- As of 2002 there were millions of dollars in unclaimed refunds the Canada Revenue Agency could not find owners for?
- Personal income tax was started in Canada as a means to finance World War One?
- Tax avoidance is legal?
- Tax evasion is illegal?
- Tax deferral is impossible?
- A tax deduction and a tax credit are the same?
- A large tax refund is a good idea?
- The Canada Pension Plan rate is double the rate for self employed people as it is for employees.
- Only 50% of capital gains are tax free.
- It is possible to sneeze with your eyes open.
Continuing on with the trend of discussing topics everyone does their best to avoid, this issue the tax return plays a starring role.
If I were to do a poll there would be few positive words attributed to doing taxes. This is one thing on the to do list that many Canadians gladly pay money to delegate to someone else.
I can fully identify with you. In the past before my chosen profession the yearly chore was a nightmare growing more fearsome with each day I put it off.
But like Robert Munsch’s dragon in Paper Bag Princess the tax return has been given undeserved dread. In fact, by procrastinating and rushing through the task or passing it off to someone else that doesn’t know your financial situation, you could be ignoring gold nuggets or a gold mine.
So first things first. Why do Canadians file a tax return? Well the government wants to know how much money you have made and therefore how much tax you will have to pay on that stated income. In essence it is verification of your income situation.
For the majority of Canadians that is a very easy equation involving a few T slips and with the advent of your choice of tax software NO CALCULATIONS! However, even if you insist on exercising your mathematical skills it still qualifies as a do it yourself project.
There are two parts to the tax return:
Act 1: You state your income for the year. The bottom line of this part is to determine your taxable income line 260.
Income includes:
Salary, commission, tips, pension income, rental income, employment insurance benefits, and three types of income from various investments. There is also business income, whether that is from a sole proprietorship, partnership, or if you own a corporation the salary you pay yourself.
There are certain items that can be used to reduce your taxable income. These are called deductions. The best known and most widely available of these deductions is the RRSP contribution. Other deductions are child care expenses, union dues and moving expenses, among others. You see what is meant by ‘widely available’ when you can only get certain deductions if you are a parent who belongs to a union who has moved.
Deductions reduce your taxable income. When you reduce your taxable income you will pay less tax. Now there’s an idea that everyone would give two thumbs up.
It is possible to have enough deductions to generate a refund of taxes. The reason for this is that a taxpayer’s income will fall into one of four tax brackets(more on that soon).
Deductions are also very important because they allow a taxpayer’s income to be reduced so he or she can qualify for certain benefits such as the GST credit, and child tax benefit for example. Deductions will also prevent these benefits from being ‘clawed back’ or reduced.
Act 2:
There are categories called tax brackets. Depending where your income is within the four tax brackets will determine how much tax you will pay. The brackets mean taxes will be paid on a percentage of your income. For instance, in 2004 if you earned between $35,000 and $70,000 you will pay 22% FEDERAL tax.
Starting in 2005 the tax brackets will be indexed to the cost of living. Therefore in 2005 a taxpayer who earns $35,595 will pay 16% FEDERAL tax.
Something called a nonrefundable tax credit will offset tax owing. Examples of a tax credit are: the Beautiful You credit that everyone gets, the age credit, pension income credit, credits based on spousal earnings, tuition, medical expenses, and charitable donations. There are others. The nonrefundable credits are totaled and then 16% of the total will be applied against tax owing. Hence the name nonrefundable. A nonrefundable tax credit, unlike a deduction, will not generate a refund of tax. In fact they are useless if you don’t have enough income to be taxable(don’t owe any taxes). Also with a deduction, the FULL amount is used to reduce income whereas only 16% of a credit can be applied against tax owing.
Therefore a deduction is always better than a credit.
Canadian taxpayers must ensure they legally take advantage of every available deduction and credit. This means not handing off the dreaded task to someone without educating yourself and asking questions. A good tax preparer will ask many questions.
Tax planning is very important. As in financial planning it is better to be PROACTIVE and PREVENT rather that REACT and CURE. Nobody likes the medicine the government dispenses. Canadians complain about how the government likes to take their money. But it is a curious corollary that every year hundreds of thousands of taxpayers lend substantial sums of their hard earned wages to the government. Even worse they don’t charge CRA any interest. Who are these people? They are the ones who every year get a big tax refund. What does that mean? Getting a refund means that the taxpayer has paid too much tax all year, and the government has got to use that money for 12 months interest free.
Whoops I must go. Please feel free to send me your tax jokes for a future issue. There’s a knock at the door, it must be the tax police. They are going to interrogate me as to why I can let this information get out. If too many people decide not to lend money to the government, who knows maybe they’ll have to lower MPs’ salaries.
The answers for the pop quiz will appear in the next issue. Please send me your answers. If 50% of my clients respond those respondents who have 8 or more right will have their names go into a draw for a prize. Chances are winning are good!
Also in the next issue I will address a question that a few clients have asked me about the market value of their investments, and the role I play in monitoring that market value.