The year you leave employment and start contracting, both income types land on the same T1. Employment income reported on a T4. Self-employment income from your contracting work reported on Form T2125. Some clients may also issue a T4A for the fees they paid you.
Filing a return with all three is straightforward once you understand how each piece fits. The complication is that your employer’s withholding was calculated based on your employment income alone. It did not account for the contracting income you earned after leaving. The gap between what was withheld and what you owe at filing is the part that surprises most contractors in year one.
What the T4 Covers
Your employer issues a T4 for the period you were employed. Box 14 reports your employment income. Boxes 22 and 16 (or 17 for Quebec) show the income tax and CPP contributions (or QPP in Quebec) withheld. Box 18 shows EI premiums deducted.
The withholding amounts were calculated by your employer based on an annualized projection of your employment income. If you left in March, your employer annualized your salary and calculated withholding accordingly. That projection did not include the contracting income you earned afterward.
At filing, all income is combined. The combined income determines your actual tax liability. The amount withheld on the T4 is credited against that liability. The difference is what you owe.
What T4A Box 048 Means
A T4A is a Statement of Pension, Retirement, Annuity, and Other Income. Box 048 specifically covers fees for services. When a client pays a self-employed contractor more than CAD $500 in a calendar year, CRA expects the payer to issue a T4A and report the amount in box 048.
A few things to understand about T4A box 048:
It is not withheld income. Unlike a T4, a T4A often does not show deducted tax. The service-fee amount is reported, excluding GST/HST or PST. No withholding was made on your behalf unless box 022 shows income tax deducted.
Your income may exceed what the T4A shows. Some clients do not issue T4As, or issue them late or inaccurately. The T4A is a reporting obligation on the payer’s side. Your obligation to report income does not depend on receiving a T4A. All contracting revenue earned in the year must be reported, regardless of whether a slip was issued.
T4A income flows to T2125, not other employment income. The T4A box 048 amount is self-employment income. It gets reported on Form T2125 as gross business income, not directly on the T1 summary. You reconcile your own records to any T4As received.
Incorporated contractors generally do not receive personal T4As for corporate contract fees. When clients pay a corporation, the payment goes to the corporation, not to you personally. Your corporation issues its own invoices and receives the income at the corporate level. A payer may still issue an information slip to the corporation, but that is a corporate reporting matter; it is not personal T4A income to you. You receive a personal T4 from your own corporation if you pay yourself salary.
CRA: RC4157 — Filing the T4A slip and summary
Form T2125 and How Self-Employment Income Is Reported
Form T2125 is the Statement of Business or Professional Activities. It is filed as part of your T1 and summarizes your self-employment income and expenses for the year.
The form works in three steps: total gross income from all business sources, deductible business expenses, and net self-employment income. The net income from T2125 flows to line 13500 or 13700 of the T1, depending on whether the income is from a business or from professional activities.
Business expenses reduce the income that is taxed. Common deductible categories for IT contractors include home office expenses, phone and internet (business use portion), professional development, software and subscriptions, professional dues, and accounting fees. Capital equipment is typically claimed through Capital Cost Allowance in the CCA area of Form T2125 rather than as a direct expense.
In a transition year, the T2125 period is from the date you started contracting through December 31. Gross income includes all client fees earned during that period, whether or not a T4A was issued. Expenses are those incurred to earn that income.
The Withholding Gap
The withholding gap is the practical problem in a transition year. Here is how it works.
Suppose you left employment in April. Your employer paid you CAD $40,000 from January through April. The employer withheld income tax based on an annualized projection, as if you would earn roughly $120,000 for the year. The withholding reflects that projection.
You then earned CAD $90,000 from contracting between May and December. No withholding was made on that income. Your total income for the year is $130,000.
At filing, CRA calculates the tax owing on $130,000. The amount withheld by your employer is credited. The remaining liability, covering the $90,000 of contracting income and potentially some of the employment income that was not fully withheld, is payable by April 30.
The size of the gap depends on how long you were employed, how much contracting income you earned, and the rates at which your marginal income is taxed. In a transition year with substantial contracting revenue, the balance owing can be significant. Identifying the approximate shortfall before April 30 and setting aside funds during the year avoids the cash flow problem at filing.
CPP on Self-Employment Income
This is the item that surprises most contractors in the first year.
As an employee, you contributed CPP on your employment income up to the annual maximum. Your employer matched that contribution. The employee contribution appears on your T4 and is credited on your T1; the employer match is not a personal credit.
As a self-employed person outside Quebec, you pay both the employee and employer portions of CPP on net self-employment income. The self-employment CPP calculation is on Schedule 8 of the T1. The combined rate in 2026 is approximately 11.9% on net self-employment income above the basic exemption of CAD $3,500, up to the Year’s Maximum Pensionable Earnings of CAD $74,600.
In a transition year, the calculation takes both the T4 employment income and the self-employment income into account. CPP contributions already deducted on the T4 reduce what remains payable on the self-employment income. If you reached or approached the YMPE through employment income alone, the additional CPP owing on self-employment income will be lower. If your employment ended early in the year and most of your income was from contracting, the CPP calculation on the self-employment portion will be larger.
For 2026, the CPP2 contribution also applies on earnings between the YMPE of $74,600 and the Year’s Additional Maximum Pensionable Earnings of CAD $85,000. The CPP2 employee and employer rate is 4% each on that band. A self-employed person outside Quebec pays both portions, subject to any CPP2 already deducted on T4 employment income.
