Tax credits are deductions a taxpayer may be able to claim when filing his or her personal T1 tax return with Canada Revenue Agency (CRA).
Some credits are used to help offset just federal tax and others only provincial, but for the most part, they are designed as complementary federal and provincial credits used to recognize common taxpayer expenses such as age deductions, disabilities and medical expenses, or offered as economic incentives as is the case for donations, tuition amounts and RRSP contributions.
However not all tax credits are created equally. The vast majority are “non-refundable” … but some are “refundable”.
Refundable tax credits are used to reduce tax liability to zero. However, if the credit is greater in value than what is needed to reduce taxes to zero, the taxpayer actually receives the remainder as a refund.
The newest of these refundable credits is the BC government’s Seniors’ Home Renovation Tax Credit. It’s designed to aid seniors to remain in their own home longer. It’s quite detailed so I recommend checking it out on the CRA website.
Non-refundable tax credits reduce taxes owing to zero just like refundable tax credits but any amount of the credit that is not required to lower tax liability to zero in many cases is lost. In other words, the government doesn’t refund the remainder. However, in some cases the balance of the credit is an allowable carry forward for application to tax liability in future years. Examples of this include education and donation amounts.
I would be remiss if I failed to mention the fact that the final taxation impact of a tax credit may not be 100% of its reported value, but rather a percentage of that amount. These inclusion rates can apply for both refundable and non-refundable tax credits.
Typically, the universal deductions are subject to a 15% inclusion rate. For example the standard federal personal exemption of about $11,000 really translates into approximately a $1,650 deduction against income.
Interestingly, political contributions – that is, money donated to a political candidate or party – have a 75% inclusion rate as compared to donations to charitable organizations that max at an inclusion rate of 29%. Go figure.
There are some deductions that are dollar for dollar, as in their inclusion rate is 100%. For example, every dollar of RRSP contribution is netted directly against income – another reason an RRSP is a very attractive Canadian investment. Of course this is why there is an annual limit to RRSP contributions. (And remember, when the day comes to cash out an RRSP, that’s taxable income.)
Some other dollar for dollar deductions include union dues, professional fees, childcare costs, and expenses incurred for relocating to a new job. By the way, these are non-refundable credits.
In no way has justice been given to the multitude of tax credits and their workings so I highly recommend research be undertaken at tax preparation time.