Your Income Sources Determine your Taxes

Income Sources

A taxpayer might earn his money from many income sources and so the amount of taxes that he pays will depend a great deal on these sources.Income will generally fall into one of the categories listed below.

  1. Income from employment including self employment
  2. Income from business
  3. Income from property
  4. Capital gains
  5. Income which does not fit into the other categories e.g. pension, employment benefits, grants, alimony, etc.

Employment income is paid to you in the form of wages, or salaries by a person or company, for services rendered. The employment may be part-time, full-time or casual. The company is required to withhold and remit taxes, Canada Pension and employment insurance premiums, to the government on your behalf. At the end of the year the employer issues a T4 or statement summarizing the total income and deductions made. For most Canadians employment is their main source.

A self-employed individual usually has a skill or profession or a sense of business which they want to use to earn a living. He may choose to work under his own name or under a trade name. He assumes full responsibility for all administrative duties including payroll and marketing, as well as getting the work done and is responsible for remitting his own taxes and Canada Pension premiums.

Despite the extra work, being self-employed has many benefits. In addition to having total control, the self-employed individual is allowed to claim more deductions than the average employed individual. Income is reported as net income as derived from a prepared income statement.

Benefits include the potential for unlimited income, opportunities to income split with family members and the advantage that losses can be applied against other income.

Although the vast majority of individuals still work in a regular job, today an increasing number of people, including the employed, are venturing into the ranks of the self-employed and establishing all kinds of businesses.

Are you self-employed or an employee? The term self-employed is very often misunderstood; a misunderstanding which has caused a lot of grief for some taxpayers. The government uses several criteria to make this determination. Ultimately, it boils down to who has control.

Do you have control over your time? Do you dictate how and how much you get paid? Do you have many clients or do you depend exclusively on one client? Who provides the tools that you use? Does the job have a specified time when it ends? Does your client remit taxes and Canada pension on your behalf? what are your income sources? Do you have more than one income source independent of the company?

Sometimes CRA may challenge your claim for self-employment. Careful documentation of all your transactions and a clear understanding of your conditions of employment are necessary to substantiate your claim.

A fairly well publicized case involving a well known company illustrates how costly this misunderstanding can be. Some years ago, the company was in the practice of employing individuals as independent contractors to do its installations and service calls. The individuals were required to sign an agreement stating their independent status and that they were responsible for all taxes and pension remittances on their own.

At the end of the year the company would issue a T-slip and the contractors would declare the income as independent contractors and claim the associated deductions. In reality however,it was determined that the company had substantial control over the contractors.Not only did they dictate the hours of work and schedule each job,they provided all the materials to complete the job. The contractors worked regular hours and had to be always available when needed. The level of compensation paid was determined by the company.

The CCRA disagreed with the self-employed status and the contractor agreement and ruled that the individuals were employees. Significant penalties and fines were imposed on the firm for not remitting the taxes and other deductions as required by law. Furthermore the deductions were disallowed and the "independent contractors" found themselves owing the government thousands of dollars in taxes plus interest. Claims made in previous years were also reversed.

Ironically, the individuals may have been allowed the deductions, as employees, if only the company had not refused to sign a Declaration of Conditions of Employment outlining the expenses eligible for deductions.

Self-employed and Business Income

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