Key tax considerations for self-employed people who become employees

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With high inflation and increased cost-of-living expenses, some advisors are noticing some of their sole-proprietor clients moving to full-time employment.

Shannon Lee Simmons, founder and certified financial planner (CFP) at Toronto-based The New School of Finance, first observed the trend in her own client base during the pandemic. Between rising expenses and the lure of a consistent biweekly paycheque, she believes the normalization of remote work and hybrid workplaces caused freelancers to take a second look at full-time employment.

“Some had the opportunity to still work from home but have a T4 employment slip for the first time,” she notes.

“There’s also a lot of decision fatigue that’s set in with self-employed clients during the pandemic. Some didn’t have a lot of bandwidth left for filing and chasing invoices, and calculating taxes. That mental and emotional load just doesn’t exist when you’re an employee.”

A steady, consistent T4 also brings group benefits and possibly an employer-sponsored pension plan or other employee-employer shared retirement vehicles such as group registered retirement savings plans or deferred profit-sharing plans.

Now that year-end tax planning is in full swing, Ms. Simmons works with these clients on issues such as HST filing, quarterly income tax instalments and calculating how much in taxes they will ultimately ow as they have a mix of self-employed and employment income.

“These clients are still on the hook for all of the same tax implications that they had up until the day they stopped earning freelance income,” Ms. Simmons says.

The first question is whether to close the sole proprietorship as soon as full-time employment starts. Ms. Simmons finds that most clients who make the move like to keep their options open and not close up shop right away.

Evelyn Jacks, founder and president of Knowledge Bureau Inc. in Winnipeg and author of Make Sure It’s Deductible, notes that if an employer lets the client work side gigs occasionally, it makes sense to leave it open and continue to file invoices and collect/remit HST.

In any case, Ms. Jacks says the clients (assuming they earned more than $30,000 in a given year) will need to continue to file HST returns for the remaining of the business’s fiscal year, even if there is a nil return. That’s part of the reporting requirements of having an HST number and it doesn’t end just because the client accepts a new job.

The same goes for keeping the business number open. “You would still have to file a tax return and report zero or reduced income,” she adds.

Deductions, expenditures and tax instalments

Clients also need to know that the deductions and write-offs to which they’re accustomed will either change or not be allowed, Ms. Jacks says.

“Many clients going from self-employed to employed will be surprised by how little they can deduct by comparison. But the trade-off is that the employer is providing the workplace, assets and usually reimbursing all the work-related expenditures,” she explains. “So, they need to keep their eyes on what their new employer is covering. Are there going to be any out-of-pocket expenditures?”

Employment expenses might be allowed to be claimed using Form T777 but only if the employer agrees and signs Form T2200. Some simplified cost claims may be allowed, Ms. Jacks says, noting advisors should consult with a tax professional.

The combination of self-employment and employment income can make things tricky. For example, while self-employed, the client would pay both the employee and employer portion of Canada Pension Plan (CPP) contributions. But that employer portion of CPP would be taken over by the new employer when employed full time. Does it work out to be enough income tax taken off? If not, a client can expect a balance due when they file their return, Ms. Jacks says.

Liisa Tatem, CFP and chartered professional accountant at Money Coaches Canada Inc. in Toronto, advises doing calculations with clients in advance on how much income taxes will be due for this year, as some taxes would have been paid directly by the client via quarterly income tax instalments, and the rest taken off the paycheque by the employer.

She provides the example of a client who stops freelancing on June 30 and starts full-time employment on July 1. The client already paid two quarterly tax instalments in March and June, but has two remaining instalments owing in September and December. Yet, now as a new employee, the client will have taxes taken off every paycheque from July to December. Should they still pay the instalments in addition to the tax taken off their paycheque?

Ms. Tatem says instalments need to be paid unless it works out that the client owes less in instalments than the Canada Revenue Agency has calculated. So, the client can opt out of paying the remaining two tax instalments or pay a smaller portion if they think their new full-time employment will take off enough taxes. But if after filing the income taxes and the client owes taxes, they can be hit with interest and penalties, Ms. Tatem says.

Finally, a client who is self-employed for any part of the tax year has until June 15 to file their income taxes. But any taxes owing would still be due on April 30 to avoid paying any interest.

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