The transition from employment to independent contracting does not come with an instruction manual. Your first T4 as an employee covered deductions automatically: income tax withheld at source, CPP contributions split with your employer, EI premiums deducted each pay period. When you go independent, all of that becomes your responsibility to track, plan for, and remit.
The first year is when most of the consequential decisions happen. GST/HST registration, incorporation timing, quarterly instalments, expense setup. These decisions do not wait until tax season. Several of them need to happen within weeks of your first contract.
This article covers what to set up, what to track, and what to file in your first year as an independent IT contractor in Canada.
Registering with CRA
When you start earning business income, you are carrying on a business. That income is reportable from the first dollar, regardless of whether you have incorporated. The GST/HST registration threshold is a separate rule.
Business number. If you are operating as a sole proprietor, you may already have a business number through your GST/HST registration (covered below). If you incorporate, the corporation has its own business number, separate from you personally. You do not need to register separately for a business number as a sole proprietor unless you are also registering for GST/HST, payroll, or an import/export account.
GST/HST registration. You are required to register for GST/HST once your worldwide taxable supplies exceed CAD $30,000 in a single calendar quarter, or over four or fewer consecutive calendar quarters. The timing matters. If you exceed the threshold in one calendar quarter, your effective registration date is no later than the supply that made you exceed CAD $30,000. If you exceed it over several quarters, you generally stop being a small supplier at the end of the month after the quarter in which you crossed the threshold. The $30,000 threshold is low enough that most IT contractors reach it quickly once they start billing.
You can also register voluntarily before reaching the threshold. Early registration lets you charge and collect GST/HST from clients and claim input tax credits on eligible business expenses. Whether to register voluntarily depends on your clients: if they are GST/HST-registered businesses, they can claim the GST/HST you charge as an ITC, so the tax is neutral to them. If your clients are individuals or non-registered small businesses, charging GST/HST adds cost they cannot recover.
Most IT contractors working with corporate clients register for GST/HST promptly in the first year, either voluntarily or because they cross the threshold within a few months of starting. Once registered, you charge GST/HST on invoices, collect it from clients, and remit the net amount (GST/HST collected minus eligible ITCs) to CRA on your reporting schedule. Keep a separate record or account for GST/HST collected. It is not your income.
For contractors in Quebec, QST registration is a separate consumption tax registration administered by Revenu Québec. The $30,000 small supplier threshold applies to QST as well.
The incorporation decision
One of the first questions new contractors face is whether to incorporate. The answer depends on your income level, your plans for the business, and your personal tax situation. There is no universal correct answer, but there is a correct time to think through it: before the first contract, if possible, or in the first few months of operating as a sole proprietor.
For most Canadian-resident owner-managed IT contractors, incorporation creates a Canadian-controlled private corporation (CCPC) that earns the contracting income. CCPC status depends on control and share ownership, so it should be confirmed where there are non-resident shareholders, public-company ownership, or unusual rights attached to the shares. A qualifying CCPC may pay corporate tax at a lower rate on up to the first $500,000 of active business income through the small business deduction. Surplus after corporate tax can be retained inside the corporation for future distribution or investment, or paid out as a combination of salary and dividends.
Operating as a sole proprietor is simpler and cheaper to administer. All income flows directly to your personal T1 return and is taxed at your marginal personal rate. There are no corporate filings, no T2, and no separate accounting for a corporate entity.
The trade-off is deferral. A contractor earning $150,000 and spending $80,000 personally each year does not need all the income immediately. Incorporating allows the excess to sit inside the corporation, taxed at a lower rate, until it is needed. That deferral compounds over time.
The PSB risk is a countervailing consideration. CRA can reclassify a corporation as a personal services business if the contractor would reasonably be considered an employee of the client but for the corporation. A PSB loses access to the small business deduction and most business expense deductions. The risk is higher for contractors with a single client and limited independence in how they work.
The sole proprietor vs. corporation comparison and the should I incorporate article cover the decision in detail. The first year is often operated as a sole proprietor while the incorporation decision is being assessed.
