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Self Employed Tax Nightmare

Stressed outI have seen this problem often this year. Self-employed people who end up with a much larger tax owing than they expected. They looked at their previous year's tax return and based on that, they thought it would be just a little more, but they were wrong.

The Problem

You get to year end, and find you have a huge amount of tax owing. You look toward your tax person and they ask why did you not come in to see them earlier. This all could have been avoided. Now you have to take out loans in the tens of thousands to pay Revenue Canada. It could take you years to get sorted out of this mess!

Not Linear

The key thing is that tax is not linear. It is not proportional to your income. You cannot assume that if you paid $2,000 tax on $29,000 income that you would owe about $4,000 on $60,000. It does not work that way.

A lot of important things to do with tax have a minimum threshold before they kick in, for example:

  • CPP, the first $3500 is exempt.
  • Personal income tax has a personal exemption of $9,600
  • GST does not kick in until you earn over $30,000.

So as your income increases, taxes increase in a non linear fashion.

You might have some good deductions, which means you offset your income against such deductions. But once you exceed those deductions, the tax kicks in again. And don't assume that you will be able to find the same deductions every year. For example a contractor buys tools one year and claims a deduction for them. The next year he already has those tools so does not claim a deduction again. It is important not to forget that. And don't assume your expenses will grow with your income either.

The Solution

Don't wait until year end to focus on your taxes. By then it is too late to make any adjustments. You should see your tax advisor on a quarterly basis to determine where you are at.

Together with your tax advisor, you can work out a plan to keep you on track. For example, you can submit GST on a quarterly basis, which is a common requirement. If you keep it until year end, you risk paying penalties and interest, plus there is the substantial risk that you will spend it.

You can make pre-payments towards your end of year income tax. Those people who work in a job have their income tax deducted at source, which means it is collected throughout the year. There is too much risk you will spend the money during the year and be faced with a huge bill at year end. Your tax advisor can help you decide on how much to pre-pay.

So go talk to your tax advisor and set up a schedule today...


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