You may wonder if the self-employed lifestyle would work for you. You've heard of the benefits such as working your own hours and no more commuting. You even have more time to file your taxes.
While these may be definite pluses, be mindful of the three issues that often surprise the newly self-employed.
Saving and preparing for taxes
Now that you're a sole proprietor running an unincorporated business, say goodbye to the handy T4 slip, which not only records your income but also the tax deducted. The onus is on you to keep track of your income and tax remittances.
Hire a bookkeeper or tax accountant to help you get organized and track all your receipts, invoices and expenses, says Evelyn Jacks, president of Winnipeg-based The Knowledge Bureau and author of Make Sure It's Deductible. She also suggests you separate your business and personal bank accounts and credit cards since that will keep the recordkeeping nice and clean. It also helps you to prove your case if you are ever audited in the future.
While it's hard to predict how much tax you'll owe (it depends on your income-tax bracket and deductions), get in the habit of setting aside a portion of your net income to go towards income taxes, Jacks says.
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You will still file an individual tax return, but your income will be reported as either business or professional income. You can write off reasonable business expenses. If they also apply as personal expenses (i.e. you work out of your home, so use the same Internet service and other utilities), you can write off the portion used for business purposes.
While you technically have until June 15 to file your taxes, Jacks says you'd ideally complete the paperwork by April 30. After all, any taxes owed are due at that time. "What you avoid is the late filing penalty, but not the interest on the taxes due," she explains. "I don't believe there is a benefit to waiting to June 15 because of the interest costs and because we're talking about last year's taxes … you should be able to keep your bookkeeping up on an ongoing basis."
Wait until June 15 and you're paying more than one month's worth of interest on the taxes owed. Currently, the annual interest rate charged on overdue remittances is 5%. This rate is subject to change, and is published on the CRA website.
If you owe more than $3,000 in taxes, you may have to pay the Canada Revenue Agency (CRA) quarterly installments.
There's also the matter of collecting HST and GST. If you earn more than $30,000 within a calendar quarter, or in four consecutive quarters, charging HST and GST for your self-employment services is mandatory, with payments due to the CRA annually for most small businesses. If taxable sales are over $6 million, you must make monthly tax remittances. Opening a separate business account helps to ensure you don't spend money that you owe to the CRA.
Managing cash flow
As an employee, you received a steady pay cheque every two weeks. Now, you are likely invoicing many different types of clients, who all have different payment schedules. That translates into getting paid at much more sporadic times. Since your bills can't wait for your clients to pay you, Jacks recommends having a buffer (an emergency account that's at least three months' worth of living expenses) you can draw on. Try to determine your payment terms with each client ahead of time, whether it's 30 days, or 50% upfront and 50% later, and come up with follow-up procedures if the client isn't meeting your timelines. "The challenge is to try and anticipate what can go wrong," Jacks says.
Deciding to incorporate or not
Incorporating your business means the business becomes a separate legal entity. The business would be taxed at a lower rate than your personal rate and you'd be filing a business-specific tax return. Your incorporated business can pay you a salary, split income with other family members and, if the business qualifies, have access to the $750,000 capital-gains exemption, according to Jacks. She says incorporating might be worth considering if you pour a significant portion of your earnings back into the business and are earning a substantial amount (say $100,000) of net income. To incorporate, you will likely need to engage the services of an accountant and lawyer who can help to explain the process, set-up costs and structure for your incorporated business.
