I pose this question… If you were asked to choose between taking advantage of a tax deduction or a tax credit, could you answer with confidence, ensuring you were selecting the best possible option? Many tax conversations use these two terms interchangeably; however, the two are very different in terms of the affect they have on your income tax return!
A tax deduction is your golden ticket to a larger reduction in your income tax bill. When a tax deduction is present, such as a registered retirement savings plan (RRSP) contribution, the total amount contributed into the RRSP is subtracted from your income prior to calculating your taxable income. This is a dollar for dollar reduction in earnings, BEFORE the governments calculated ‘slice of the pie’.
For example, let’s say Amanda, a Nova Scotia taxpayer, was to earn $45,000 this tax year and has contributed $5000 into her RRSP during the tax year. Her taxable income now becomes $40,000, instead of $45,000. Without getting too technical, the difference in taxes owed would now be $6610 versus $8134 that would have existed if the tax deduction did not occur. Amanda has now effectively reduced her income tax balance by $1524, while also saving $5000 towards her retirement.
A few of the common tax deductions include:
• RRSP Contributions
• Childcare Expenses
• Employment Expenses
• Moving Expenses
A tax credit, while still beneficial, only comes into play after the taxable income has been established and only at a percentage of the amount claimed. The stipulated percentage is based on the lowest federal income tax bracket of 15%.
Let’s say Amanda now wishes to claim her university tuition of $5000 for the year. Since this is a tax credit, we would be able to claim 15% of the $5000, equating to a $750 reduction in the income tax balance for the year.
A few of the common tax credits include:
• Eligible dependant
• Canada Employment Amount
• Medical Expenses
• Tuition Expenses
You can clearly see how each scenario affects the taxpayers return in significantly different ways. If we were to only look at each scenario in terms of reducing the income tax balance, tax deductions are the way to go!
It is also good to note the difference between non-refundable and refundable in terms of deductions and credits. Tax deductions are non-refundable in the sense that they can only ever eliminate the taxable income to zero, thus rendering a zero-tax balance. These will never result in a refund on your tax account. Refundable tax credits on the other hand, such as the working income tax benefit, can reduce your income tax balance owed and have the ability to create a refund to your tax account.
With the 2018 tax season about to kickoff, let’s all hope for a little sprinkle of both tax deductions and credits this tax year!
~ Natasha McDonald ~