A “tax refund” is really just the CRA giving you back your own money.
“The government gave me money back” is a common phrase often heard after the April 30 or June 15 filing deadline. The truth is that the government is not being charitable; it is only refunding the tax that you or your employer had overpaid throughout the year.
Because the rate of tax withheld at source throughout the year may be different than the tax rate applicable to your actual taxable income (after taking into consideration all other income and deductions), you might have remitted more money to Ottawa than was necessary. Your “tax refund” is the difference between your remittances and your actual tax liability.
One of the biggest misconceptions is that, upon filing of their personal income tax returns, people with a lower income will likely receive a tax refund while people with a higher income will usually end up owing tax. This is not necessarily true because the tax refund/liability is not based on your income level but rather on the difference between the remittances paid compared to the actual tax liability.
How It Works
For example, assume Mrs. A, who normally earns a $200,000 annual salary, only worked six months during 2016. Mrs. A’s employer would have withheld taxes based on the $200,000. However, since Mrs. A worked only half the year, her actual 2016 income was $100,000. Because the tax remittances calculated on $200,000 were higher than the actual taxes applicable on the $100,000, Mrs. A will receive a tax refund.
On the other hand, assume Mr. B has two jobs each paying $30,000 throughout 2016. Mr. B’s employers would have withheld taxes based on Mr. B’s actual income of $30,000 from each of them. However, Mr. B’s actual income for 2016 was $60,000. Because the sum of the two tax remittances calculated on $30,000 earned from each employer would be lower than the actual taxes applicable on the $60,000, Mr. B will likely have to pay additional taxes.
In order to avoid such differences between the withheld taxes and the actual tax liability, everyone should review their current personal and taxable income situation to determine whether they can reduce withholding taxes to minimize the cash advance provided to the treasury. It is very important that your employer be aware of any other sources of income you may have or other deductions to which you are entitled, so that all of it can be considered when determining the appropriate amounts to be withheld.
What Should I Consider?
Here are some of the personal tax credits that your employer should consider in reducing the amount of withholding taxes to be remitted:
- Are you eligible for an age amount (e.g., tax credit available for those 65 or older)?
- Are you eligible for a spousal credit (i.e., if the spouse’s income is under the basic personal amount)?
- Are you (or your children) enrolled at a university, college or other educational institution and are eligible to receive tuition credits?
- Are you (or your dependants) qualified for a disability amount?
Before you approach your employer to reduce source deductions, consider the total of all deductions allowed as well as your individual tax bracket. On the one hand, there is little to be gained in cash flow savings if the overall taxable income reduction is miniscule. On the other hand, if the gain could be substantial, taxpayers should make every effort to minimize the tax dollars advanced to the Canada Revenue Agency (CRA). At the same time, taxpayers should understand the rules and regulations that accompany an attempt to reduce deductions at the source.
Make sure your TD1 information is correct.
The CRA requires that employees complete a TD1 form when starting employment. Make sure the information provided is correct from the start to enable payroll to make the correct calculations for source deductions. Correct information regarding spousal amounts or caregiver amounts makes a difference to non-refundable tax credits and the calculation of source deductions. If life circumstances have changed, submit a revised TD1 form.
CRA Form T1213
Should you have significant deductions available in any given year to reduce the withholding taxes at source, file a “Form T1213 Request to Reduce Tax Deductions at Source” (see CRA website for the forms). Regulations require that this form be submitted each year; however, if similar circumstances will exist for two consecutive years, you can apply for two years as long as you submit one T1213 form for each year. Given the CRA’s response time, it may be advisable to consider the two-year option and provide such data to the CRA before the end of 2017 so that it will become effective January 1, 2018. When you receive the letter of approval from the CRA, submit it to your employer to reduce the source deduction amount or adjust your instalment payments as required. Some of the tax deductions that can reduce the tax withholding at source are listed below:
- Will you be contributing a lot of money to your RRSP for the next few years?
- Are there significant child care expenses?
- Are you making any support payments?
- Does your employee contract or self-employment require you to pay for work-related expenses such as vehicle, lodging, supplies, or tools?
- Will you split pension income with a spouse in a lower income bracket?
- Are you anticipating costly moving expenses when moving for employment reasons?
- Do you have non-capital losses you can carry forward for a number of years?
- Do you pay significant brokerage fees to manage your investment portfolio?
- Have you borrowed for investment purposes?
- Have you purchased rental properties that will create rental losses for the foreseeable future?
CRA Interest Percentages
In the event you do not make sufficient source deductions or instalment payments, the CRA will charge you with interest and penalties of 5% on overdue income taxes. If you are overzealous and overcontribute to the treasury, the prescribed rate for refunds of overpaid tax is 3% for individuals.
A single adult in Ontario earning $100,000 employment income had source reductions for 2016 of approximately $24,829 or $2,069 per month. If the anticipated RRSP contribution for 2016 was $12,000, the tax liability would have been $19,763 (using 2016 tables), an annual cash flow reduction to the CRA of $5,066 ($422/month).
If other factors increased the overall deductions to $20,000, total source deductions drop to $17,127 and thus reduce cash outflow to the CRA to approximately $7,702 ($642/month).
By filing the T1213 form, the foregoing scenario anticipates two-year reductions in cash outflow to the CRA ranging from $10,132 to $15,404. Rather than waiting for a lump-sum refund at the time of filing, these funds could be received each month and used to pay down a mortgage, reduce high-interest debt or invest in additional RRSP, Tax Free Savings Account (TFSA) or make other investments.
Keep Cash Advances to a Minimum
As personal debt and the cost of living rise, taxpayers should consider the financial advantages of ensuring cash advances to the treasury meet their obligations and nothing more. The advantages of reviewing the impending 2018 and 2019 taxation years with your CPA and forecasting the potential to put money in your pocket sooner, rather than later, is certainly worthwhile.
The preceding article is reprinted from the June 2017 newsletter Business Matters with the permission of the Chartered Professional Accountants of Canada. Business Matters is a bi-monthly newsletter, the full version of which can be obtained on request.
This post deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.
Although every reasonable effort has been made to ensure the accuracy of the information contained in this article, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.