Last updated: Jun. 6, 2023
Employee or Self-Employed Contractor?
There are important differences between a self-employed contractor and an employee.
Employment classification determines entitlement to employment insurance (EI) benefits, Canada Pension Plan (CPP), and Income Tax Act legislation.
Here’s what you need to know about employee and self-employed contractor taxes.
Self-Employed Taxes: Employer and Employee
In a relationship between an employer and employee, the payer is considered the employer, and the worker is the employee. The employer hires the employee in what the CRA refers to as a “contract of service.”
Employees may be paid based on an hourly, weekly, or monthly salary; incentives such as commissions; or a combination of incentive-based earnings and a salary.
As an employer, you’re responsible for deducting an employee’s CPP contributions, EI premiums, and income tax from their paycheque. You must remit these deductions with your share of CPP contributions and EI premiums to the Canada Revenue Agency (CRA).
If you fail to deduct the required CPP contributions or EI premiums, you’ll be held responsible for paying both the employee and the employer portions of any owed amounts, plus penalties and interest. There are some situations in which salaries paid to non-arm’s-length employees aren’t insurable. That’s why it’s important to speak with a payroll specialist to ensure you’re compliant.
You’re also required to provide a T4 slip to the employee and submit this information to the CRA. T4s are typically due before the last day of February following the calendar year to which the information applies. If that date falls on a weekend, the T4 will be due on the next business day.
Self-Employed Taxes: Filing Taxes as a Contractor
If you’re a self-employed contractor, you must operate a business and participate in a business relationship with the payer. The CRA describes this relationship as a “contract for services.”
This means you’re responsible for knowing how much money you make, what you can and can’t deduct as a business expense, and how much money you’ll need to remit in taxes.
You can set up your contracting business as a sole proprietor, a partnership, or an incorporated business. (Read more about your business structure options.)
CRA income reporting requirements are dependent on your business structure:
- If you’re a sole proprietor, you must report your self-employment income and related expenses on CRA Form T2125, Statement of Business or Professional Activities. You will submit this form with your completed T1 income tax package.
- If you’re in a partnership, the partnership fills out a partnership information return (T5013), but you’re required to report your share of the partnership’s net income or loss on your personal tax return using Form T2125.
- If you’re incorporated and your contracting services are invoiced through your corporation, the income would be reported on your T2 corporation income tax return. The compensation drawn from your corporation, whether it’s through a salary, dividends, or a combination of the two, would be reported on your T1 tax return. For more on salary versus dividends and the different reporting requirements, read our blog post.
- If your net self-employment income adds up to more than $3,500 per year, you’re required to make contributions to the CPP.
Self-Employed Taxes: Contractor vs. Employee in Canada
How does the CRA define a self-employed contractor versus an employee?
It’s simple: The CRA determines whether or not the person carrying out services is a self-employed individual in business on their own account or whether they’re working for an employer. The CRA wants to know when the self-employed contractor and the payer entered into the working relationship and whether their intent was to enter into a contract of service, or a contract for services (business relationship).
The CRA has identified certain criteria to determine whether you’re an employee, an independent contractor, or an employer that has hired a contractor or an employee. Asking yourself the following questions can help:
- How much control does the worker have?
- Who provides the tools used for the job?
- How much profit, loss, and risk is involved?
- Does the worker have the ability to subcontract work or hire additional help?
Here are several important factors that define a contractor.
1. Contractors set their own terms.
Contractors decide how and when to perform the required work. They work independently, and no one is overseeing their activities. They’re free to work for different clients when they choose, and they have the ability to provide their services to different payers at the same time. Ultimately, contractors can accept or refuse work from the payer.
2. Contractors assume the financial risk and have the opportunity to profit.
Employees don’t assume financial risk in the operation of a business. They aren’t required to make capital investments, and their expenses are reimbursed. Generally, the working relationship between the employee and employer is continuous, with an assumed degree of security for the employee.
All employees of a business (except those who have contributed to the achievement of business profits and/or losses) are normally unable to realize a business profit or loss, and they generally don’t share in profits or suffer losses incurred by their employer.
If a commission-based employee earns more money due to greater productivity, those incentives aren’t viewed as a business profit.
Meanwhile, a self-employed contractor has a greater degree of control over their ability to profit from business activities or how much work they pursue. They can also negotiate the terms and payments for their work.
A contractor also doesn’t have a guaranteed stream of income. They’re also responsible for their own expenses and the fixed costs that must be covered, even when there is no work being done. Contractors could incur losses and are financially liable if they don’t fulfill the obligations of the contractor.
3. Contractors can subcontract work or hire assistants.
Contractors can hire a subcontractor to carry out or help complete work. The contractor is responsible for paying the costs for doing so, and the payer has no say in who is hired.
4. Contractors purchase and maintain tools and equipment.
Self-employed contractors supply the tools and equipment required for completing a job, such as computer equipment, hammers, or trucks. They are responsible for all repair, maintenance, and insurance costs. Since they’ve made an investment, they retain ownership of their tools and equipment.
Note: There are some situations in which an employee is required to supply their own tools—auto mechanics are an example.
However, contractors can deduct the cost of certain business expenses against their income, lowering their overall tax bill.
Some common tax deductions for self-employed contractors are:
- Accounting, bookkeeping, and tax preparation fees
- Bad debts
- Business advertising and marketing costs
- Expenses related to the maintenance of vehicles
- Meals and entertainment
- Office space
- Supplies, tools, and materials
- Subcontractor salaries
Free Guide: Tax Preparation Toolkit for Contractors and Trades
With just a little tax preparation, you can fulfill your tax obligations stress-free! Our comprehensive tax preparation toolkit will help you organize your expenses and deductions.
Learn what information and key documents you need to prepare for the tax-filing deadline. We’ve even created a printable checklist that includes all the documents business owners will need. Get the prep out of the way so you can get back to running your business.
For 70 years, we’ve focused on supporting Canadian business owners just like you, bringing you financial peace of mind and helping you hold onto more of your hard-earned money. We’ll help reduce your tax burden and support your back-office needs through affordable bookkeeping and payroll services.
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