Canadian income tax system for many is very confusing and complicated. There are so many rules and regulations to follow; it can feel as though all you are doing is spinning your wheels.
If you do not have a handle or a basic understanding how the tax system works, it can feel overwhelming. Instead of ignoring or hiding from taxes, here are a few basic guidelines how tax credits and deductions can work in your favour.
Income – Deductions = Taxable Income
Let’s begin with Canadian tax law. Every personal income tax return is calculated based on the individual’s income, minus the deductions that qualify, bringing the total known as taxable income. The taxable income is first taxed by the federal government and the remaining from the province or territorial your residence is registered with Canada Revenue Agency (CRA).
Different Sources of Income
The most common and combined sources of income include;
- Employment income
- Investment interest
- Taxable capital gains
- Business or professional income
A Tax Brackets is based on levels of income. Each level has a rate of tax associated with it. These brackets and rates are determined by the government’s annual budgets. Higher the tax bracket, the more advantageous it is to apply tax credits and deductions in order to lower the amount of income tax owing.
Tax credits and deductions work best for higher tax earners. If you have no income or in a lower tax or tax bracket, tax credits and deductions will not largely benefit you. Tax credits and deductions do not automatically provide a tax refund from CRA. You need to have earned enough money in order to take advantage of the tax credits and deductions CRA approves.
Tax Credits and Deductions – Differences and how they work
Tax credits and tax deductions may sound similar, but they very differently affect the final result of an individual’s tax return.
Tax deductions lower your taxable income which affects your marginal tax brackets; which, in turn, affects the percentage of tax you pay.
Non-Refundable Tax Credit
A non-refundable tax credit can only reduce any taxes owing to zero. A non-refundable tax credit can only be used against tax you owe. They provide dollar for dollar reduction of income tax liability. This means $1,000 tax credit saves you $1,000 in taxes A few non-refundable examples include;
- Basic personal amount
- Medical expenses
- Charitable donations
- Disability amount
- Caregiver amount
An example if you had a $1,500 tax credit, but only owed $1,000 in taxes, it would reduce your tax bill to $0
Take note if the total of these credits are greater than the amount of tax owing, CRA will not provide a refund for the difference.
Refundable tax credit
Referring to the same example, if the tax credit was refundable, you would receive an additional $500 tax refund. The two most common refundable tax credits are GST/HST credits and the working income tax benefit.
This is a very basic explanation how our Canadian income tax system works. There are many variables and exceptions for every individual tax return that is reviewed. If you have any questions about your own personal or corporate tax, contact us today.