Being your own boss is a dream for many people. Working on your own terms and having the ability to dictate your work-life balance are something that many entrepreneurs chase after. As your lifestyle evolves, your tax compliance requirement changes as well. In this article, we will explore your tax obligations of being a sole proprietor so that you will be better equipped to start your own business journey.
Sole proprietor, or self-employed individual, is an unincorporated business that is owned by one person. You are responsible for making all business decisions, entitlement to all the profits, losses, and you do not have a separate legal status from your business. This means any risks in the business will be extended to your personal property and assets.
As a sole proprietor, all revenue generated and all expenses incurred for the business are reported on your T1 personal income tax return. The net income will be subject to tax at your marginal tax rate. In addition, all self-employed individuals are required to remit both the employee and employer portion of this Canada Pension Plan (CPP). This could be substantial as the required CPP contribution has doubled. Employment Insurance (EI) is optional for sole proprietor and should be considered depending on your circumstances.
Tax Filing Requirement
It is important to note that not all sole proprietor are required to file a personal tax return. You are only required to file a T1 if any of the following situation applies:
- You have a tax liability;
- You disposed of a capital property;
- You have to make Canada Pension Plan/Quebec Pension Plan (CPP/QPP) payments on self-employed earnings;
- You want to access employment insurance (EI) special benefits;
- You received a request to file letter from the CRA; or
- You want to claim an income tax refund, a refundable tax credit, a GST/HST credit, or the Canada Child tax benefit.
Charging Sales Tax
Depending on the type of product or services you sell and where your customers are located, you may be required to charge sales tax. Certain products or services are considered “exempt supplies” or “zero-rated supplies” in which no sales tax can be levied. However, most products and services are considered taxable and as a result sales tax should be charged if your annual revenue exceeds $30,000.
We have summarized the steps below to assist with your sales tax obligation:
Step 1: Review the products or services you sell to determine if your business needs to register for sales tax (e.g. GST/HST). Exempt supplies, such as prescribed medical goods and services, are not eligible for sales tax registration.
Step 2: Determine the appropriate sales tax rate to levy. If you are selling goods to customers located in Ontario, you would charge 13% HST on most goods. For customers located in Alberta, you would only charge a GST rate of 5%.
Step 3: During business operation, you must keep detailed records of all sales tax collected and paid. The law requires that all supporting documents must be kept for at least 6 years. Amounts that cannot be supported are denied and your business will be subject to additional tax liability along with penalties and interest.
Step 4: Prepare and file a sales tax return (e.g. GST/HST return) for each jurisdiction that your business is registered. If the sales tax collected is greater than the sales tax paid for the reporting period, your business is required to remit the difference to the CRA and vice versa.
Tax Instalment Requirement
One of the difference between an employee and a self-employed individual is that you no longer receive pay cheques from an employer in which payroll taxes are being deducted. With the absence of payroll withholding on self-employed earnings, you may be subject to a significantly larger tax owing at the time when you file your tax return. If your tax liability exceeds $3,000 in a tax year, you are required to pay tax by instalment on a quarterly basis in the following year. The amount of instalment required will generally be determined by the taxes you owe in the previous year.
As your business continues to grow, you may realize that running your business as a sole proprietor may not be the most optimal tax position because your net income is subject to tax at the marginal rate. You may wish to consult with your accountant to incorporate your business in order to benefit from the low corporate tax rate.