Generally, a tax credit is a deduction a taxpayer may be able to claim when preparing their personal tax return to lower tax liability with Canada Revenue Agency (CRA). Sometimes tax credits create benefit beyond tax reduction.
Some credits are used to help offset just federal tax and others only provincial tax, but for the most part, federal and provincial credits recognize common taxpayer expenses such as the Age Amount for those over 65, Pension Amount for those receiving a pension, or medical claims for those who are ill and have incurred medical expenses.
Other credits, often referred to as deductions, reward employment and economic investment. Such is the case for the Canada employment amount, tuition expense, RRSP contributions, and donations.
Tax credits are typically non-refundable, meaning they reduce tax owing to zero, with any amount of the credit not required usually lost. In other words, the government does not refund you the remainder. This is the case for medical and childcare expenses.
However, in some cases the balance of the non-refundable credit is an allowable carry forward for application to tax liability in future years, examples being tuition expense and donation amounts. Some credits can have their balance transferred to others, such the Disability Tax Credit.
The taxation impact of a tax credit is not always 100 per cent of its reported value, but a percentage of that amount. In other words, a dollar is not always worth a dollar.
Typically, the universal deductions are subject to a 15 per cent inclusion rate. For example, the standard federal personal exemption of about $13,808 really translates into approximately a $2,071 deduction against income, likewise for the $7,713 Age Amount it’s a $1,157 deduction, and the $1,257 Canada Employment Amount it’s a $189 deduction.
Donations have an inclusion rate of 15 per cent on the first $200, 29 per cent above that amount to a maximum of 33 per cent. Interestingly, political contributions, money donated to a registered political party, have a 75 per cent inclusion rate.
There are some deductions that are dollar for dollar credit. For example, every dollar of RRSP contribution nets directly against income, as are tuition expense, union dues, professional fees, childcare costs, and moving expenses incurred for relocating to a new job. Some of these are subject to a limit, and if the limit is exceeded the balance is not refunded such as childcare costs. Others have their balance carried forward to future years, such as tuition expense.
It is necessary to point out that this dollar-for-dollar deduction is against income and not against taxes due. This means the inclusion rate of these deductions against your tax liability is in fact your marginal tax rate. For example, if you make a $5,000 RRSP contribution, it reduces your income by $5,000. The tax on that $5,000 would have been say 30 per cent, so the $5,000 RRSP deduction to income is a reduction of $1,500 in tax, which translates into a 30 per cent inclusion rate.
Finally, not all tax credits are created equally. The majority are “non-refundable,” but some are “refundable.”
A refundable tax credit is paid to you if your income level qualifies you. The tax credit comes to you either by way of a tax refund such as the Canada Working Benefit and the BC PST Credit, or in some cases it is paid directly to you like the GST Rebate and the Canada Child Benefit. Refundable tax credits are tax free.
It appears there are as many variations of outcomes as there are credits and deductions themselves. With that in mind, this brief overview cannot give justice to the multitude of tax credits and their workings. Be wise so you aren’t surprised.
Ron Clarke, owner of JBS Business Services in Trail, provides accounting and tax services.