What’s the difference between a tax deduction and a tax credit?

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Questions

Tags: Benefits Budgets Debt Financial Planning Investing Life Events Retirement Saving Taxes

What's the difference between a tax deduction and a tax credit?

Tagged: Taxes

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The end result of both is the same: you will owe less income tax. The simple difference between deductions and credits is:

Deductions save tax at marginal rates dependent on your income.

Credits save tax at the standard rate of 15%.

To understand the implication of this, it is useful to have a grasp of how the Canadian tax system works.

Under a marginal tax rate system, incremental increases in income are taxed at progressively higher rates.  A simplified example follows for income of $100,000, deductions of $15,000 and credits of $15,000;

Gross income $100,000
Deductions ($15,000)
Taxable income $85,000
                                 X marginal tax rates i.e. $20,000
Credits $15,000
                                X standard tax rates 20% ($3,000)
Net tax owing $17,000

 

The more income you earn, the more income tax you pay.  For 2014 in Ontario, we pay at a combined rate of 20% tax on the first $40,120 earned.  Any income above that is taxed at gradually higher rates. At an income of $85,000, the top tier is taxed at approximately 33%.

The deductions in the example cited above actually save the individual 33% of $15,000, whereas the tax credits save approximately 20%.  Credits are of the same value to all taxpayers no matter how much income is earned.

Some examples of Deductions are;

  • pension and RRSP contributions
  • split pensions
  • union dues
  • child care expenses
  • spousal support payments
  • employment expenses

Some examples of Credits are;

  • eligible dependents
  • CPP and EI premiums
  • public transit
  • children’s fitness and art amounts
  • home buyer amounts
  • tuition
  • disability
  • family tax cut

Medical expenses and donations are technically like credits but have a specialized calculation and treatment.

The province is free to either follow the federal tax credit system or introduce tax credits that are unique to Ontario.  In most cases, the amounts are very similar.

Both credits and deductions save you money, but understanding how each works may help you maximize those savings.

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What tax write-offs should every midwife take advantage of to minimize taxes?

Tagged: Benefits Taxes

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Writing off something on your taxes simply means deducting an amount -- permitted by the Canada Revenue Agency -- to reduce your taxable income. You can write off numerous items on your taxes, ranging from RRSP contributions to self-employment expenses.

Some tax write-offs also come in the form of nonrefundable credits, which reduce the amount of tax you owe directly. Tax write-offs are beneficial to you as a taxpayer because they can save you money on your tax bill.  The most common write-offs for midwives are as follows:

1. RRSP Contributions: Deductible RRSP contributions can be used to reduce your tax. Generally, any income you earn in the RRSP is exempt from tax as long as the funds remain in the plan; that said, you usually have to pay tax when you receive payments (withdrawals) from your RRSP.

Midwives can determine their RRSP contribution amounts for tax purposes from the receipts mailed to them by Morneau Shepell (for contributions prior to January 1st, 2015) and Desjardins (for contributions on or after January 1st, 2015). You should receive 2 receipts for each calendar year; one for the first 60 days and another for the remainder of the year. Contact the AOMBT if you are missing any receipts.

2. Medical Expenses and Health Premiums: Married or common-law couples are allowed to pool their medical expense claims together. Taxpayers claiming medical expenses should be sure to keep all receipts related to their returns. The expenses eligible for the medical expense credit are quite lengthy. Refer to IT519R2 (CRA website) for a complete list.

You can deduct the premiums you paid for health coverage. Midwives receive a receipt with premiums paid for the previous year every March.

3. Donations: The CRA allows a tax credit on charitable donations of approximately 21% for the 1st $200 (in Ontario) and 40% on amounts over $200, up to a maximum of 75% of net income.

Spouses can pool their contributions to maximize the tax break. Furthermore, contributions need to be included but not be claimed in the tax year they were made, but can be carried forward for up to five years. Donations under the $200 limit can be accumulated and claimed in later years to qualify for the higher credit allowance.

CRA offers a searchable database (http://www.cra-arc.gc.ca/chrts-gvng/lstngs/menu-eng.html) of registered charities permitted to issue tax receipts.

4. Out of pocket expenses not reimbursed by the midwifery practice: According to the CRA, you can write off any reasonable expense you incur to earn business income (on the self-employment statement called T2125). This includes expenses such as:

  • Telephone
  • Internet
  • Courses/development
  • Accounting fees
  • Vehicle
  • Professional fees and memberships

If you are going to write off expenses on your taxes, it is a good idea to hold onto receipts for 7 years as the CRA may request them. The CRA also sets the requirements for each type of deduction and credit, which can be reviewed on their website: www.cra-arc.gc.ca. -S.M.

