Entrepreneurship of some kind has become a way of life for young workers today. As the sole proprietor of your business, the sole employee of an incorporated business, a freelancer, or an independent contractor, your tax situation is less straightforward than that of a typical salaried employee.
Two areas where self-employed individuals differ from regular employees are in contributions to the Canada Pension Plan (CPP) and to Employment Insurance (EI).
CPP for self-employed
Everyone between the ages of 18 and 70 whose income is greater than $3,500 must contribute to the CPP. Regular workers contribute 4.95 percent of their wages above $3,500, up to an annual maximum of $2,593.80, while their employer contributes an equal amount.
Self-employed individuals are on the hook for both the employee and employer amounts, meaning they’d contribute 9.9 percent of net income up to an annual maximum contribution of $5,187.60.
CPP contributions from self-employment are based on the net income of your business. To calculate your annual contributions at tax time start with line 1 on Schedule 8 (CPP Contributions on Self-Employment and Other Earnings) and transfer the numbers as directed to your personal tax return.
Your 9.9 percent CPP contribution pays into one of the major pillars of Canada’s retirement benefit system. The maximum CPP benefit available to retirees in 2018 is $1,134.17 per month, with the average Canadian receiving $691.93 per month.
You’ll also receive a tax deduction for the “employer half” of the contribution plus a 15 percent federal tax credit for the “employee half” of the contribution.
Self-employed individuals do have some flexibility on their CPP contributions depending on the way their business is structured. For example, a sole proprietor might consider incorporating, which gives them the option to pay themselves a salary or dividends.
Incorporated individuals can opt to pay themselves a lower salary and then take the rest of their income as dividends to reduce CPP premiums. Incorporated individuals can also participate in a pension plan. Sole proprietors don’t have that option.
EI for self-employed
While paying double the CPP contribution rate might seem excessive for some entrepreneurs, the good news is that self-employed workers do not have to pay EI premiums. That is, unless they opt into the EI program for access to employment insurance special benefits, which include maternity, parental, sickness, compassionate care, and parents of critically ill children benefits.
Opting in means registering with the Canada Employment Insurance Commission (CEIC).
When self-employed workers opt into the EI program to access EI special benefits, they pay the same EI premium rate as employees pay, which for 2018 is $1.66 per $100 of insurable earnings. The level of earnings required by self-employed Canadians to be eligible for EI special benefits is $6,947.
EI premiums are paid when the self-employed worker files his or her T1 income tax and benefit return using Schedule 13 (Employment Insurance Premiums on Self-Employment and Other Eligible Earnings). Unlike with the regular EI program, self-employed workers do not have to pay the employer’s portion of EI premiums.
You must pay premiums for a full 12 months before collecting benefits.
Once a self-employed person starts contributing to EI, she can only opt out if she has never collected benefits.
Even after paying into the system for 12 months, if your business fails you will be ineligible for unemployment benefits.
An extended leave might not be suitable for a business that relies on your time and effort to keep running.
Rather than opting-in to the EI program, you might consider investing the equivalent of the premiums instead. For example, the maximum premium one could pay into the EI program in 2018 is $858.22. Set that amount aside in a Tax Free Savings Account each year and watch your savings grow.
If you’re set on opting-in to the EI program, plan on taking at least two, if not three, full parental leaves for the program to pay off in your favour.
About Robb Engen
Robb Engen co-founded the award winning personal finance blog Boomer & Echo in 2010 where he writes about saving, investing, and consumer advocacy. He also writes a monthly column for the Toronto Star. Robb lives in Lethbridge, Alta, with his wife and two children. You can reach him at firstname.lastname@example.org.