Best way to plan for tax season?
April 26, 2014 8:09 AM Subscribe
I’m about to become a contractor. I live in Canada. When I get paid, there will be nothing automatically deducted in the way of income tax, CPP, etc. How should I handle this?
Should I just set aside the appropriate amounts in a separate bank account and pay it off in a lump sum when tax season rolls around? Is there an optimal way I could invest that money during the year to make something off it? Would there be any advantage to setting up automatic payments to CRA on a monthly basis instead?
Thanks in advance for your advice!
Should I just set aside the appropriate amounts in a separate bank account and pay it off in a lump sum when tax season rolls around? Is there an optimal way I could invest that money during the year to make something off it? Would there be any advantage to setting up automatic payments to CRA on a monthly basis instead?
Thanks in advance for your advice!
How should I handle this?
By hiring an accountant well-versed in self-employment.
posted by DarlingBri at 9:40 AM on April 26, 2014
By hiring an accountant well-versed in self-employment.
posted by DarlingBri at 9:40 AM on April 26, 2014
Should I just set aside the appropriate amounts in a separate bank account and pay it off in a lump sum when tax season rolls around?
This is precisely what I did in my first couple of years of contracting. Once I started making enough the CRA required me to switch to quarterly installments.
I used an ING/Tangerine high-interest savings account, which combined a decent enough interest rate with no risk. Whatever you use as an investment vehicle, you want little to no risk. Tax money is not something you want to gamble with.
As always, having an accountant vet your plan is a good idea.
posted by DrJohnEvans at 9:47 AM on April 26, 2014
This is precisely what I did in my first couple of years of contracting. Once I started making enough the CRA required me to switch to quarterly installments.
I used an ING/Tangerine high-interest savings account, which combined a decent enough interest rate with no risk. Whatever you use as an investment vehicle, you want little to no risk. Tax money is not something you want to gamble with.
As always, having an accountant vet your plan is a good idea.
posted by DrJohnEvans at 9:47 AM on April 26, 2014
I usually set aside $1000 per month for every $5000 of income. I don't pay the quarterly instalments, either. My income is variable, so I need that money as a hedge in case I encounter a lean spell.
I also have an actual accountant. Although filing taxes when you're self-employed is pretty easy, the $400 I pay the firm to do my taxes (and my wife's taxes) allows me to call him up throughout the year in case those bastards at CRA give me a tough time about something, and they can just call them up and fix the problem in 5 minutes.
posted by KokuRyu at 10:08 AM on April 26, 2014
I also have an actual accountant. Although filing taxes when you're self-employed is pretty easy, the $400 I pay the firm to do my taxes (and my wife's taxes) allows me to call him up throughout the year in case those bastards at CRA give me a tough time about something, and they can just call them up and fix the problem in 5 minutes.
posted by KokuRyu at 10:08 AM on April 26, 2014
You don't have to pay the instalments, although CRA may make you pay a $300 fine. It's really weird though - they say you have to pay the fine, but they never collect it (this is something my accountant and I have discussed). It is not a black mark on your file.
The one big thing to keep in mind is that sole proprietors do *not* have to file a T4 in February, but if you are incorporated (and therefore must report on both your business revenue and your personal income) you do.
People who are incorporated don't generally understand this, and my own father said one year that, hey, haven't you submitted a T4 yet? So I hurriedly did, and then filed taxes as a sole proprietor, and then got a huge tax bill based on double my actual income, and I "owed" $20K above and beyond what I had already paid.
This is when having a relationship with an accountant came in very handy. But it took almost 12 months to sort out.
If you have higher amounts of income (higher than, say, $80K as a ballpark figure on a reliable basis) it makes sense to incorporate in order to reduce your tax load.
However, for lower amounts of annual revenue remaining as a sole proprietor is more simple to administer (less reporting requirements that you do not get paid to do).
posted by KokuRyu at 10:15 AM on April 26, 2014
The one big thing to keep in mind is that sole proprietors do *not* have to file a T4 in February, but if you are incorporated (and therefore must report on both your business revenue and your personal income) you do.
People who are incorporated don't generally understand this, and my own father said one year that, hey, haven't you submitted a T4 yet? So I hurriedly did, and then filed taxes as a sole proprietor, and then got a huge tax bill based on double my actual income, and I "owed" $20K above and beyond what I had already paid.
This is when having a relationship with an accountant came in very handy. But it took almost 12 months to sort out.
If you have higher amounts of income (higher than, say, $80K as a ballpark figure on a reliable basis) it makes sense to incorporate in order to reduce your tax load.
However, for lower amounts of annual revenue remaining as a sole proprietor is more simple to administer (less reporting requirements that you do not get paid to do).
posted by KokuRyu at 10:15 AM on April 26, 2014
Talk to an accountant and get some advice, in particular in how much to set aside.
I've set aside between 20-40% when contracting and paid quarterly in the US. Most tax accountants/preparers will prefer you set aside the funds and pay as much as possible when your tax season occurs, minimizing your quarterly payouts. (The idea is that that money in your bank account makes you money on interest, paying quarterly to the gov't doesn't)
posted by bitdamaged at 1:52 PM on April 26, 2014
I've set aside between 20-40% when contracting and paid quarterly in the US. Most tax accountants/preparers will prefer you set aside the funds and pay as much as possible when your tax season occurs, minimizing your quarterly payouts. (The idea is that that money in your bank account makes you money on interest, paying quarterly to the gov't doesn't)
posted by bitdamaged at 1:52 PM on April 26, 2014
I used a separate savings account and hired an accountant. I wasn't making enough that it felt worth trying to invest it, I just had it in a "high" interest savings account.
posted by looli at 7:25 PM on April 26, 2014
posted by looli at 7:25 PM on April 26, 2014
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If your total tax burden for the year is high enough, you might be required to make installment payments through the year. Again, the definition of "high enough" depends on which province you live in.
When you begin working as a contractor, it's a good idea to simulate what you think your tax return will look like come the end of the year. Then you can get a picture of which taxes you'll be subject to (federal income tax, provincial income tax, CPP, PPIP, various health taxes, etc.) and be able to estimate the tax rates of each component. If you're unsure how much money you'll make this year, it's a good idea to analyze a couple different scenarios so that you can say, "when I hit $x in sales, I need to make an installment payment."
Finding an accountant well-versed in self-employment taxes can help you effectively plan to avoid surprises during tax season and to ensure you put enough money aside.
posted by bkpiano at 8:34 AM on April 26, 2014