Despite the pandemic’s influence on our approach to work, self-employment is still a preferred choice; 87% of Canadians say they would choose to be self-employed rather than forced into it. If you’re a business owner or are self-employed, there are many opportunities to minimize your tax burden, for example, expenses or write-offs. With all the freedom and advantages comes the burden of keeping track of your receipts and figuring out your tax obligations as a self-employed individual.
However, due to inconsistent and/or unreliable income, your borrowing power, aka, your net taxable income, is impacted by this. Furthermore, traditional lenders, like the banks, are not willing to acknowledge cash or additional income to include in your overall borrowing power.
Are you self-employed and finding it difficult to arrange competitively priced mortgage financing for your home? Read on to learn more about some of your options and contact our team at The Windrose Group if you’re planning to make any real estate transactions this year or in the future.
What Is the Rate of Self-Employed in Canada?
Who Qualifies as Self-Employed in Canada?
The Canada Revenue Agency (CRA) distinguishes between employees and self-employed individuals. This status determines a worker’s entitlement to benefits under the Employment Insurance Act, the Canada Pension Plan, and the Income Tax Act. Statistics Canada breaks self-employment into several categories, including people who own an incorporated or unincorporated business, farm or professional practice, or those without a business, such as newspaper carriers or babysitters. Most self-employed Canadians are a business-of-one, but about one-third employ other people.
The following are some criteria that the CRA uses to identify a self-employed individual:
- A self-employed individual usually works independently.
- The worker does not have anyone overseeing their activities.
- The worker is generally free to work when and for whom they choose and may provide their services to different payers at the same time.
- The worker can accept or refuse work from the payer.
- The working relationship between the payer and the worker does not present a degree of continuity, loyalty, security, subordination, or integration, all of which are generally associated with an employer-employee relationship.
What Are Some Advantages of Self-Employment?
The Covid-19 Pandemic in 2020, and substantial layoffs in the Tech Industry, are just a handful of events that exposed the vulnerabilities of conventional or traditional employment systems. This gave people a reason to consider alternatives, such as self-employment. The apparent advantage of this model is freedom.
The individual is free to chart their growth and work. According to a 2021 report from FreshBooks, some of the motivations cited in a FreshBooks 2021 report on Canadian Self-Employment were:
- Greater career control
- Greater fulfillment
- Financial reasons
- Family reasons
- To change careers
- For Health-related reasons
- To leave a Negative work situation
Deductibles For Self-Employed Workers
Tax Deductible expenses are necessary expenses that contribute to your business’s ability to generate income. These deductions are meant to reduce your taxable income. The deductions you’re entitled to as a self-employed worker are mentioned in Part 4 of the CRA publication T4002.
Some examples of deductions include:
- Business Operating
- Office Expenses and Home Office Expenses
- Entertainment and Business Travel
- Business Expenses
- Vehicle Expenses
The road to self-employment isn’t easy, but reports reveal it’s becoming increasingly appealing to many. Self-employment is increasingly adopted by many young professionals attracted to the independence and opportunities afforded by this model. Many factors, including the rise of non-traditional arrangements like gig work and work-from-home, also contribute to the situation.
While Canadians dream of being their own boss, what are the realities and risks at stake? Read on to learn about potential drawbacks of self-employment, and dive into Canada’s taxation model and the implications for self-employed workers.
What Are Some Considerations Of Self-Employment?
The Covid-19 Pandemic in 2020, and substantial layoffs in the Tech Industry, are just a handful of events that exposed the vulnerabilities of conventional or traditional employment systems. This gave people a reason to consider alternatives, such as self-employment. However, with all the freedom and advantages comes the burden of keeping track of your receipts, and figuring out your tax obligations as a self-employed individual
Let’s dive into a few examples a little deeper:
One of the most noted barriers for making a move to self-employment is foregoing the trappings of traditional employment, such as health and dental care benefits, insurance, and a steady, reliable paycheque
According to 40% of all potential entrepreneurs, they noted inconsistent and unreliable income as the number one concern in considering self-employment.
Every year, thousands of Canadians choose to leave the stability and security of traditional employment for what they hope will be the greener pastures of self-employment. While many of those who make the leap are largely satisfied, the path to feeling secure is a journey.
