Are You an Employee or a Contractor?

With more Canadians juggling side gigs or building their own thing, work doesn't look like it did a decade ago. Perhaps you work full-time hours and have a company email address, but you submit invoices to your employer every month. Maybe you have one steady client, but they don't deduct taxes for you. Or tax season rolls around and a client sends you a T4A, and you're wondering, “Wait…am I on the payroll now?”

It may sound like a small detail. It's not. “Your work status affects everything from how taxes are deducted to what expenses you can claim,” says Maria Eliza Santos, a tax expert at TurboTax Canada. “It's one of the first things you should understand when you start earning income.”

Once you understand the differences between an employee and a contractor, you can plan ahead and avoid surprises at tax time.

Employee vs. independent contractor

Basically, the difference between employee vs. independent contractor comes down to control.

What is an employee?

An employee works under an employer's direction and as part of that company's business. This is known as a “contract of service.” Generally, your employer sets your schedule, decides how the work gets done, and provides the tools. You're paid through payroll, taxes are deducted from your paycheque automatically, and you receive a T4 slip for your tax return.

What is an independent contractor?

Independent contractors work for themselves. This is often called a “contract for services.” You decide how and when the work gets done, and often how much you charge. You invoice clients instead of being paid through payroll. Instead of a T4, you may receive a T4A or no slip at all, which makes tracking your own income essential.

“If you're an employee, your employer handles most of the heavy lifting when it comes to taxes,” says Santos. “If you're a contractor, you're essentially running a small business, even if it doesn't feel like one.”

For example:

A graphic designer who works a regular 9-to-5 schedule for one company, using a computer that it provided, and receives regular paycheques? This person is likely an employee. The company sets the hours, provides the equipment, and deducts taxes.

A freelance graphic designer who works with multiple clients, sometimes on-site, and submits invoices? Typically, an independent contractor. This person is responsible for setting aside money for income tax and CPP contributions, as well as possibly charging and collecting sales tax such as GST/HST.

But what if most of the freelance designer's income comes from just one client? What if that client sets deadlines, approves the work step by step, or expects the designer to be available during certain hours? The working relationship becomes less clear.

Sometimes the lines can get blurred, says Santos. “You might work full-time hours for one company and feel like part of the staff, but you're still paid as a contractor. That's where confusion can creep in.”

How to tell if you are an employee or a contractor

The label in your contract is one piece of the puzzle, but it doesn't automatically dictate whether you're an employee or a contractor for tax purposes. Here's what to consider.

Quick checklist: Employee vs. independent contractor
Question	You may be an employee if…	You may be a contractor if…
Who directs how and when work is done?	The company.	You do.
Can you work for others?	Typically no.	You can usually work for multiple clients.
Can you hire help?	You usually must do the work yourself.	You can typically hire or subcontract to others.
Who covers tools and expenses?	The company.	You do.
Who absorbs the financial risk?	The company. You're paid steady wages and don't absorb business losses.	You. Income can fluctuate, you may be legally and financially responsible for your work, and you cover expenses.
Who manages and invests in the business?	The company.	You're the boss and the bank account.

Still uncertain? Review the CRA guidelines to get clarity and avoid tax questions later.

How employee taxes and contractor taxes differ

Once you know your worker classification, the next question is how it affects your taxes. The short answer: quite a bit.

T4 vs. T4A

A T4 slip is a tax form employees receive from their employer. It shows how much was earned during the previous calendar year and how much was already deducted for income tax, CPP, and EI. Because employees are paid through payroll, those deductions are typically handled automatically.

A T4A slip is a tax form that may be issued to independent contractors or freelancers. It shows how much a client paid for services. Independent contractors may receive a T4A slip from a client showing income paid for contract work during the previous calendar year. The big difference? Taxes usually aren't deducted. Whether you receive a T4A or not, you're responsible for reporting all income and paying the tax owed.

Why aren't taxes deducted? Because contractors aren't on payroll. Clients are paying for a service—not acting as an employer—so they don't withhold income tax, CPP, or EI from those payments. Contractors are paid for their services and are expected to set aside money themselves. That said, some contractors pay regular instalment payments to the CRA throughout the year to avoid a large bill at tax time, and some are required to make quarterly payments to avoid interest or penalty fees.

“With a T4, a lot of the work is done for you,” says Santos. “With a T4A or no slip, you're responsible for setting money aside for taxes.”

CPP, EI, and other deductions

For employees, CPP contributions and EI premiums are automatically deducted from each paycheque, and the employer pays a share too. You don't have to calculate anything—it's built into payroll.

Contractors must take care of these details themselves. If you earn more than $3,500 per year through self-employment, you must contribute to CPP and pay both the employer and employee amounts. You can opt in to EI if you wish and start paying EI premiums. Why would you? It can give you access to certain benefits, like maternity, parental, or sickness benefits, if you qualify. (Learn more about self-employment, CPP, and EI.)

What contractors file at tax time

Independent contractors complete a T2125 (Statement of Business or Professional Activities) to report business income and expenses. It's more paperwork, but the upside is that you can claim eligible business expenses that most employees can't, such as part of your property insurance and mortgage interest, if you work at home, and capital costs like equipment and furniture.

For example, if you work from home as a freelancer, you may be able to claim a portion of your internet and electricity costs based on how much of your space you use for work. Bought a new laptop or desk for your business? Those costs may also be deductible.

The bottom line: Employee taxes and deductions run through payroll. Contractor taxes require you to be diligent and organized and to plan ahead for taxes and contributions. Generally, it's a good idea to set aside 25% to 30% of your income to ensure you can cover your taxes for the year.

What happens if you're misclassified?

If you've filed your taxes as a self-employed worker but the CRA considers you an employee, your tax situation may need to be corrected. Here's what could happen:

• Misclassification can be costly. If the CRA determines a contractor is actually an employee, the employer may be reassessed for unpaid CPP and EI contributions, plus penalties and interest—sometimes going back years.
• If you're reclassified as an employee, it can change how your income is taxed. You may lose access to certain business expense deductions and could owe additional tax, CPP, and possibly EI if too little was set aside. Past tax returns may also be reassessed, which can lead to interest on any amounts owing. On the flip side, employees may become eligible for benefits they weren't receiving before, like CPP, EI, or vacation pay.

The CRA reviews the facts of the working relationship, not just the contract label. If you're unsure whether you're an employee or a contractor, you can request a ruling from the CRA.

Common myths of employee vs. independent contractor

There are some misconceptions about employee vs. independent contractor status. Here are three common ones:

• Myth: Contractors always earn more. Not necessarily. It's true that contractors can set their rates. But they also pay business expenses, handle their own taxes, and don't get paid for non-billable tasks and downtime between projects. A higher rate doesn't always mean higher take-home pay.
• Myth: Contractors don't pay CPP. They absolutely do. In fact, independent contractors pay both the employee and employer portions of CPP.
• Myth: Your employer decides your classification. Not quite. A contract might say “contractor,” but the CRA looks at how the relationship actually works in practice.