Self Employment & CPP: How does the CPP Enhancement Rules Affect You
Per Statistics Canada, the self-employed made up 15% of the Canadian workforce in 2018. Of these, 46% operated through a corporation. The remaining 8% operated proprietorships. This is generally what people refer to when using the phrase “self-employment” in the tax context.
As a self-employed individual, it’s important to know what your tax obligations are so that you can budget more effectively. In contrast to employees, whose employers are obliged to withhold and remit income tax from their pay cheques, self-employed individuals need to budget to meet their income tax needs throughout the year. They also need to care for their own Canada Pension Plan (CPP) contributions.
Under Canadian tax law, a distinction is drawn between the self-employed, who earn income from a business, and the employed, who earn income from an office or from employment.
The CRA and the Courts consider the following factors, among others:
- Whether the parties mutually agreed to an employment or self-employment relationship
- 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, the greater personal risk you assume, and the greater the opportunity for profit, the greater likelihood you will be considered to be operating a business.
Filing & Paying Personal Income Tax
Generally, individuals are not obliged to prepare and file income tax returns unless they have a balance owing at the end of the year. Both employed and self-employed individuals need to pay income tax on their income, although employed people generally have this income tax deducted from their pay as they earn it. As the self-employed do not, they are generally obliged to file returns and can be subject to late-filing penalties if they do not.
Self-employed people also pay CPP contributions on their income along with income tax at the end of the year.
Paying Tax By Installments
Taxpayers with taxes owing in excess of $3,000 at the end of one year are obliged to pay by instalments in the next year. If you fail to do so, CRA charges interest if you have a balance due in the next year.
As the self-employed do not have employers who withhold income taxes on their behalf, they generally have outstanding balances at the end of the year.
Click here for the calculation chart for installment payments for 2019.
Similar rules apply for the HST for annual filers.
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, your tax bill at the end of the year will include CPP in addition to income tax. CPP contribution are based on what you earn above the minimum of $3,500 and the maximum of $57,400.
There are no CPP contribution on income above $57,400, up from $55,900 in 2018. 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?
CPP has two components: payments for employers and payments for employees. Employers withhold the employee’s portion from the employee’s pay, and pay the employer portion themselves. Since self-employed people juggle the roles of the employer and the employee, they must pay both what he and an employer would pay.
Using 2019 figures, a self-employed person would contribute a CPP rate of 10.2% (taxpayers who are employees pay 5.1%, and employers pay 5.1%.). This is up from the 9.9% CPP rate in 2018. The increase of 0.3% to the 2018 contribution rate is due to the CPP enhancement, which was implemented on January 1, 2019.
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
Self-employed people can claim a non-refundable tax credit valued at 15% of one-half of CPP contributions, and may claim a deduction against income for the other half. This credit reduces tax payable dollar-for-dollar, while the deduction reduces taxable income, which reduces tax in turn at the taxpayer’s marginal rate.
Let’s look at an example to see how this works, using CPP rates applicable in 2019. 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 2019 CPP contribution rate of 10.2%, giving you a tax credit of $5,253.
To calculate the amount you can claim for a tax deduction, follow the same formula again to get to tax deduction of $5,253. 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 $5407.50.
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.
While the mechanics of these calculations may be complicated, they are generally determined along with income tax when individuals file their return. However, as CPP payments can be an important income source during retirement, it is helpful to have general idea of how this works. 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
Shira Kalfa is the founding partner of Kalfa Law. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law 2020
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.