Becoming an independent contractor in Canada has many advantages, but it does put the onus on you to properly estimate and remit income taxes on a regularly scheduled basis as dictated by the Canada Revenue Agency (CRA). "How do I pay income tax as an independent contractor in Canada?" is a common question for new entrepreneurs.
I am married and a mother of three. I am working for someone who calls me an independent contractor. It’s my responsibility to pay my own taxes, and I don’t know where to start.
My husband brings home $495.00 a week after taxes and he claims the children. I make anywhere from $400 one week to $800 another week before taxes and have no idea what I should be putting aside. I am at a loss and losing sleep over this. I don’t want to do anything wrong.
Signed: Very Confused
It's not being an independent contractor that determines how you pay your income tax but your legal form of business ownership.
If your business is not incorporated—you are either a sole proprietor or are in a partnership—business income and expenses are simply recorded on a separate form (T2125) which is part of your regular T1 personal tax return. ("Your First Business Income Tax Return" will lead you through the process of completing your T1 return.)
Your business income minus business expenses determines whether you have a profit or a loss for the year. If you have a profit, you add it to your other income. If you have a loss, you subtract it from your other income. This is one of the many advantages of starting a business on the side: losses in the first few years of business can be written off against regular employment or other income.
How to Estimate How Much Money to Set Aside for Income Tax
If this is your first year in business, you can approximate how much money you need to set aside by estimating your income and your tax bracket.
- If you made $400 a week all year, your income before tax would be $20,800—the lowest your income would be.
- If you made $800 a week all year, your income before tax would be $41,600—the highest your income would be.
So we can guesstimate that your income would be in this range and use these figures to see approximately how much tax you will pay by using the Canada Revenue Agency's Canadian income tax rates for individuals. The federal tax rates for 2021 are:
|Tax Rate||Tax Bracket|
|15.00%||Up to $49,020|
|33.00%||$216,511 and over|
In your case, both the low and high estimates are still within the 15% tax bracket, so you want try to put aside at least $3,120 ($20,800 x 15%), and it would be better if you could put aside $6,240 ($41,600 x 15%) to cover your potential tax bill.
Now it's not quite that simple, because this estimate does not take into account provincial and territorial tax rates, which vary depending on what province you're in, or the fact that presumably you're going to have various business expenses and income deductions that will lower your net income.
Keep in mind that these are estimates, and any overpayment or underpayment will get sorted out when you complete your tax return at year end, but setting aside these amounts will ensure that you won't get any unpleasant surprises at tax time.
Subsequent Tax Years
After your first year in business (and your first tax return), you will be required to pay tax in quarterly installments. The CRA will send you notices every quarter indicating how much tax you need to pay based on the previous year's business income.
Note that these are only estimates. If your business income greatly increases during the year and you continue to pay only the amount indicated on the installment notices you may wind up with a significant tax bill when you file your annual return. To avoid this shock you can increase your quarterly payments by estimating your annual tax bill based on your increased business income.
Conversely, if your business income drops drastically during the year you can reduce your quarterly payments. Otherwise the over payment will be refunded at tax time.
After every tax year the CRA updates the estimated tax owing for the following year, and this is reflected in the quarterly payments.
Canada Pension Plan (CPP) Payments
In addition to income tax, you are required to make contributions to the Canada Pension Plan (CPP) if your income is greater than $3,500 in a given year, even if you are self-employed. The rate for CPP contributions in 2021 is 10.9%, up to an annual maximum of $6,333 (if you were working for an employer your contribution would be half the normal rate, or 5.45%, and the employer would contribute the other half).
When making quarterly installment payments you can include an additional amount for CPP contributions based on your annual income, or pay the assessed amount for the year when you complete your tax return.
Learn More About Canadian Income Tax
- How Does Freelancing Affect Your Canadian Income Tax?
- Canadian Tax & Your Business
- Guide to Canadian Payroll Deductions
- The Most Overlooked Tax Deductions for Canadian Small Businesses