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What are the differences in income tax considerations between when I am working and when I am retired?

Tagged: Financial Planning Retirement Taxes

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The biggest difference between working and retirement is often the sources of your income, which have different tax withholding requirements.

Most often, midwives are self-employed, and income comes from billable courses of care.  Self-employed midwives usually make installment payments each quarter, settling with the government each year when they finalize their personal tax returns. When you are working,  you may be living on 100% of your income – paying for expenses such as taxes, your children’s education, mortgage payments and other discretionary spending.  Hopefully, you are also saving for retirement as well.

On retirement, your income will come from different sources:

  • Canada Pension Plan: you have to apply for benefits, and can do so as early as age 60 (with a reduction) or as late as age 70 (with increased benefits).
  • Old Age Security: you have to apply for benefits at age 65.  Be aware of potential clawbacks; if your total income is too high, you have to repay OAS benefits.
  • Registered Retirement Savings Plans (RRSP) withdrawals: the RRSP money that you have saved for retirement can be withdrawn to supplement your income. 
  • Registered Retirement Income Funds (RRIFs): At age 71, your RRSP must be transferred to a RRIF (which can be an annuity, a stock portfolio, or a variation of both), and a minimum amount must be paid to you each year.
  • Income from non-registered investments like interest, dividends, and/or possibly capital gains.
  • Pensions or other income from your spouse (they may still be employed).

Pension splitting is also available to those who are retired.  This means that you are able to split your pension (and RRSP withdrawals if you are over 65) with your spouse, to minimize the amount of tax that you pay as a couple.

The issue that people in retirement often face is that each source of income assumes that they are your only source of income, and therefore they withhold tax on that basis.  The result is that minimum amounts of tax are withheld, causing large balances of tax owing at the end of the year when taxes are filed.  This may result in requiring to pay tax installments. 

The good news is paying installments is not new for many midwives. Therefore, the main goal is to estimate what your income will be.  A financial planner can work with you to plan and save accordingly.

To learn more about planning for retirement and how your GRSP can help, click here to access a video and presentation from Desjardins. -RMI

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I’m a new registrant. One of my colleagues mentioned that she pays her tax in installments. How does this work?

Tagged: Taxes

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http://www.cra-arc.gc.ca/esrvc-srvce/tx/mypymnt/menu-eng.htmlWhen you are self-employed (as midwives are considered), you file a form T2125 with your personal tax return. Your tax owing and Canada Pension Plan (CPP) premiums are due by April 30th. As such, it is very important that you set aside the funds throughout the year so that you can pay the balance owing by April 30th and avoid paying interest.

Tax installments are the process by which the self-employed person pays their tax in installments during the calendar year in which you are earning your taxable income, rather than paying the lump sum on or by April 30th the following year.

You are not required to pay installments if your tax owing in either of the two preceding years does not exceed $3,000. As a new registrant, it is unlikely that you owed more than $3,000 in the two years prior simply because you would have been in school. 

However, you always have the option of paying tax ahead of time. If you choose this option, you claim the amount paid on line 476 when you file your personal tax return and calculate the difference (owing or refund). If you have overpaid, you receive a small amount of interest.

How much tax you owe depends on how much income you earn and specifically what credits you are entitled to. You need to consult a tax professional to assist with your individual situation.

Once you cross over the threshold of owing more than $3,000, you will then be required to pay installments on Mar 15, June 15, Sept 15 and Dec 15. If you file your tax return the following year and did not make the required installment payments, interest on balances owing will be charged from those dates.

As an example, let’s look at a new registrant midwife making $60,000 in 2014 with very few credits. The midwife would be expected to pay tax of approximately $11,167, plus CPP of $4,851, for a total of $16,018. 

In the first year of installments, the midwife must only make two installments of 50%: $8,009 on Sept 15 and Dec 15.

In the second year, if income remains the same, the midwife would be required to make four installments of 25%: $4,004.50 on Mar 15, June 15, Sept 15 and Dec 15.

You can make installment payments through:

If you have questions, you can always call Canada Revenue Agency at 1-800-959-8281, visit the CRA website, or talk with your tax advisor.

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How do I put together a T4 for my nanny?

Tagged: Taxes

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The T4 is called the Statement of Remuneration paid, and one must be completed for any employee you have, including a nanny.  T4s for caregivers may be complicated by the fact that they may be live-in caregivers, and therefore you must account for room and board paid.

