What payroll taxes are and how they work

Welcome to payroll taxes 101 (a mini guide)

Payroll taxes (employment taxes) are one of those lessons that most of us never even knew existed. That is: Until you had to pay employees. Whenever you run payroll, there are things you add to the paycheques and things you take out. (We see you smart alecs. Sorry, a pain-in-the-neck fee is not something you can legally charge.)   

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The most common payroll taxes, also known as source deductions, are Canada Pension Plan (CPP), Employment Insurance (EI) and income tax (federal and provincial/territorial). In this article, we’ll walk through what they are, how they work and your responsibilities as an employer. 

Thinking of skipping this class? 

Think again. The statistics show the impact payroll taxes have on small businesses. 

• According to the National Payroll Institute, approximately 60% of the time you spend on payroll goes toward compliance issues (following the laws) — with payroll taxes being one of the primary pain points. 
• As the largest employer with the least amount of resources, small businesses feel this pain even more. In fact, Canada’s Red Tape Report found that businesses with fewer than five employees spent 198 hours per employee on compliance, nearly 25 times the mere eight hours for businesses with 100+ employees. 

Now that I have your attention, let’s get to it. 

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The most common payroll taxes explained

In an attempt to avoid an encyclopedic journey through payroll taxes, I’m going to focus on the most common payroll taxes you’ll manage as a small business employer.

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Canada Pension Plan (CPP)

CPP is a federal pension program that helps employees save for retirement. CPP also steps in when someone becomes permanently disabled. Participation is mandatory, requiring both employees and employers to contribute up to a maximum annual limit. 

What you need to know about CPP:

• It’s required in most situations. One notable exception: If the employee’s province of employment is Québec, they will fall under the Québec Pension Plan (QPP).
• Mandatory contributions: For payroll, you deduct (withhold) a specific amount for the employee and add (contribute/match) the same amount with each pay run. 

The math:

Employee & Employer CPP Amounts: (Pensionable Earnings － Annual Basic Exemption) x Contribution Rate

• Pensionable earnings is a big word for taxable income and benefits, including: salary/wages, commissions, and bonuses. Note: Some benefits, like car allowances, are also taxable. The CRA has a full list of taxable benefits here. 
• The annual basic exemption and contribution rates are set by the CRA. They love their tables, so of course, there’s a table. 

Something new:

• Before January 1, 2024, there was a maximum limit for CPP withholdings and contributions. But where’s the fun in that? Now, if an employee earns more than the yearly limit, there’s a second CPP additional contribution with its own rate and maximum amount. 
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Employment Insurance (EI)

Like CPP, EI is a federal social support program. EI contributions help employees set aside funds that they can access for unemployment, parental leave and short-term disability. EI participation is also mandatory, requiring both employees and employers to contribute up to a maximum annual limit. 

What you need to know about EI:

• It’s required in most situations. One notable exception: If the employee’s province of employment is Québec, they will fall under the Québec Parental Insurance Plan (QPIP). 
• Mandatory contributions: You deduct (withhold) a specific amount for the employee and add (contribute/match) 1.4 times the employee amount with each pay run. 

The math:

Employee EI Amount: (Pensionable Earnings － Annual Basic Exemption) x Contribution Rate

Employer EI Amount: Employee Contribution x 1.4 

• The annual basic exemption and contribution rates are published as tables. 
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Federal and Provincial/Territorial Income Taxes 

Anyone who's ever received a paycheque has had federal and provincial/territorial income taxes removed. If you’re the one issuing the paycheques, that means you’re the one who has to take these amounts out each time you pay your employees. 

What you need to know about income taxes:

• They’re required. 
• Mandatory contributions: For income taxes, you only have to deduct employee amounts. 
• Federal rates are shared by the CRA. Provincial/territorial income taxes are shared by the provinces and territories. See these tables. 

The math:

Federal Withholding: (Taxable Earnings － Exemptions) x Federal Contribution Rate

Provincial/Territorial Withholding: (Taxable Earnings － Exemptions) x
Provincial/Territorial Contribution Rate

Total withholding: Federal Withholding + Provincial/Territorial Withholding

• These calculations are for “regular payments” and common pay periods
• Any income tax exemptions your employees claim are documented when an employee fills out a TD1 form, usually when they’re hired. Updates can be made as needed by submitting a revised form. 

Side quest:

• If you’re up for it, the Canadian government offers a mini-course on the purpose of taxes. Yes, there’s even a quiz. 
• Fun Fact: The first taxes Canadians ever paid were colonial taxes that went back to England and France. 

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Ways to calculate payroll taxes 

Essentially, there are three ways you can do the math for CPP, EI and income tax deductions. 

1. Manually with the tables and a personal calculator (unless you really like to punish yourself). 
2. Using the federal Payroll Deductions Online Calculator (PDOC)
3. Using small business payroll software, where the tables and formulas are already uploaded and the calculations are automated. 

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Key concept: Employee rates and employer contributions are determined by the place where the work is performed. If your business is in Ontario and your employee travels daily from Québec to Ontario to work at your business, you’d follow Ontario’s employment tax laws.  

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Other basics small business employers should know 

In addition to taking out or adding in the right amounts of payroll taxes, employers must also:

• Provide employees with accurate pay stubs each pay run. 
• Provide employees with accurate T4s each year by the last business day of February. 
• Report and remit (pay) these amounts to the proper authorities, either the CRA or Revenu Québec (RQ).
• Report the employer amounts as part of the business income taxes. 
• Take responsibility for any mistakes. 

Beyond the financial and administrative consequences of any payroll tax mistakes, there’s the breach of trust between you and your employees. They’re trusting you to pay them correctly. Mistakes can prevent them from accessing key benefits and/or cause further problems with personal income taxes. 

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There’s more to small business payroll than writing paycheques 

In this one article alone, we’ve hit on the fact that paycheques involve a lot more than basic wages. That’s exactly why Huumans is creating tools like Huumans Payroll. 

Beyond automating payroll tax calculations, reporting and payments, this payroll software is embedded within the Huumans dashboard. This lets you see how your payroll data affects your financial health and vice versa, such as ensuring you can meet your payroll obligations.

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