Setting Aside for Taxes or RRSP?

[IronMac]

Hi all,

Suppose you're working as an independent contractor and are paid straight cash with no deductions for CPP, EI and income taxes. Would it be better if you were to sock away a certain percentage out of each paycheque for such deductions when it comes time to do your taxes or would it be more beneficial to place the same amount into your RRSP?

I realize that you will have to pay for the CPP and EI deductions at the end of the year but what about the taxes?

Thanks!

[Justin C]

If you put "the same amount" into an RSP you will still owe taxes at the end of the year, plus 9.9% CPP and no EI.

[IronMac]

Thanks for the quick response, Justin! So...three "buckets" then? Taxes, RRSP and CPP?

[Bullseye]

No EI for contractors, but double the CPP, as Justin said.

Up to you how you want to do it. If you have a mortgage, this would be a good place for one of the open mortgages (ie. Manulife One or similar), you could apply the Tax/CPP money against the mortgage now, then pay it out from there the following year. That would beat sticking it in a savings account, where you'd be taxed on the interest.

[TopTaxGuy]

If I understand your question directly, you are paid by your clients and you want to know how to handle the taxes you will pay at year end.

Here is what I suggest:

• Open a high interest savings account!
• Estimate the amount of taxable income you expect to have this year.
• Then estimate the amount of federal tax, provincial tax, and CPP you will need to pay on your estimated income. To estimate your taxes you can use a simple payroll calculator at www.cantax.com (http://www.cantax.com).
• Add 5% to 10% to your estimate for a contingency.

Divide the estimated tax into your estimated taxable income to get your average tax rate.

From each pay you receive, deduct the percentage calculated and put it into the high interest savings account.

You'll earn interest on the funds you have socked away for taxes and don't have to worry about a large tax bill at the end of the year. You should have enough cash on hand for the tax bill and thus avoid interest and penalties if you've come up short.

As a contractor or self-employed individual you do not have to file your return until June 15th, but your taxes are still due and payable April 30th. See When are returns due in Canada? (http://taxresource.ca/rates_stats/taxfilingtimelines.html)

[pitz]

The CRA will put you on quarterly payments next year if you end up owing them a crazy amount of money this year.

Depending on your circumstances, you may wish to consider incorporation as an alternative to paying CPP and other deductions on your income, and corporations enjoy lower tax rates on their investments, and have the ability to set up IPP (individual pension plans) which have certain advantages over T4'ing the money to yourself and contributing to a RRSP. Talk to an accountant for more information.

There may also be certain legal advantages as well to being incorporated.

[dutchca]

The CRA will put you on quarterly payments next year if you end up owing them a crazy amount of money this year.

Depending on your circumstances, you may wish to consider incorporation as an alternative to paying CPP and other deductions on your income, and corporations enjoy lower tax rates on their investments, and have the ability to set up IPP (individual pension plans) which have certain advantages over T4'ing the money to yourself and contributing to a RRSP. Talk to an accountant for more information.

There may also be certain legal advantages as well to being incorporated.

Hey Pitz - are corps not taxed at a higher rate on investments - non-active business income is not eligible for the SBD, therefore taxed at a rate higher than most marginal personal tax rates?

[pitz]

Hey Pitz - are corps not taxed at a higher rate on investments - non-active business income is not eligible for the SBD, therefore taxed at a rate higher than most marginal personal tax rates?

I don't know about Corporate taxes -- but if you have an active business, ie: not just an investment corporation, AFAIK, you can earn some investment income and have it taxed at lower rates.

Doctors, lawyers, engineers, and other professionals incorporate all the time for various reasons -- run some numbers by an accountant, heck, spend $1000 to have an accountant do your tax return this year, and get some advice.

[IronMac]

Thanks everyone for the info! :)

Guess I may have to talk to my CGA friend about this after all...

[Jucius Maximus]

Suppose you're working as an independent contractor and are paid straight cash with no deductions for CPP, EI and income taxes. Would it be better if you were to sock away a certain percentage out of each paycheque for such deductions when it comes time to do your taxes or would it be more beneficial to place the same amount into your RRSP?