When completing the T4 there are actually two items to be completed:

  • The T4, which reports the gross earnings, Canada Pension Plan (CPP) withheld, Employment Insurance (EI) withheld, and the income tax withheld at source as well as other items in respect of the employee’s remuneration. 
  • The T4 Summary, which reports in Canadian dollars and cents, a summary of each payroll program account, in case you had multiple caregivers in any given year.  This is where you report the matching CPP and EI that you as an employer were required to pay during the year.

Board and lodging – if you are providing your live-in caregiver with free or subsidized housing, then this is a taxable benefit and they must pay tax on the value of that subsidized housing.  However, if they are paying your fair market value rent for living in your home, then you exclude the amount paid for any of your calculations.  This is very important, because you may be exchanging “net cheques”, meaning you only pay your caregiver the net amount that you pay them (gross salary, less tax withholdings, less payment for rent), but for taxation purposes, you should ignore the rent and make sure you are reporting the correct amounts paid.  If the housing is subsidized, you have to add the employee’s salary plus the fair market value of the board and lodging you provide minus any amount the employee paid.

Please note that you must put your nanny’s social insurance number on the slip, or you could face significant penalties.

Guide RC4120 – The Employers Guide to Filing the T4 Slip and Summary is available on line to assist you with the line by line preparation of the slip.

If you are filing on paper, the original summary and the related slips must be sent to the Ottawa Technology Centre at 875 Heron Road, Ottawa, ON, K1A 1A2.  Alternatively, you can file your return electronically on line via the web using the web access code provided by Canada Revenue Agency.

The deadline for filing the T4 and T4 Summary is February 28, 2015.  Failing to file on time can result in penalties and interest.  The slips must be distributed to your employee on or before the last day of February to which the slips apply.

As always, if you aren’t sure about what to do, seek the help of a professional tax advisor.

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What is a REIT?

Tagged: Investing Taxes

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REIT stands for a ‘Real Estate Investment Trust’. Investments are made in a portfolio of income- producing real estate properties such as office or apartment buildings, commercial buildings such as warehouses, health care facilities such as hospitals and retirement homes, shopping centers, and hotels. This provides investors with the opportunity to diversify their portfolio. Because of the variety of industries in which a REIT can invest, it’s critical to your investment success to understand what’s happening in those markets. In addition, there are many new REIT products being introduced that make comparisons even more difficult.

Similar to mutual funds, a REIT management team directs the focus of the investments. Performance can vary depending on the objectives of the management team and what is happening in the marketplace. The returns for REITS have been very strong over the past several years. This trend is expected to continue, however you need to do some research into finding the REIT that is best for your investment strategy.

REITs are similar to mutual funds as they also allow the average individual to invest in real estate at an affordable investment level. Often the minimum level of investment starts at $5,000, but there are REITS with a significantly lower minimum investment. REITs differ from mutual funds in that they must pay out at least 90% of their taxable income. REITs are not taxable as long as they distribute all the net taxable income to their shareholders. This can be done two ways:

  1. On a yearly basis, the distributions are usually split into dividend income and return on capital. Return on capital reduces the cost of your investment and you don’t pay any tax until you sell the investment.
  2. When you sell the REIT, the proceeds, less your adjusted cost, is recorded as a capital gain. This is taxed at half the value of the capital gain. This makes REITS a tax-efficient investment.

Many investors are drawn to REITS because of cash flow, so an important term to understand is “Adjusted Funds From Operations” or AFFO. This is a financial measurement tool used to analyze REITs. There are different methods of computing the AFFO, but the objective of them all is to show income from operations with adjustments for ongoing capital expenditures (used to maintain the REIT assets). The AFFO provides a measure of residual cash flow for shareholders and a better prediction of the REITs ability to pay dividends in the future.

It’s important to pick investment strategies that fit with your goals and objective. While REITs are a good strategy if you are looking for both regular income and growth within your portfolio, they do require a higher level of understanding, which increases the risk when investing in a REIT. It is very important to review your goals and objective with a qualified advisor, and always consider the tax implications as part of your investment decision.

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I have heard I can access a first-time home buyer’s program. Can you tell me more about this?

Tagged: Benefits Life Events Taxes

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The Home Buyers’ Plan (HBP) allows you to withdraw up to $25,000 from your Registered Retirement Savings Plan (RRSP) to buy or build a qualifying home if you have not owned a home in the past four years.

If, for example, in December 2007, you sold your home and moved into a rental property, you would be considered a first time home buyer eligible for the HBP as of January 2012, because you have not owned property for four years (January 1, 2008 to December 31, 2011). If you have a disability and are purchasing a home that is more accessible, you do not have to meet the first time buyer condition.   

