As an unincorporated sole proprietor or contract worker, you must report your income on your personal tax return. You do this using the T2125 Statement of Business or Professional Activities. You can deduct business-related expenses to determine your net income. Additionally, make sure you understand your GST/HST obligations and income tax installment requirements.
As your business grows or your risk landscape changes, you will also have to consider if incorporating. We recommend discussing incorporating with both a lawyer (to discuss legal reasons for incorporating) and a tax professional (to discuss tax reasons for incorporating).