When I was an independant contractor, I socked away money every month AND put a little into the RRSP. This gave me a nice little bonus at the end of the year because I had an excess after paying my taxes.

[Piccolo]

The CRA will put you on quarterly payments next year if you end up owing them a crazy amount of money this year.

Depending on your circumstances, you may wish to consider incorporation as an alternative to paying CPP and other deductions on your income, and corporations enjoy lower tax rates on their investments, and have the ability to set up IPP (individual pension plans) which have certain advantages over T4'ing the money to yourself and contributing to a RRSP. Talk to an accountant for more information.

There may also be certain legal advantages as well to being incorporated.

$3000 owing in tax for the current year and any two proceeding years.
If you can keep your tax owing less then $3000 then you wont be put on instalments.

This is an interesting thread - I have never been self-employeed or a contract worker so haven't had to think about methods of tax deferral. I would suggest RRSP because its the only thing (that i know of) that decreasing your net income i.e. your taxable income. Also, estimate how of the contribution you wll owe for CPP etc. and makes sure you are not in a tough spot when it comes time to pay it.

I applogize for my ignorance with this subject. I am in the learning processes and trying to get as much insight and infomation as I can.

So based on my limited knowledge I suggest to do both.
Contribute to RRSP and set aside $ for CPP.

I agree with the comments to higher an accountant.

[Jucius Maximus]

$3000 owing in tax for the current year and any two proceeding years.
If you can keep your tax owing less then $3000 then you wont be put on instalments.

Weird, I had to pay about $8K in 2006 and I was not put on installments in 2007.

[Piccolo]

Weird, I had to pay about $8K in 2006 and I was not put on installments in 2007.

If you estimate that you will be paying more then $3000 this year (2008=current year) even if you didn't pay more then $3000 in 2007 then you will definitely need to pay your tax liability as instalments. You might get a letter "suggestion" it or you might get a letter "demanding it" or perhaps you wont get a letter at all. I would really find out about this asap. First instalment fee is due Mar 15th.
There are different methods of calculating your instalement payments.

http://www.cra-arc.gc.ca/tax/individuals/topics/income-tax/payments/instalments/menu-e.html

Under proposed changes, you have to pay your income tax by instalments for 2008 if your net tax owing (see the definition below) is more than $3,000:
in 2008; and
in either 2007 or 2006.
Quebec resident - If you live in Quebec on December 31 of a year, use a limit of $1,800 instead of $3,000 for that year.

Farmers/Fishers - Different rules apply if your main source of income in 2008 is self-employment income from farming or fishing. For details, see Farming and fishing.

Net tax owing - In general, this is the amount you owe on your tax return. The items used to calculate net tax owing are listed in the Calculation chart for instalment payments.

[Jucius Maximus]

If you estimate that you will be paying more then $3000 this year (2008=current year) even if you didn't pay more then $3000 in 2007 then you will definitely need to pay your tax liability as instalments. You might get a letter "suggestion" it or you might get a letter "demanding it" or perhaps you wont get a letter at all. I would really find out about this asap. First instalment fee is due Mar 15th.
There are different methods of calculating your instalement payments.

http://www.cra-arc.gc.ca/tax/individuals/topics/income-tax/payments/instalments/menu-e.html

Thanks for the info. Looks like I won't have to do installments because my situation has changed and I expect to be getting refunds again for 2007 and 2008.

[Piccolo]

Thanks for the info. Looks like I won't have to do installments because my situation has changed and I expect to be getting refunds again for 2007 and 2008.

Thats good news.

[Pavel]

What about in the situation where you end up owing CRA the same amount, say $3000? I did a calculation for a friend and she would have to buy $12,000 in RRSPs not to owe.

Would it be better to pay the $3000 and keep the $9000 in a contingency fund?

[IronMac]

When I was an independant contractor, I socked away money every month AND put a little into the RRSP. This gave me a nice little bonus at the end of the year because I had an excess after paying my taxes.

That's what I've decided to do. I'm going to put 20% of each cheque into a new Cash Optimizer account over at E*Trade and shunt a small sum into my RRSP. The 20% may not cover all of my taxes but I'm hoping that as my financial situation improves I can either up that to 25% or increase my RRSP contributions.