Deductions, credits, refundable, non-refundable, carry-forwards - when tax planning, there are a lot of terms thrown around that all mean tax savings. For many Canadians, however, the distinction between these terms are not clear.
To be able to properly understand your tax planning strategy, understanding these terms is essential.
To help you on your way, here are explanations of common tax terms:
Deductions
Income tax deductions reduce your amount of taxable income (income that is subject to tax). This means that when a deduction is applied to your tax return you no longer have to pay tax on the amount deducted.
The value of a deduction depends on your marginal tax rate, which is why deductions are especially beneficial for taxpayers that are in a higher tax bracket.
In Canada, personal income tax rates in 2018 are:
- 15% on the first $46,605 of taxable income.
- 20.5% on the next $46,603 of taxable income.
- 26% on the next $51,281 of taxable income.
- 29% on the next $61,353 of taxable income.
- 33% of taxable income over $205,842.
As such, if you make $210,000 this year and apply a deduction of $1,000 you will save $330 in taxes ($1,000 x 33%). If on the other hand you make $30,000, a $1,000 tax deduction will save you $150 in taxes ($1,000 x 15%). While the value differs from tax return to tax return, the outcome is the same - more money in your pocket.
Some tax deductions available for Canadians include:
- RRSP Contributions.
- Union and professional dues.
- Child-Care Expenses.
- Moving Expenses.
- Employment Expenses.
- Credits
Credits reduce your tax owing (your taxable income multiplied by the applicable tax rate). It is important to note that often time your credit is equal to only 15% of the eligible expenses. For example, if you have $400 in donations your tax credit is $60 ($400 x 15%).
There are, however, two types of credits - refundable and non-refundable.
A refundable tax credit means that the government will return the unused portion of your tax credit to you if your tax owing becomes $0 without using the full amount.
Non-refundable tax credits, on the other hand, will be used to reduce your tax owing but if there is still credits remaining once your tax owing equals $0, you will not be refunded the remaining amount.
To illustrate the difference between the refundable and non-refundable tax credits, consider the following:
You have taxes owing of $100 and a refundable tax credit of $200. In this situation you would receive a $100 tax refund ($200 - $100) because only $100 would be needed to bring your tax owing to $0.
If this credit had been non-refundable, you would still have a tax owing of $0 but would not receive a refund.
Some tax credits available for Canadians include:
- Adoption expenses.
- Volunteer firefighter/Search and Rescue detail.
- Interest paid on student loans.
- Medical Expenses.
- Donations.
Carry Forwards
Carry forward amounts are amounts that are unused in the current tax year but can be used in future tax years. Donations are a perfect example of a carry forward.
If you owe $0 in taxes in 2018 but have an unused donation tax credit of $60, you can carry it forward to the following tax year and use it to reduce your taxes owing in 2019. It is important to note that not all credits can be carried forward.
For more information on tax credits, deductions and carry forwards contact us today! We look forward to helping you plan for the 2018 tax year to optimize your after-tax position.
