By the time this summer reached the halfway mark, most Canadian taxpayers have filed a tax return for 2015, received a Notice of Assessment with respect to that return, and considered that their income tax obligations for this year were complete.
For a significant number of those taxpayers, however, the filing of that return will trigger the issuance of a 2016 Tax Instalment Reminder from the Canada Revenue Agency (CRA), and that reminder will show up in their mailboxes sometime during the month of August. On that form, the CRA will suggest to the recipient that he or she should make instalment payments of income tax on September 15 and December 15, 2016, and will identify the amount which should be paid on each date.
Unexpected correspondence from the tax authorities is always unsettling and where a first instalment reminder is issued in August, it is almost certainly being sent to someone who has never before received an instalment reminder and, quite possibly, doesn’t even know what a tax instalment is. And, in any case, for someone who thought their tax obligations for the year were already met, receiving mail from the CRA suggesting that tax amounts are owed is likely to evoke both surprise and worry.
The fact is, however, tax instalments are just another way of paying tax throughout the year, rather than when the tax return for that year is filed. The reason that most Canadians are unfamiliar with instalment payments of tax is that most of them work as employees throughout their working lives and income tax is automatically deducted from their pay “at source”. Their employer deducts an amount for income tax from their gross pay, before any paycheque is issued, and remits that amount to the CRA on their behalf.
When the individual files a tax return the following spring, he or she is credited with those tax payments, which were remitted to the CRA on his or her behalf throughout the year. However, for those who are self-employed or, frequently, those who are retired (especially recently retired), no such deduction is automatically made from their income, and the issuance of an instalment reminder by the CRA may be the result.
Canadian tax rules provide that where the amount of tax owed is more than $3,000 ($1,800 for Quebec residents) in the current year and either of the two previous years, that taxpayer may be required to pay income tax by instalments. The reason that first instalment reminders are issued in August has to do with the schedule on which Canadians file their tax returns. Any tax amount payable on filing for the immediate prior year can’t be known until the tax return for that year has been received and assessed by the CRA. The tax return filing deadline for individuals is April 30 (or June 15 for self-employed taxpayers and their spouses).
Consequently, by the end of July, the CRA will have the information needed to determine whether a particular taxpayer owed taxes on filing for 2015 or 2014 and, if so, the amount that was payable on filing for each year. In many cases, a first instalment reminder is triggered where an individual has retired within the past two years.
Take, for instance, the example of an individual who retired at the end of 2014 from employment in which tax deductions were automatically taken from his or her paycheque. Beginning January 1, 2015, that individual’s sources of income changed from employment income to Canada Pension Plan and Old Age Security benefits, and monthly withdrawals from an RRSP or RRIF, or pension payments from the former employer. In order for the amounts withheld from such income to match the taxpayer’s actual tax liability for the year, the taxpayer would have to have calculated the amount of that tax liability and made arrangements for withholdings to be made from one or more of the three or four income sources, to total that overall tax liability amount.
For most taxpayers, that’s not a very likely scenario. Consequently, it would be almost inevitable that correct withholdings would not be made and that tax of more than $3,000 would be owed when the 2015 tax return was filed.
Where the taxpayer’s income levels and withholding amounts are unchanged for 2016, and it is expected that once again, more than $3,000 will be owed on filing the tax return for 2016, the criteria for the instalment requirement would be met, and a first tax instalment reminder would be issued for the taxpayer this month.
There is a reason that the form received by taxpayers is entitled Instalment Reminder, as those who receive it are not actually required to make instalment payments of tax. There are, in fact, three options open to the taxpayer who receives an Instalment Reminder, each with its own benefits and risks.
First, the taxpayer can pay the amounts specified on the Reminder, by the respective due dates of September 15 and December 15. A taxpayer who does so can be certain that he or she will not face any interest or penalty charges. If the instalments paid turn out to be more than the taxpayer’s tax liability for 2016, he or she will of course receive a refund on filing.
Second, the taxpayer can make instalment payments based on the total amount of tax which was paid for the 2015 tax year. Where a taxpayer’s financial and living situation is relatively unchanged, and there hasn’t been any significant change in income or available deductions and credits, the likelihood is that total tax liability for 2016 will be the same or slightly less than it was in 2015, owing to the indexation of tax brackets and tax credit amounts. A taxpayer who chooses this option should pay 75% of the total amount owed in September 2016 and the remaining 25% in December 2016.
Third, the taxpayer can estimate the amount of tax which he or she will owe for 2016 and can pay instalments based on that estimate. Where a taxpayer’s income has dropped from 2015 to 2016 and there will consequently be a reduction in tax payable, this option may be worth considering. Taxpayers who wish to pursue this approach can use the tax instalment calculation tool or can obtain information on federal and provincial tax rates and brackets for 2016, on the CRA website.
And, once again, taxpayers who choose this option should pay 75% of the total amount owed in September 2016 and the remaining 25% in December 2016.
Many taxpayers who receive an Instalment Reminder are less than pleased about the fact that they are being asked to, as they see it, pay their taxes “early”. However, the reality is that most of them have been paying income taxes “early” throughout their working lives, by means of source deductions. Source deductions are, however, more or less invisible to the taxpayer, as they are taken before any paycheque is issued, and actually writing a cheque or making an online payment to the CRA for taxes owing feels much different.
While no one actually likes paying taxes, by any method, making tax payments by instalments can actually help taxpayers, particularly those who are juggling multiple income sources for the first time, with budgeting and managing cash flow. Because most Canadians don’t have to think about setting money aside for income taxes during their working lives, they don’t always include them (or include them in sufficient amounts) when planning a budget when they first retire.
As well, for those retirees who receive Canada Pension Plan or Old Age Security income and want to have their taxes paid “automatically”, as they were during their working years, there is another option. The federal government will deduct income tax amounts from CPP and OAS benefits and remit them to the CRA, in the same way that an employer does for employees.
It is relatively simple to set up such withholdings and remittances, and the taxpayer can specify the amount to be withheld for income tax from each type (CPP or OAS) of payment. To do so, he or she completes Form ISP3520, which is available on the CRA website, and files that form with Service Canada.
A listing of Service Canada offices can also be found on the CRA website.
There are few financial surprises more unwelcome than finding out that there is a balance owing when the tax return for the year is filed. For most, it’s an annoyance and an aggravation. For those who live on a fixed income, however, being faced with an unexpected bill for taxes owed on filing can create a significant financial crisis.
Receiving an Instalment Reminder serves to give notice that taxes are not being withheld (or not being withheld in sufficient amounts) from income amounts paid to the taxpayer throughout the year and that it is necessary to make some provision for those taxes — whether by paying instalments or arranging for withholdings at source. Doing either will avoid the scenario in which a taxpayer has to come up with the entire tax amount owing for the year when the return for that year is filed the following spring.
