Taxes and the self-employed worker: avoid these 5 pitfalls and save money

Optimize your retirement savings while avoiding unwanted surprises on your taxes.

By Dominique J. Favreau

Personal finance blogger

Self-employed workers have a very different financial reality from salaried workers, which means they need to develop personal financial management strategies tailored to their specific needs. If you've chosen to be your own boss, a good understanding of tax rules can help you maintain healthy finances. For instance, did you know that there are specific tax deductions for self-employed workers? Taking advantage of them can help you optimize your ability to save for retirement and other projects. To make the job easier, here are the main pitfalls to avoid from a tax perspective.

01Neglecting available deductions

By not taking advantage of all the tax deductions available to them, some self-employed workers risk leaving a lot of money on the table. Keep in mind that you can reduce taxes on the money you make by deducting a number of expenses from your income.

You can deduct, for example, all kinds of expenses from office supplies to telecommunications charges to the dues you pay to a professional order. And that’s not all! Dinners you purchase when courting new customers, travel costs, registration fees for conventions or skills-building seminars, they are all expenses that can be used to lower your taxable income. Even the bad debt of your clients can be deducted…

However, you should take care to deduct only the expenses you need. In fact, by lowering your net income by deducting expenses, your RRSP contribution room or any social benefits you receive one day can be reduced as well. For example, by making insufficient contributions, you may not get the most from your employment insurance benefits, or you may be subject to a reduction in your Quebec pension (QPP) benefits when you retire.

02Forgetting to reduce your taxable income with RRSP contributions

Just like salaried workers, as a self-employed person you can benefit from tax savings when you contribute to an RRSP. Tax refunds are hardly negligible and can be very helpful for increasing your income or putting aside money as a safety cushion. For instance, if your annual income is $60,000, by contributing $5000 to your RRSP, you can save 36.1% on your combined federal and provincial taxes. You’d get back over $1,805 while saving for your retirement1.

Self-employed workers do not have access to a company pension plan unlike some salaried employees. Instead, they need to take care of planning their retirement themselves. By optimizing your RRSP deductions, you can start benefiting from your tax savings today in addition to saving money for retirement.

The benefits of automatic savings

Automatic savings through automatic bank withdrawals, can be a convenient way to reach your financial goals. By regularly contributing a set amount to your RRSP, you gain peace of mind knowing that you're saving for retirement without putting strain on your finances.

Start with the smallest amount you can manage (e.g., $50 a week). You can then modify that figure according to your needs and circumstances. Since RRSP contributions are tax-deductible, you can count on an eventual tax refund: in other words, that $50 a week will end up costing you less. Plus, you'll get into the habit of saving without even trying!

03Not balancing your income with your QPP and RRSP contributions

It’s inevitable. As soon as you have income, you have to pay tax and make contributions. Of course, making more money means being able to save more money! To make the most of your retirement savings efforts, you need to keep everything in balance. Making contributions to the QPP now lets you benefit from a stable and predictable pension later, no matter what the markets do.

Of course, if you are self-employed the contributions can be quite high, as you will need to cover both the employee and employer portions. Given this fact, you might be tempted to withdraw only dividends as income, rather than a salary, to avoid having to contribute to the QPP. But that may become less attractive when you consider how only drawing a salary gives you the right to make contributions to your RRSP equal to 18% of income (up to a maximum of $31,560 in 2024). So you’d actually be reducing your capacity to save on your tax bill!

Depending on your income and your retirement plans, it can be to your advantage to pay yourself a salary to accumulate this RRSP contribution room for the year, while making contributions to the QPP. You’ll be able to secure a stable, predictable pension for yourself from the QPP which will be complementary to your RRSP upon retirement. You can increase the remainder of your income by paying yourself dividends instead, thus paying less tax on this portion of your income. Your personal situation and goals are unique, so your tax strategy should be unique too! You can’t go wrong by talking it over with your financial advisor.

04Neglecting to recover the sales tax

All self-employed workers who generate over $30,000 in sales over four consecutive quarters must register for the PST and GST with Revenu Québec and collect these sales taxes. If your sales are less than $30,000, you’re not obligated to do so but, if you do, you can enjoy some great benefits. In fact, when you collect the taxes on your sales, you don’t just simply pass them along to the government, you also get a chance to claim tax credits and refunds.

By getting together all your expenses on which you paid taxes, you can calculate your input tax refund (ITR) which Revenu Québec will reimburse you. You can do the same for the federal government which will give you an input tax credit (ITC). By adding the two together, you’ll save close to 15% on all the business purchases you make all year long.

05Failing to set aside a financial cushion and paying interest instead of earning it

It’s a well-known fact that self-employed workers’ incomes can fluctuate enormously over time. Also, unexpected expenses can crop up, like bad debt or a tax balance owing. So it’s important to set aside savings for a rainy day, while continuing to meet your obligations. This way, you can always dip into your emergency fund instead of resorting to your credit cards or line of credit, or paying your tax balance late and getting hit with interest charges. Better yet, you can generate interest on your savings, for example, by placing them in a high-interest savings account until the time arises when you need them.

That way you’ll enjoy the peace of mind of always being able to pay your bills even if you experience a dry spell, and thus avoid debt, all while growing a portion of your assets.

There’s no question that for the self-employed worker taxes can be quite a burden. To make them simpler and to avoid unpleasant surprises, many people prepare for the big event throughout the year, organizing documents regularly, like invoices, receipts and instalment payments made. In this way you can take a load off your mind while avoiding tax traps, maximizing your savings and, most of all, not getting caught unprepared if ever you do undergo a tax audit!

  • Example for the 2024 taxation year, based on a person with a $60,000 taxable annual income with a marginal tax rate of 36.1%. These amounts are estimates that could vary depending on your taxation status.

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