The pandemic has placed more value on the flexibility and control offered by self-employment, especially when it comes to managing other household responsibilities like childcare. We expect the trend of Canadians leaving traditional employment will continue, but the struggles of financial stress, making time for vacations, and planning for retirement are constant.
Retirement is also problematic for many self-employed. Only 56% of those business owners aged 65 and older felt they were on track to retire. In addition, 38% of all self-employed respondents say they plan to work beyond the age of 65 to make ends meet financially
Home Ownership and Borrowing Power
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Canadian Income Tax Rules On Self-Employed and Freelancers
Canada’s tax regulations cover self-employed workers and freelancers. As a self-employed individual, the Canada Revenue Agency (CRA) taxes your business income earned from a profession, trade, manufacture, or any undertaking in the nature of trade or profit.
Self-employed professionals must file a T2125 Statement of Business or Professional Activities form. If your job includes providing services to a company as a self-employed individual, the company should issue your T4A slip. This form, also known as a ‘Statement of Pension, Retirement, Annuity, and Other Income,’ covers exchanges that are not within the ambit of regular employer-employee paycheques like contract work.
Types of Self-Employed Income Verification
There are three major verification types based on the income declared:
- Traditional Income
- Non-traditional income
- Stated income
Traditional income under which regular employment income is classed can be verified via personal tax returns. This verification type would likely not work for most self-employed business owners looking to confirm their “real” income.
Here, the personal tax return is not a reflection of actual income. Rather, it’s the business’s bank statements and financial statements that can be used to verify real income. This is the category where most self-employed individuals fall. Most first-time buyer contractor mortgages fall in this category as well.
This is otherwise referred to as “no income verification mortgages.” A stated-income mortgage is one where the lender skips the income verification stage. All documents related to your finances, such as financial statements or bank statements, and tax returns, would not be checked. For instance, if your earning is commission-based, it might be difficult for you to verify your income. Rather, the lender allows you to “state” or “declare” your income.
Your stated figure would then be compared to the average income in your business or industry, and it must be found reasonable. The downside to this mortgage type for lenders is that potential borrowers may state more than what they actually earn so that they can get a larger mortgage.
This mortgage type also requires a significant down payment of up to 35%. Stated income mortgages are easier to get from B Lenders and private mortgage companies.
Note: Generally, borrowers who are able to verify using the traditional income method get the least down payment requirements and pay less in mortgage interest too. Non-traditional income confirmation requires paying extra in the way of down payment, features a higher mortgage rate, lender fees and may include mortgage default insurance as a requirement.
Stated-income mortgages come with restrictions on the property that can be purchased and feature the highest mortgage rates and a down payment of all three methods.
Depending on the lender, you may be required to provide the following:
- Personal and business credit scores
- Financial statements for your business
- Proof indicating full payments of your HST and/or GST
- Proof of principal ownership in the business
- Contracts showing previous and potential/expected revenue for the next couple of years
- Copy of GST license or Article of Incorporation proving that you are licensed or a copy of your business license
- Evidence indicating that your down payment was not a gift
Dividend income for a mortgage is allowed, as well as traditional investment income provided you are able to demonstrate a 2-year stability period as well as show a guarantee of continued income through the mortgage term.
Here are four major requirements that all lenders would typically request:
Notices of Assessment and Income Tax Statement (T1)
Dated 2-3 Years Previous
Lenders mandate submission of your Notice of Assessment and Income Tax Statement (T1) because it typically contains your entire income comprising self-employment income that is reported as business income as well as any unpaid taxes.
Unpaid taxes can cause the CRA to register a lien on your home and carry out a seizure and sales of assets if you are unable to pay off your debts.
Therefore, lenders consider unpaid taxes a red flag and would review your Notice of Assessment or T1 General income tax returns for the last 2-3 years at least to check.
Articles of Incorporation, Business Number Registration, or GST/HST Account Number
This usually provides information about the duration of time you have been self-employed or been running your business. Articles of incorporation are limited to corporations. Also, provided you make an excess of $30,000 in the most recent four quarters revenue or gross sales, you are required to have a GST/HST number.
Bank Statements from your business account, as well as your T2 Corporation income tax return (if the business is incorporated), can serve as additional proof to solidify your business income claims. Future income from signed and sealed contracts can be included as well.