CRA: Schedule 8 — CPP contributions and overpayment
CRA: 2026 payroll deductions formulas
Quebec residents have a separate QPP calculation administered by Revenu Québec. QPP uses its own rate structure for Quebec employment and self-employment income, and the mechanics differ from federal CPP.
EI in a Transition Year
EI premiums are deducted from employment income on the T4. They are not payable on self-employment income unless you opt into the self-employment EI program.
Most IT contractors do not opt in. If you did not opt in, you will not be paying EI on your contracting income, and you will not have access to EI special benefits (parental leave, compassionate care, illness benefits) based on that income.
If you left employment and collected EI before starting to contract, that is a separate matter from the EI treatment of self-employment income. EI benefits received during the year are taxable income and must be reported on the T1.
RRSP Room in a Transition Year
RRSP room accumulates based on earned income from the prior year. Employment income, self-employment income, and net rental income all contribute to earned income for RRSP purposes. Pension adjustments reduce room for members of employer pension plans.
In a transition year, earned income includes both the T4 employment income and the net self-employment income from T2125. The RRSP contribution limit for the following year is 18% of that combined earned income, up to the annual RRSP dollar limit, minus any pension adjustment from your former employer.
If you were a member of an employer pension plan before leaving, the pension adjustment on your T4 reduces the RRSP room generated by your employment income. The self-employment income from T2125 is not reduced by a pension adjustment. For contractors who left a defined benefit plan, the pension adjustment can be substantial and significantly reduces available RRSP contribution room.
Your Notice of Assessment from CRA confirms your actual RRSP contribution limit for the year after filing.
The Year-Two Instalment Problem
In the first year of contracting, quarterly instalments are often not yet required. The instalment trigger for individuals outside Quebec requires net tax owing of more than CAD $3,000 in the current year and in either of the two preceding years. A first-year contractor with no prior contracting income may not meet the two-year condition.
By year two, the condition is typically met. If you owed more than $3,000 in year one, CRA will issue instalment reminders for year two. Those reminders are not optional guidance. If instalments are required and not paid on time, CRA charges instalment interest from the original due dates and may impose an instalment penalty.
The instalment due dates are March 15, June 15, September 15, and December 15. In a transition year where you are tracking a large balance owing, setting aside a portion of each contracting payment throughout the year is the most straightforward way to prepare for both the year-end filing balance and the instalment obligations that follow.
CRA: Paying income tax by instalments
For Quebec residents, Revenu Québec has a separate provincial instalment system with a CAD $1,800 threshold. Quebec instalments are required in addition to CRA instalments, not instead of them.
What Changes If You Incorporate Mid-Year
If you incorporated partway through the year, the structure of the return changes.
For the period before incorporation, employment income from your former employer is on a T4. Self-employment income earned as a sole proprietor before incorporating is on T2125. For the period after incorporation, your corporation earns the contracting income at the corporate level. What flows to your personal T1 is whatever salary or dividends the corporation paid you during the year. If the corporation paid you a salary, you receive a T4 from the corporation. If it paid dividends, you receive a T5 slip.
The transition year involving an incorporation has a more complex filing. The T1 covers employment income from the former employer, any sole-proprietor income from the brief period before incorporation, and salary or dividends from the corporation. The corporation also has a separate T2 filing.
Whether to operate as a sole proprietor briefly before incorporating, or to incorporate before the first contract, is a timing decision that affects both the transition year tax treatment and the administrative setup. That decision is better addressed before the first contract is signed than reconstructed at filing time.
What to Prepare Before Filing
For a transition year return, you will need:
- Your T4 from your former employer
- All T4As received from clients (reconcile against your own invoice records)
- A record of all contracting income earned from each client
- A record of all business expenses incurred after starting contracting, with receipts
- Banking records showing business deposits and payments
- Any EI benefit statements (T4E) if applicable
- Confirmation of your RRSP contribution limit from your prior year Notice of Assessment
If you have both a T4 and self-employment income, the return is not a simple slip-only return. Use tax software that supports Form T2125 and Schedule 8, complete the forms manually, or work with a professional.
Quebec Note
Quebec residents filing a TP-1 have parallel versions of most of these considerations. Quebec employment income is generally supported by an RL-1 slip in addition to the federal T4. Self-employment income is reported on TP-80 (the provincial equivalent of T2125). QPP applies on Quebec employment and self-employment income with a separate rate structure.
If you left an employer and your T4 showed CPP deductions but your self-employment income is connected to Quebec, the provincial treatment may require separate analysis. A contractor who was employed in one province and contracted in another should confirm the CPP/QPP treatment before filing.
Related Articles
- The First Year as an Independent IT Contractor covers GST/HST registration, bookkeeping setup, instalments, and year-end filing in the first year.
- Quarterly Tax Instalments for IT Contractors covers the instalment calculation methods, due dates, and how to avoid instalment interest.
- Should I Incorporate as an IT Contractor? covers the incorporation timing decision and what changes when income flows through a CCPC.
- Reasonable Salary for Incorporated IT Contractors covers salary vs. dividend decisions once incorporated, including CPP and RRSP implications.
Get in touch if you are in a transition year and want to understand what the return involves before it is filed.