Income Taxes: Consultant (Self-Employed) vs. Payroll Employee

Written by Bryan Daly
Fact-checked by Caitlin Wood

Income Taxes: Consultant (Self-Employed) vs. Payroll Employee

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Gig Workers Income Tax Tax

No matter what you do for a living, one thing is sure. Eventually, you will have to pay taxes on the income you earn throughout the year. Typically, the more money you make, the higher your annual income tax bill will be. However, your tax return will also be greater and you may even be eligible for some benefits that others aren’t. 

That said, what some taxpayers might not realize is that you’ll have to file a different tax return if you’re not an employee of a traditional business. In fact, if you’re a consultant, freelancer, or another type of contract worker, paying your income taxes may be a bit more complicated. 

Are You A Consultant Or A Payroll Employee?

As mentioned, there are a few significant differences between paying taxes when you’re self-employed and when you’re on a company’s payroll.

For instance, paying taxes is a bit easier for the average full or part-time payroll employee because their employer will simply deduct a portion of their bi-weekly paycheck and send it to the Canada Revenue Agency on their behalf. Afterward, the employee only needs to file their T4 slip and wait for their return. 

On the other hand, consultants and other self-employed individuals must monitor their own earnings and figure out exactly how much they owe the CRA per annum. In turn, they must have the appropriate funds set aside when tax season rolls around, rather than having their income deducted in automatic installments. 

What To Consider

According to the CRA, these are the 4 key components you would use to determine whether you qualify as a consultant or payroll employee:

• How Much Control You Have – If you’re a payroll employee, you would have a traditional employee-employer relationship with your boss and, as a result, you’ll have very little control over how much you earn or what you pay in taxes. As a consultant, however, you get to work as little or as much as you desire and set your own rate, so the size of your income tax bills will often fluctuate.
• Who Provides The Tools of the Trade – As a payroll employee, your employer should be providing any training, supplies, and equipment you use on the job, as well as dealing with any associated costs and taxes. If you’re an independent contractor, you’ll generally need to finance, insure, and repair all your own tools, the costs of which you might be able to deduct on your taxes. The same can be said about your meals and other business expenditures, such as vehicle-related costs, utilities, and resources. 
• How Much Profit, Loss & Risk is Involved – When you’re an independent contractor, not only will you be responsible for declaring your income, you’ll also be liable for any debts you’ve accumulated or investments you’ve made. As a payroll employee, on the other hand, any profits, losses, and risks the business takes on are the sole responsibility of your employer. 
• Whether You Can Subcontract Work or Hire Additional Help – Another area where you’ll have less control as a payroll employee is who you work with. Although you can always recommend a friend or family member for a job at the same company, they may not work for or with you. However, if you’re a consultant, you can subcontract extra work and hire any assistants you want, at the optional expense of whoever is paying you.

The Advantages Of Being A Consultant And A Payroll Employee

Now that you’re able to figure out if you qualify as a consultant or payroll employee, let’s talk about some of the personal and financial advantages that come with both statuses, whether they relate to taxes or not:

Advantages – Consultant 

• On average, you can make more money per year (your income is not fixed) 
• You have more flexibility on and off the job (rate, hours, time off, etc.)
• You can subcontract additional work and hire whoever you want
• You have full control over your business and its budget

All this said, being a consultant may have more disadvantages than being a payroll employee because you won’t qualify for any sort of medical or financial benefits, including job security. If and when your payer needs to make cutbacks, your contract will probably be one of the first to go, while a payroll employee can file unemployment.

Advantages – Payroll Employee

• You may be eligible for job security, paid vacation time, and other benefits
• You generally have a guaranteed income 
• Your employer makes half your EI and CPP contributions for you
• You are not responsible for any debts or losses your employer incurs

As mentioned, perhaps the main disadvantage of being a payroll employee is that you’ll have less flexibility in terms of how much income you’re making, what hours you work, and who you work with. You also have less control over how much you’ll pay in taxes and how large your return will be every year. 

Check out these tax tips for independent contractors and gig workers.

How Much Money You Should Set Aside For Taxes As A Consultant

Remember, if you’re an independent contractor, your taxes won’t automatically be deducted from your paycheck throughout the year, so you must save up as much money as possible before the next tax season arrives. 

Although the specific amount you need will fluctuate according to how much revenue you pull in, it’s recommended that you save up at least 25% of your total earnings. You can also get a basic estimation by finding out which tax bracket you fall into.

Your Federal Tax Rate, According To Your Tax Bracket

Here’s a quick look at the federal tax rates and brackets for 2021:

• On the first $49,020 of taxable income = 15%
• On the next $49,020 (the portion over $48,535 & up to $98,040) = 20.5%
• On the next $53,938 (the portion over $98,040 & up to $151,978) = 26% 
• On the next $64,533 (the portion over $151,978 & up to $216,511) = 29%
• On taxable income over $216,511 = 33% 

The Tax Advantages And Disadvantages Of Being A Consultant

These days, the vast majority of Canadian workers would still qualify as payroll employees. Then again, the last few years have seen a significant surge in the realm of self-employment, especially in the months following the COVID-19 pandemic. 

So, if you’re thinking about taking on some independent contract work or starting your own business entirely, it’s also essential to be aware of the main tax advantages and disadvantages that are associated, such as the ones below:

Advantages

• It’s possible to deduct certain business expenses (utilities, resources, etc.)
• You can claim the depreciation of your fixed assets and other losses
• You might make more income and earn a better tax return

Disadvantages    

• Your final tax bill can be larger than that of a payroll employee
• You have to file any returns, deductions, or claims by yourself 
• You have to pay your own employer and employee contributions toward Employment Insurance (EI) and Canada Pension Plan (CPP) 

How To File Your Taxes As A Consultant 

In the end, there are both benefits and drawbacks that come with paying taxes as an independent contract worker. Although you’ll have to file all the necessary paperwork on your own, the process is relatively simple. Here’s how you get started:

Complete Form T2125 

The first thing you must do is fill out Form T2125, otherwise known as a Statement of Business or Professional Activities. This form will help you to declare any income and expenditures you made from self-employed commission sales. On it, you will find various spaces to identify things like:

• The details of your business and partners, if any (names, addresses, etc.)
• Your main sources of income (professional, business, etc.)
• The cost of goods you sold and gross profit you made 
• Your net income losses before and after adjustments 
• Your business expenses (equipment, building additions, etc.) 
• The details of your equity/assets (land, vehicles, etc.) 
• Your Capital Cost Allowance claim (CCA)
• The penalties and/or interest your assets have incurred (CCP, EI, etc.)

Before you get started, keep in mind that the exact documentation you’ll need to file during tax season will differ according to how much income you’re earning, as well as the general financial state of your business. 

It’s Never Too Early To Get A Jump Start On Your Taxes 

While you may have just finished paying your federal income taxes, it’s good to have an idea of what your income and employment situation will be like when the next fiscal year comes to an end. If you’re having trouble with this, it may be wise to speak with a certified professional so you can pay your tax bill without a hitch.