Tax Organization System for the Self-Employed
One of the main disadvantages of being self employed is the necessity to report and remit income taxes yourself. Employees have it easy. Their employers withhold taxes from their paycheque before their paycheque hits their bank account, and they receive a T4 at year end. Things aren’t so easy for the self-employed.
A common cause of insolvency is failure to accurately report and remit income taxes and HST to the Canada Revenue Agency (“CRA”). Most individuals who have struggled with their reporting and remitting requirements have had trouble due to their lack of a tax organization system.
As a Chartered Accountant, and Trustee in Bankruptcy, I’ve helped my friends, family, and debtors alike set up tax organization systems to make the task of reporting and remitting tax manageable. While a tax organization system takes effort to set up, and slightly more time to manage than tossing receipts in a box that will never be opened, I can promise you that it will save much more time in the future and help ensure that you remain on the good side of the tax man (or woman).
Step 1 – Separate Business and Personal
Does your self-employed income flow directly into your personal chequeing account? If so, you’ve given yourself the tall task of sifting through all of your personal and business transactions each time that you’re required to report and remit your taxes.
I always recommend opening a separate chequeing account to be used for business purposes only (it doesn’t have to be a business specific account, which is often more expensive). In addition, if you use your personal credit card for business expenses regularly, aren’t an undischarged bankrupt, and have good credit, then consider obtaining a credit card for business purposes as well.
Now that you have your new self-employed bank (and possibly credit card), your bank and credit card statements serve as your audit trail. Simply attach your receipts to those statements, and perform some simple arithmetic or hand the neatly organized statements and receipts to your accountant to prepare your monthly, quarterly, or annual tax reports.
Step 2 – Deduct Tax From Every Self-Employed Cheque You Receive
When you’re client hands you a cheque for $1,130, what do you do after you deposit into your self-employed bank account (now separate from your personal chequeing account)? I recommend that you create yet another (this is the last one…) bank account and transfer any portion of the money that you receive that you wouldn’t have received if you weren’t self-employed. In this example:
$700 = Net Pay – Transfer to personal chequeing account
$300 = Income Tax – Transfer to Tax Savings Account (To be remitted)
$1,000 = Gross Pay
$130 = HST – Transfer to Tax Savings Account (To be remitted)
$1,130 = Face value of cheque received
As you can see from the example above, by receiving the entire $1,130 cheque in your personal chequeing account, and spending it, you have created a $430 ($300 Income Tax + $130 HST) debt payable to the CRA. If you do this weekly, you’ll end up owing the CRA $22,360 plus interest and penalties come year end. The CRA charges 12% interest per year, and a 5% late payment fee the day that your remittance is late. Failing to be organized and administer your taxes properly can create huge financial challenges very quickly.
Bankrupts and debtors who have filed a consumer proposal have been given a fresh start. The last thing that anyone wants is for them to fall back into their old habits and end up in financial difficulty due to tax debt. That’s one of the great things about bankruptcy or a consumer proposal: a fresh start to allow you to break old habits and start anew, including the implementation of a new tax organization system.
Before you can set your taxes aside, you have to know how much is appropriate. One way to do this is by using a tool like the CRA’s Payroll Deductions Online Calculator or PDOC (note that most self-employed individuals are EI exempt, but have to contribute twice as much CPP as the PDOC calculates). If you don’t receive payments on a set schedule, then estimate your net annual self employed income, divide by twelve, and enter that monthly amount as monthly income into the PDOC.
Once you know how much to deduct from your income, I recommend doing one of two things:
1) Make a payment to the CRA on a monthly basis for the amount of your income taxes (including CPP), and HST (if applicable). If you end up paying the CRA too much, you’ll get a refund. You can make payments through the CRA’s website or at your bank.
2) Set the amount you calculate as owing to the CRA aside in a separate bank account. This way, as you prepare your tax returns (be they quarterly HST reports, or annual income taxes), you’ll be able to cover even the largest tax bills as the money will be sitting their waiting for you (earning interest all the while). You can use any account, but I like the online bank Tangerine (Formerly ING Direct) as their accounts are free, they pay high interest, and since the balance isn’t as easily accessible you are less likely to spend it on something other than taxes. By using the following referral key, you will receive free money when you make your first deposit of $100 or more (Referral Key: 13882352S1).
Step 3 – Report and Remit
Don’t be afraid of the CRA. They want you to report and remit your taxes and will spend unlimited time with you on the phone to make sure that you have the right forms, and understand your responsibilities. The CRA can be reached at 1-800-959-5525. Considering contacting them to:
- Ensure they have your current address
- Understand how frequently you must report
- Understand how you can report (online vs. paper)
- Understand how you can make payments
To make your life even easier, consider retaining a bookkeeper, or utilizing accounting software like Quickbooks or Simply Accounting. Bookkeepers will help you to avoid missing deadlines, and ensuring you stay organized. Accounting software can speed up your reporting as you can download your self-employed bank statement directly into the software and allocate each line item to a different account electronically.
Paying your taxes can’t be ignored. The CRA catches up with everyone. If you’re self employed and either want to avoid falling behind on your taxes, or never repeat your past mistakes, then its important to create a tax organization system, like the one described above to set yourself up for success. While all of my friends, family, and clients who have implemented the system complained at first, they always thank me after they get used to it and realize how easy that tax reporting and remitting can be once organized.
If you’re having trouble with the CRA, keep in mind that tax debt can be erased through a bankruptcy or consumer proposal. Our consultations are always free, so never hesitate to contact us to have your unique personal situation reviewed. We solve debt problems, and we’re here to help.