Being an independent contractor offers many benefits, including choosing work that best aligns with your interests and schedule. Many of the independent contractors I speak with enjoy the freedom that comes with their work. However, with that freedom comes accounting and tax responsibility.
It is very important for independent contractors to plan proactively for their taxes. Otherwise, trouble can loom. Common errors I see include independent contractors not collecting GST/HST when they should be, or the reverse, where independent contractors collect GST/HST, but fail to make the required payments to the CRA. In both scenarios, these errors can be very costly.
Other common issues include contractors not having an accounting system, not remitting tax instalments to the CRA, having an unexpected large tax liability at year-end or not taking advantage of the available tax deductions.
For those contractors who operate through a corporation, there are other risks as well, but I will not get into those in this article. Feel free to reach out if you operate a corporation as you will want to ensure you properly address the Personal Services Business (PSB) matter correctly, if applicable.
The following are some accounting and tax tips for independent contractors to consider:
1) GST/HST Registration – Generally, when a business exceeds annual sales of $30,000, then registration is required (assuming you make taxable sales in Canada). You will want to determine whether your sales exceed this threshold. If they do, then registration would be required and you would be required to collect GST/HST accordingly.
If your annual sales are below $30,000, then you are classified as a small supplier, and GST/HST registration would not be required. This means that you would not charge GST/HST.
There are specific details of this rule, so it is important to understand the requirements for your individual situation. For example, some businesses will need to collect HST even if they are below the threshold.
2) Record Keeping and Accounting System – I advise contractors to setup an accounting system. Through this system, you can prepare invoices, collect payment, track expenses and monitor your financial performance. There are many good accounting systems out there. If you are looking for a cloud based system, you can check out Wave, Xero or QB Online.
There are also document management systems out there, which essentially will allow you to store your invoices, receipts and other important documents. You can check out both Receipt Bank and HubDoc.
An accounting system and document management system will not only help you manage your finances throughout the year, but it will make the year-end tax process much easier (and cheaper). Further, it will help you should the CRA request further information and documentation regarding your filings.
3) Separate Bank and Credit Card Accounts – Independent contractors should have separate bank and credit card accounts. This means that your contracting revenue and expenses should not flow through your personal accounts. By having a separate bank account where only your business transactions flow, the record keeping is easy. Further, by having a separate credit card, you can charge your business expense through this card. These practices will separate your personal activity from your contracting (business) activity.
4) CRA Compliance – Unlike being an employee, there are generally no payroll/source deductions taken on the payments contractors receive. A common error with contractors is that they receive these funds and use them all for personal use. The issue with this is that at year-end, when they are preparing their taxes, a large tax bill can arise as no tax payments were submitted to the CRA during the year. It is very important to set aside the cash for the eventual personal taxes. Making instalments is a great option for pre-paying the tax and it could be required depending on your situation.
Similarly, GST/HST registrants will want to ensure they keep the GST/HST portions on hand for the eventual GST/HST CRA payments. Instalments can also be setup and may also be required.
5) Tax Deductions – One of the most common questions I am asked by independent contractors is what expenses they can deduct. Essentially, to claim an expense, it must be incurred to earn business income and it must be reasonable under the circumstances. Below
are common expense deductions for independent contractors.
For a full list, please see the following link - https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/business-expenses.html
-Advertising
-Business tax, fees, licenses and dues
-Business use of home office expenses (see below for details)
-Motor vehicle expenses (see below for details)
-Insurance
-Interest and bank fees
-Meals and entertainment (50% deductible)
-Legal, accounting and other professional fees
-Office expenses and supplies
-Rent
-Property tax
-Travel
6) Business Use of Home Office – You can deduct expenses for the business use of a work space in your home, assuming it is your principal place of business and you use the space only to earn your business income and use it on a regular and ongoing basis to meet clients. The portion that is deductible is the space of the office relative to the entire home. For example, if your office represents 15% of the home, you can deduct 15% of the respective expenses. Expenses include mortgage interest, property taxes, rent, repairs and maintenance, insurance, electricity, hydro, water, heat, internet, etc.
7) Motor Vehicle Expenses – You can deduct expenses you incur to run a vehicle you use to earn business income. However, only a portion can be deducted, which is based on the vehicle’s business use percentage. Further, a log is required to be maintained should the CRA ask for support. The type of expenses that can be claimed include leasing costs, CCA (amortization), maintenance and repairs, interest on money borrowed to buy a vehicle, insurance, fuel and license and registration fees.
Templates for the business use of home and motor vehicle expenses are available, which will make it easier to calculate the above portions.
In conclusion, it is very important to plan proactively for your taxes. I hope the above tips can guide you in the right direction. I realize that each situation is unique, so feel free to reach out should you have any questions.
Disclaimer – The information contained in this article is for information purposes only. It does not provide legal or accounting advise and it should not be relied upon. All tax situations are unique to their facts and will differ from the situations in this article.