Setting up bookkeeping from day one
The books you keep in the first year form the foundation for every filing you will do. Starting clean is significantly easier than reconstructing records later.
Separate your business and personal finances. Open a dedicated business bank account and use it exclusively for business deposits and expenses. This is the single most useful step you can take in the first year. A mixed personal/business account requires reconstructing which transactions were business at year-end, which is time-consuming and error-prone.
Record every invoice issued. Each invoice should include your name or business name, the date, the client name, a description of services, the amount, and any applicable GST/HST. Keep a copy of every invoice in a consistent location.
Record every expense. Track all business expenses with receipts. Home office, phone and internet, professional development, software subscriptions, professional dues, and accounting fees are all potentially deductible. The deductibility of each expense depends on whether it is incurred to earn business income and whether it is reasonable in the circumstances.
Use accounting software from the start. QuickBooks, Wave, or a similar tool makes it easier to categorize transactions, track GST/HST separately, and produce reports at year-end. Setting it up in month one is straightforward. Setting it up in April after a year of unrecorded transactions is not.
Quarterly instalments
In employment, income tax is withheld from each pay period, and CPP is split with the employer. As a contractor, there is no withholding. Once the instalment rules apply, CRA expects tax to be paid throughout the year rather than all at once when you file.
Quarterly tax instalments are payments due on March 15, June 15, September 15, and December 15. CRA requires instalments when your net tax owing exceeds CAD $3,000 in the current year and in either of the two preceding years. For Quebec residents, CRA uses a CAD $1,800 federal threshold, and Revenu Québec has a separate provincial instalment system.
In the first year, most new contractors do not yet have a prior-year tax liability, so the technical requirement to pay instalments may not apply. However, if you expect to owe tax at filing, setting aside money throughout the year is still prudent. A large tax bill due in April, covering a full year of self-employment income, is a cash flow problem for anyone who has not planned for it.
In the second year, if you owed more than $3,000 in the first year and expect to owe more than $3,000 again, CRA may send instalment reminders. At that point, instalments may become mandatory. The instalment amounts can be based on CRA’s reminder amounts, the prior year’s tax liability, or an estimate of the current year’s liability. Your CPA will help you determine which method applies and what amounts to pay.
If instalments are required and not paid on time, CRA charges instalment interest and may also impose instalment penalties. These are avoidable with planning.
Mixed T4 and self-employment income in year one
If you left employment mid-year, your year-one T1 will include both T4 income (from your employer) and self-employment income (from your contracting). This is common and has a few practical implications.
Your employer withheld income tax based on your expected full-year employment income. That estimate was based on your employment salary, not on your total income for the year including contracting revenue. If your contracting income is substantial, you may owe additional tax at filing that your employer’s withholding did not cover.
CPP contributions work differently for employed and self-employed income. As an employee outside Quebec, you and your employer each contributed CPP up to the annual maximum. As a self-employed person outside Quebec, you pay both the employee and employer portions of CPP on net self-employment income. In a year where you have both T4 income and self-employment income, the CPP calculation on your T1 takes both into account. Quebec residents have a parallel QPP calculation under Quebec rules.
EI premiums are not payable on self-employment income unless you opt into the self-employment EI program for access to special benefits. Most IT contractors do not opt in.
Expense categories to track
Deductible business expenses reduce your taxable income. The rules differ slightly between sole proprietors and incorporated contractors, but the categories are broadly similar.
Home office expenses. If your home is your principal place of business, or you use a workspace only to earn business income and use it regularly to meet clients, you may be able to deduct a reasonable portion of home costs. For sole proprietors, eligible expenses can include rent or mortgage interest, utilities, property taxes, insurance, and maintenance. Business-use-of-home expenses cannot create or increase a business loss, and claiming CCA on a home can create principal-residence and recapture issues.
Phone and internet. The portion used for business purposes is deductible. Track a reasonable business-use percentage and exclude personal use.
Professional development. Courses, conferences, certifications, and technical books directly related to your contracting work are generally deductible.
Software and subscriptions. Development tools, cloud services, productivity software, and any subscription used in the business are deductible business expenses.