Financial statements can also be used to prove business income. This is especially useful during non-traditional income verification, where you want both your personal income and business income to be considered by the lender.
Getting A Mortgage While Self Employed
Required Documents for a Self-Employed Borrower
To qualify for a self-employed mortgage, you must have held the same occupation or operated your business for a minimum of two years. Certain lenders or circumstances may require up to three years; however, the more common requirement is two years.
Similarly, you would need to present personal tax Notices of Assessment for at least 2 to 3 years prior alongside the mortgage application. Presenting this proof of income may enable you to enjoy the same products and rates enjoyed by traditional borrowers, which differs from self-employed mortgage rates.
Self Employed Mortgage Lenders
In Canada, self-employed mortgages are offered by the three major categories of mortgage lenders, namely:
- A Lenders
- B Lenders
- Private Lenders
They comprise the six biggest banks and non-bank monoline lenders. A Lenders require that prospective borrowers pass a mortgage stress test to show that they have a stable and sufficient personal income to cover debts over the length of the mortgage term. It is a way of ensuring that borrowers do not place themselves in a risky position.
Discussing the requirements for A Lenders requires highlighting the 5 C’s of credit. These are the major factors that A Lenders consider:
- Capacity: this refers to the borrower’s financial capability to combine mortgage payments with other expenses. Income is an important consideration here and your TDS is reviewed too.
- Character: for fear of sounding cliché, character is everything here too. A lender would typically review information like employment duration, how you have fared with previous payments as well as how many years you have resided at your current home. This is mainly evaluated to check for reliability and
- Collateral: assets or property that you currently own and can borrow against. The lender also considers your down payment as well as the marketing potential of the property. In the event that you default on your loan, the lender wants to know that they can recoup most of their funds from a sale stability.
- Credit: your credit report is reviewed to determine your nature towards paying back debt. Your credit score is a major determinant too, as well as how long you have managed credit.
- Capital: a simple asset minus liabilities calculation would give you your net worth or capital. This chiefly considers whether you can still be financially stable even in the light of unforeseen circumstances.
You do not necessarily have to have all 5 C’s perfect. A stronger one can possibly make up for a weaker one to an extent. For instance, if your credit score was negatively impacted by student loans or treating an illness, evidence of job stability and/or an increased down payment can mitigate the effect.
This is the next port of call for a self-employed mortgage if you are unable to meet up with the stringent criteria of A Lenders.
You would need a mortgage broker to apply for a mortgage with a B Lender. Mortgage brokers are professionals who specialize in finding the mortgage best suited to your needs and financial standing. Your broker is in the best position to and would inform you about the required documentation. B lenders provide added flexibility surrounding income confirmation and all of the 5 C’s of credit. In exchange for this flexibility, they charge slightly higher rates than A lenders do as well as charge lender fees.
This is the last resort. They have very high-interest rates (could be between 7-18%). Their activities are unregulated and as a result, getting approval is a lot easier. They typically comprise of syndicate or group investors as well as individual lenders.
Private mortgage lenders evaluate creditworthiness as well as property value. To calculate the amount of mortgage you qualify for under Stated Income Mortgage, private lenders would factor in your gross income. Generally, the requirements are less stringent, and you would be informed by the lender.
Examples of Common Challenges, and Solutions, For The Self-Employed
Incorporated showing little personal income.
- Solution? Retained earnings and net income after taxes of the corporation factored into personal qualification.
Less than two years self-employed.
- Solution? B lender using flexibility of bank statement cashflow as opposed to tax returns.
Self-employed for more than two years but incorporated less than two years
- Solution? Two-year average of net business income and dividends and/or salary reported on tax returns
Increased borrowing rates and/or slowdown in business post-covid leading to cashflow issues
- Solution? Refinance to decrease monthly mortgage obligation and relieve cashflow pressures
Renewal coming up and increased payments due to current rates could make finances too tight month to month
- Solution? A mortgage where monthly payments are interest-only. Relieves the monthly burden over the short-term until rates come back down.
Long-time salaried employee decides to move to contract employment with less than two-years history
- Solution? Evidence of working in the same industry/capacity with consistent contracts or a current long- term contract