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 Canada Revenue Agency (CRA) gets their money on time.
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 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 request those forms from the CRA website.
Saving Money on Your Taxes
One of the biggest challenges of working as a freelancer is Canada Pension Plan (CPP) contribution. This special tax is applicable only to those who are self-employed, and it consists of the combined employee and employer share of the tax that fund the CPP. When you are self-employed, you are considered both the employee and the employer, and that essentially doubles those two taxes.
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, but you cannot afford to take any risk with the money.
Health Savings Accounts
Finding affordable health insurance is a challenge faced by every freelancer, but there are some ways to make purchasing the coverage you need less of a burden. One strategy is to combine a high deductible health plan with a health savings account. High deductible plans are usually much less costly than traditional plans, and that can help you save a lot of money.
Opening a health savings account can save you even more, since you can deduct the amount you set aside from your taxable income. You do need to make sure the health plan you have is HSA-eligible, something your insurance agent can tell you. You can also write off the cost of your health insurance premiums, provided you are not eligible for coverage under a group plan.
Open a Retirement Plan
When you work as a freelancer, you are also responsible for funding your own retirement. Fortunately, the CRA has ways to make saving for retirement less costly and more effective. Freelancers can choose from a number of retirement plans, including the Tax Free Savings Account (TFSA) and the individual Registered Retirement Savings Plan (RRSP). Each of these plans has its pros and cons, but they can all save you substantial money on your taxes.
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.
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.