Earning an Income as an Employee Versus Being Self-Employed: the Tax Pros and Cons

Earning income as a salaried employee

Sure, some may think working for a corporation is “selling out.” But if the idea of earning a consistent and predictable income appeals to you, becoming a salaried employee is a great choice. Having a regular paycheque makes it easier to budget and plan for expenses. And year-end tax filing is usually simpler because your employer has already taken care of deductions for you. The downside? You have less control over your earning potential. 

A few key things to know about being an employee: the salary you negotiate when you accept your job offer isn’t what you’ll see in your paycheque. Why? Because there are things called taxes and deductions. To understand what you can expect to see on your first paycheque, let’s first define gross annual income and net salary.

• Gross annual income is your total pay before taxes and deductions (in other words, what we all wish we were pocketing!). 
• Net salary is what’s left after taxes and other deductions are taken out (your “take-home pay”).

What amount of taxes is taken out of my paycheque?

Thanks to your employer, tax time is simpler. Mandatory deductions are withheld by your employer and remitted directly to the Canada Revenue Agency (CRA), so you don’t have to think about them much. 

By law, your employer must make the following deductions from your earnings: 

1. Federal income tax
2. Provincial/territorial income tax
3. Employment Insurance (EI) deductions 
4. Canada Pension Plan (CPP) deductions

Let’s take a closer look at each one:

• What is federal income tax? The biggest bite to your paycheque is income tax—a mandatory tax imposed by the government on income earned by people and businesses. It’s used to fund various services like healthcare, education, infrastructure, and social programs. In Canada, people who make more money pay a higher percentage of their income in taxes. How much you’ll pay depends on your situation, but you can calculate an estimate with this calculator.

• What is provincial/territorial income tax? Anyone who lives in, or has earned income in, a province or territory is also subject to provincial or territorial income tax. Rates vary depending on where you live.

• What is Employment Insurance (EI)? EI is a federal program that provides temporary income support to unemployed workers while they look for a new job. Your employer deducts EI premiums from each dollar of your insurable earnings, up to a yearly maximum (the CRA updates this annually). They must also contribute 1.4 times the amount of EI premiums they deduct from an employee’s pay.

• What is the Canada Pension Plan (CPP)? Funded through contributions from eligible employees, employers, and self-employed workers, this government-run retirement pension plan pays a monthly benefit to replace part of your income once you retire. Your employer deducts your CPP contribution from your salary or wages throughout the year. Check out this year’s contribution rates and maximums.

As a salaried employee, you get credit for having paid these amounts. You’ll see that on your T4 slip (a document you’ll get from your employer when it’s time to file your annual tax return). It shows how much you earned during the year and provides the figures you need to file your annual tax return.

Earning income as a self-employed worker 

Being your own boss and doing something you love sounds like a dream, right? After all, self-employment gives you the possibility of having more control over your income and more options for tax deductions. 

When it comes to self-employment, you have a choice: operate as a sole proprietorship or a corporation. 

Sole proprietorship: This is the simplest kind of business structure and means that you are the only owner. You run the show, taking on financial profits and losses and filing your own business and personal taxes together. Your income is taxed at a personal rate, but you can deduct business expenses which may put you in a lower tax bracket and reduce your overall tax burden.

Corporation: If you choose to incorporate your business, you and your business are two separate entities, and your personal and business taxes are paid separately. As a corporation, your income is taxed at the small business rate; this is generally lower than a personal income rate and also allows you to reduce your tax burden.

When it comes to taxes as a self-employed individual, the buck stops with you. You don’t have an employer giving you a T4 slip that tells you what you’ve earned and how to file, so the onus is on you to cover your tax obligations. 

How do I pay taxes as a self-employed worker? 

Here’s what you need to know about taxes and deductions: 

• How much do I need to pay in federal and provincial/territorial income tax? If you’re a sole proprietor you can deduct common business expenses from your income and lower your taxable income, making what you owe a bit more manageable. Incorporated? Your income is taxed at the small-business rate (approximately 12% depending on the province you live in) allowing you to retain more of what you earn and defer taxes until you withdraw it, ideally when you’re in a lower tax bracket, like in retirement. 

• Do I need to pay CPP? CPP contributions are mandatory if you’re a self-employed Canadian to ensure you’re getting some guaranteed income once you retire. But you’ll need to pay both the employer and employee portions. For 2023, the CPP contribution rate is 5.95%, with a maximum annual contribution of $7,508.90 on net income of $66,600 or more.
• Do I need to contribute to EI? EI contributions are optional, so if you decide you’d like to have access as a self-employed person, you’ll need to register and pay the premiums. In 2023, this premium is $1.63 for every $100 you earn, up to a total of $1,002.45.

Plan ahead so you don’t end up underpaying or seeing a higher tax bill than expected at year-end. A good rule of thumb is to set aside funds based on your tax bracket. In other words, if your marginal tax rate is 30%, set aside 30% of your earnings until you are ready to pay the taxes you owe. 

There’s no need to feel lost at sea. Knowing the tax implications and responsibilities of being a salaried employee versus going the self-employed route will help you narrow down your choice to the one that makes the most sense for you.