Self Employment & CPP: How does the CPP Enhancement Rules Affect You
Self-employed individuals make up 16% of the Canadian workforce. As a self-employed individual, it’s important to know what your tax obligations are so that you can budget more effectively.
It is also of critical importance for self-employed individuals to save money for their retirement since the money they earn is not withheld by an employer and directed to a Canadian Pension Plan (CPP). There are also additional tax considerations for self-employed persons with the advent of the CPP enhancement rules, which came into effect in January of 2019.
Before we dive further into the CPP rules for self-employed persons, let us first define what a self-employed person is according to the CRA. Sometimes determining whether you are an employee or are self-employed can get murky, especially when you provide the majority of your services to one client.
According the CRA, the factors that determine whether you are self-employed depend on the following:
- the level of control the payer has over the worker
- whether or not the worker provides the tools and equipment
- whether the worker can subcontract the work or hire assistants
- the degree of financial risk taken by the worker
- the degree of responsibility for investment and management held by the worker
- the worker’s opportunity for profit
- other relevant factors, such as written contracts
Generally speaking, the more independence and control you have in operating your business, the greater personal risk you assume, and the greater the opportunity for profit, the greater likelihood you will be deemed a self-employed individual.
Paying Personal Income Tax
As a self-employed person or sole proprietor of your business, you must pay personal income tax on the net income generated by your business.
Self-employed persons are required to file a T1 return if they have
- earned taxable income;
- disposed of capital property or had a taxable capital gain;
- have to make Canada Pension Plan (CPP) payment or Quebec Pension Plan (QPP) payments on their earnings;
- want to access employment insurance (EI) benefits for self-employed persons; or
- wish to claim an income tax refund, a refundable tax credit, a GST/HST credit, or Canada Child Benefit.
Paying Tax By Installments
In the province of Ontario, if you are a self-employed person or sole proprietor who owes a net tax that is more than the $3000 threshold, you are required to pay your tax by installments.
Click here for the calculation chart for installment payments for 2019.
How does the CPP Enhancement Affects Self-Employed Persons?
If you are a self employed person and earn more than $3,500 per year of net income, you are required to make CPP contributions on your income; that is, using 2020 figures, your CPP contribution will be based on what you earn above the minimum of $3,500 and the maximum of $58,700.
If you make more than $58,700, you are not required or allowed to make additional CPP contributions. The ceiling amount of $58,700 is up from $57,400 in 2019. Each year, the federal government sets a new ceiling using a formula based on the growth in average wages and salaries in Canada.
How much are you required to pay into CPP?
Since the self-employed person is juggling the unique role of employer and employee, he must pay both what he and an employer would pay.
Using 2020 figures, a self-employed person would contribute a CPP rate of 10.5% (taxpayers who are employees pay 5.25%, and employers pay 5.25%.). This is up from the 10.2% CPP rate in 2019. The increase of 0.3% to the 2019 contribution rate is due to the CPP enhancement, which was implemented on January 1, 2019.
Increases or CPP enhancements will continue to increase over two phases: the first phase, which will take place from 2019 to 2023; the second will begin in 2024.
Contribution Rates Under CPP enhancement Schedule
During phase one, a self-employed person’s total contribution rate of 9.9% will increase by 0.3% in each year of 2019 and 2020. It will then increase an additional 0.4% for 2021, and 0.5% in each of 2022 and 2023. That means that by 2023, the contribution rate will have increased by 2% for a new rate of 11.9%.
Tax Credits and Tax Deductions: Phase 1
As a self-employed person in 2019, you can claim a non-refundable tax credit of 10.5% of your pensionable income and a 10.5% tax deduction on the same earnings. You will also be able to claim an additional tax deduction of 10.5% on the entirety of the enhanced part of your contribution.
Let’s look at an example to see how this works, using CPP rates applicable in 2020. If you were earning $55,000, you would calculate your tax credit by subtracting your basic exemption of $3,500 from your earnings, for a total of $51,500.
Next, you will multiple this amount by the 2020 CPP contribution rate of 10.5%, giving you a tax credit of $5,407.50.
To calculate the amount you can claim for a tax deduction, follow the same formula again to get to tax deduction of $5,407.50. Next, you will multiple your $51,500 income by the enhanced rate of 0.3% to get to a total of $154.50. Adding up both amounts, you will be able to claim a tax deduction of $5,562.00.
Tax Credits and Tax Deductions: Phase 2
Phase 2 of the CPP enhancement schedule will take effect in 2024, at which time, a new earnings ceiling will take effect. You will only need to contribute 8% on the part of your earnings that are between the first earnings ceiling and the second earnings ceiling.
This means once the phase-in is complete you will pay a contribution rate of 11.9% on earnings up to the first earnings ceiling and 8% on the second earnings ceiling. This will, in turn, increase your benefit amounts.
This second set of contributions is also mandatory, and much like we previously explained, if you earn more than the second earnings ceiling, you are not required or allowed to contribute more to the CPP.
Let’s see how phase 2 of CPP enhancements will work with an example. Say you are earning $75,000 annually in 2025. It is expected that the first earnings ceiling in 2025 will be $69,700 and the second earnings ceiling will be $79,400.
First, you will subtract the basic exemption of $3,500 from your earnings up to the first ceiling of $69,700, for a total of $66,200. Next, you will multiply this amount by 11.9% for a total of $7,877.80. This is the amount you can claim as a tax credit. This is the same amount you can claim as a tax deduction.
However, there is more to do because of the second ceiling. You will now take what you earn in excess of the first ceiling ($75,000 — $69,700) for a total of $5,300, which you will multiply by 8% for a total of $424.
This amount will also be tax-deductible. Therefore, the total tax deduction will be $7,877.80 + $424 for a total of $8301.80.
Getting ready for your retirement can be made easier if you know how much to put away into your CPP retirement fund and how much you can claim in tax deductions and credits each year. Contact a lawyer at Kalfa Law if you are self employed to help you make the most of your retirement.
You work hard for your money. We work hard for you to keep it ™ .
-Shira Kalfa, BA, JD, Partner and Founder
© Kalfa Law 2019
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.