The Challenges and Joys of Working for Yourself – Tax Tips for Freelancers

Working for yourself can be extremely rewarding in terms of both time and money. When you work as a freelancer, you have the freedom to pick and choose the projects you work on. You also have the ability to set your own hours and work around your schedule instead of relying on a rigid schedule set by a supervisor.

Of course there are a number of challenges involved in the freelance lifestyle as well, including uneven workflow, the difficulty of landing new projects and of course higher taxes. Those who work for themselves face a higher tax burden, and that means that freelancers need to make tax planning an integral part of their lives.

No Withholding – No Automatic Payments

One of the most difficult adjustments for new freelancers is moving from automatic tax withholding to a system where they must compute their own taxes and make the appropriate payments. When you work for someone else, your boss automatically computes how much you owe in taxes and withholds that amount from your paycheck. Since you never see that money, you may not even look upon it as part of your income, making taxes a relatively painless part of life.

Things are a lot different when you work for yourself. When you work as a freelancer, there are no taxes withheld from your payments, but that does not mean there are no taxes due. It just means you are now responsible for assessing how much you owe and making sure the Canada Revenue Agency (CRA) gets their money on time.

Quarterly Payments

If you are successful in your freelance career, chances are you will need to make quarterly payments to the CRA. The CRA typically expects freelancers to make quarterly estimated payments if they expect to owe more than $3,000 (Tax & CPP) at the end of the year. With taxes on the self-employed so high, it does not take a lot of income to reach that $3,000 threshold.

If you are new to freelancing, one of the first things you should do is run the numbers to determine whether or not you are subject to the quarterly payment requirement. If you are, you will need to use your best guess when determining what you expect your total annual freelance income to be. If you use tax software to prepare your return, that software will automatically prepare the payment vouchers for you. Otherwise, you can simply download those forms from the CRA website. Or pay using online banking; your social insurance number is your account number with CRA.

Canada Pension Plan

One of the biggest challenges of working as a freelancer is the Canada Pension Plan (CPP). The CPP is normally taken off each paycheque with the employer remitting the same amount. Now that you are a freelancer you must pay both the employee and employer share. When you are self-employed, you are considered both the employee and the employer, and that essentially doubles the amount of CPP you pay.

That higher tax burden makes it even more important to plan ahead by setting aside a percentage of each client payment to cover the cost of taxes. Setting that money aside now is the best way to ensure it will be there when you need it. You can earn a bit of interest by stashing those funds in a high-yield savings account (such as a TFSA, see below), but you cannot afford to take any risk with the money.

Medical Expenses

As a freelancer (and you are registered as a sole proprietorship) you cannot deduct medical expenses as part of the business. You would deduct them as part of the medical expense deduction on your tax return. However, there is a way to make them deductible with either a group benefits plan, which can get very expensive, or through a medical trust. The medical trust is a good way to go as you only pay when you have medical expenses. Talk to your accountant or financial planner to find out more.

Open a Retirement Plan

When you work as a freelancer, you are also responsible for funding your own retirement. Fortunately, there are ways for you to save for retirement.

Registered Retirement Savings Plans or RRSPs are one way to save. Unfortunately, you must have earned income from the business in order to be able to contribute to RRSPs and then it’s 18% of your income that you can contribute.  If you have been an employee before you may have accumulated contribution room over your work life; check your notice of assessment for the previous year and it will tell you how much contribution room you have. The advantage of RRSPs is that the amount you contribute gets deducted from your income and reduces your tax burden; however, when you draw the money out it then becomes taxable income.

Another way to save is the Tax Free Savings Account or TFSA. This is not a traditional savings account where you accumulate interest. This account allows you to invest in interest bearing items, stocks, bonds, etc. Each year you get a maximum of $5000 you can contribute and your previous year notice of assessment will tell you how much TFSA room you have. The advantage to the TFSA is that you can accumulate earnings in one and not pay tax one it and you don’t pay any tax on the withdrawals. You can also draw out money from your TFSA and put it back in addition to the $5000 you get per year to put in.

Or, you could just put money away in investments such as stocks, bonds, mutual funds, etc.

It is a good idea to start checking into the various retirement plans as early in the year as possible. Planning early gives you time to choose the right plan, and time to put money aside here and there. If you already have an account with a brokerage firm or mutual fund company, that organization can help you set up a retirement plan specific to your freelancing business. Please don’t just go to your bank and set up and RRSP or TFSA, they are not as independent as they lead you to believe.

No matter how much or how little you make from your freelance work, it is important to factor taxes into the equation. Taxes can have a huge impact on your earnings, and no self-employed individual can afford to ignore that effect.