Professional dues and insurance. Memberships in professional associations and professional liability insurance premiums are deductible.
Accounting and legal fees. Fees paid to your accountant for business tax preparation and to lawyers for business-related legal work are deductible.
Equipment. Computers, monitors, peripherals, and other equipment used in the business are typically claimed through Capital Cost Allowance (CCA) rather than as a direct expense in the year of purchase. CCA allows you to deduct a portion of the equipment’s cost each year over its useful life.
CRA expects that each deduction claimed is supported by a receipt or invoice and was incurred to earn business income. Maintaining organized records throughout the year is more straightforward than reconstructing them at filing time.
What year-end looks like: T1 with business income
For sole proprietors, year-end means preparing a T1 personal income tax return that includes Form T2125 (Statement of Business or Professional Activities). Form T2125 summarizes your gross business income, deductible expenses, and net business income. The net business income flows into the T1 calculation alongside any other income for the year.
Self-employment income also has CPP or QPP implications. Outside Quebec, net self-employment income over the basic exemption ($3,500 annually) is subject to CPP contributions. Both the employee and employer portions are calculated on your T1 and form part of the tax owing at filing. This is often the largest surprise for first-year contractors: the effective CPP obligation on self-employment income is roughly twice the amount deducted from an employee’s pay. Quebec residents have a parallel QPP calculation.
The tax filing deadline for self-employed individuals is June 15. However, any tax owing is still due on April 30. Filing by June 15 with an April 30 balance avoids the late-filing penalty but does not eliminate interest on any unpaid balance after April 30.
For incorporated contractors, year-end involves a T2 corporate return for the corporation (due six months after the corporation’s fiscal year-end) and a T1 personal return that reports salary and dividends received from the corporation. The two returns interact with each other through the compensation decisions made during the year.
PSB risk from the start
The personal services business rules apply to incorporated contractors who are functionally employed by a client despite contracting through a corporation. A PSB determination by CRA results in loss of the small business deduction and most business expense deductions.
The factors CRA considers include whether the contractor works exclusively or primarily for one client, whether the client directs and controls how the work is done, whether the contractor could substitute another person to do the work, and whether the contractor has integration into the client’s business rather than operating as an independent entity.
For most IT contractors in the first year, the PSB risk is real. A single large client, on-site work with client hardware and tools, set hours, and limited other business activity all increase the risk profile. The PSB risk article covers the factors CRA assesses and what steps reduce exposure.
Understanding the risk in year one, before the corporate structure has been running for several years, allows you to structure engagements more defensively. The analysis is not about whether you are legally independent. It is about whether the working relationship, if examined by CRA, would support or undermine that characterization.
Related Articles
- Should I Incorporate as an IT Contractor? covers the incorporation decision in detail, including the tax deferral benefit, the PSB risk, and the administrative cost of running a CCPC.
- Sole Proprietor vs. Corporation for IT Contractors compares the two structures side by side across tax rate, cash flow, flexibility, and long-term planning.
- GST/HST Registration for IT Contractors covers when registration is required, the voluntary registration decision, and how to handle GST/HST on invoices.
- Quarterly Tax Instalments for IT Contractors explains how instalments are calculated, when they are required, and how instalment interest and penalties work.
- Personal Services Business Risk for Incorporated IT Contractors covers the PSB rules, the factors CRA assesses, and the consequences of a PSB determination.
Scope of This Article
This article covers the tax and compliance considerations for IT contractors in their first year of independent work in Canada. It does not cover:
- Quebec-specific rules for QST registration, TP-1, or CO-17 filings
- The legal mechanics of incorporating or choosing a corporate structure
- US tax obligations for contractors with US-based clients
- Detailed CPP contribution calculations for mixed employment and self-employment income
- The employment expense rules that apply in employee situations
The first year is where habits form. Books set up correctly from the start, GST/HST tracked from the first invoice, and instalment obligations understood before the second year begins will produce a cleaner filing experience than reconstructing records after the fact.
Get in touch if you are starting out and want to understand what structure and setup makes sense for your situation.