If you are married or common-law, each partner is eligible separately for the HBP, allowing for a total withdrawal of up to $50,000.  

It is important to review your RRSP to determine the amount of funds available. The funds must be in an RRSP for at least 90 days prior to the withdrawal; therefore you need to plan your contributions to ensure you meet the time requirement. In other words, contributions made within the last 90 days are not eligible for withdrawal for the HBP.

You can withdraw from more than one RRSP, however funds cannot be withdrawn from a “locked in” RRSP. If you are a member of a group RRSP, you will need to check to see if withdrawals are permitted under that specific plan. 

Once you have signed your contract to build or purchase a home, you have one year to withdraw the funds and move into your home. Canada Revenue Agency form T1036 – Home Buyers’ Plan (HBP) Request to Withdraw Funds from an RRSP needs to be completed for each RRSP you are withdrawing from and needs to be approved and submitted to your RRSP provider.  It is very important to ensure you are eligible and meet all the conditions prior to making any withdrawals, otherwise the withdrawal from your RRSP could be considered ineligible and you may be penalized by CRA by being required to claim this withdrawal as personal income on your tax return. 

The amount of money that withdrawn must be repaid to your RRSP over a 15 year period, so if you took the maximum ($25,000) it will need to be repaid, at a minimum of $1,667 each year for 15 years.  Repayments begin the second year. If a payment is missed in a year, then the amount of the yearly repayment will be included in your income for the following year and will impact your RRSP contribution limit.

For complete details, see Canada Revenue Agency (CRA) Guide RC4135 – Home Buyer’s Plan (HBP).  You can access this guide from the CRA website at http://www.cra-arc.gc.ca/E/pub/tg/rc4135/README.html www.cra.gc.ca.

There is also a First-Time Home Buyers’ Tax Credit of $750 for qualified home purchase and the conditions are similar to the HBP.  More details can be obtained from CRA website.

It is always recommended that you speak with a qualified accountant to review your situation to ensure you have considered all the facts and take advantage of any potential tax savings or deferral. - JR

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What happens to my RRSP after I retire?

Tagged: Retirement Taxes

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The short answer to this question is that it depends on when you retire.

If you retire at an early age (and by early, I mean anything before age 71), then you have some options.  You can:

  • Do nothing.  Leave the money in the RRSP and let it continue to grow until age 71 when you have to start drawing down the funds
  • Start drawing down the funds to supplement your retirement income, based on your needs
  • Withdraw all the funds out (not recommended!).

An RRSP is a registered retirement savings plan that allows you to deposit funds into a registered account, which allows the funds in that plan to grow and be invested tax free, until such time as you withdraw the funds.

The Canadian Income Tax Act stipulates that you must begin making withdrawals from your RRSP by December 31st of the year in which you turn 71. This is true whether you are still working or not. Now, it is generally not recommended that you withdraw all the funds out at once, because you would be required to declare the full amount as income and would be taxed on the amount accordingly.

Generally speaking, the better option is to transfer your RRSP assets into a Registered Retirement Income Fund (RRIF), which essentially converts the investments into a regular monthly retirement income.  What does this mean? You don’t have to actually sell off all the investments within the registered account, but rather the name of the account changes. You can no longer add money to the account, and you must start withdrawing the funds. The financial institution that you have your money invested in will inform you of the minimum amount that you must withdraw each year. Generally, you have to withdraw 7% of the value of the RRIF each year, and that amount increases so that by the time you are 100 years old, the RRIF is totally de-registered.

Whether or not you retire early, you can always withdraw a greater amount from the RRSP or RRIF (depending on how old you are), with the consequence being that you are using your retiring funds sooner, and thus they may not last as long for as long as you need them. 

It is always recommended to work with a financial advisor who can prepare a financial plan for you, so you know how much money you will need in retirement.  My general rule is it doesn’t matter how much you save, it matters how much you spend.  It is often more important to know how much money you will need in retirement (what your spending habits are today and will be in the future), so you know how much money you have to save to ensure you can continue to live comfortably in retirement.  Once you have a handle on how much you need, then you can decide if you can retire earlier or later in life. - RMI

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I want to save money for my children’s education. I understand how RRSPs work, are RESPs similar? What do I need to do to set one up?

Tagged: Life Events Saving Taxes

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A Registered Education Savings Plan (RESP) is a contract between an individual (or the subscriber) and a person or organization (the promoter, such as a bank) for the purpose of saving for the education of one or more beneficiary (the future student).  The plan is registered, meaning that during the period of saving, the income earned within the plan is able to grow tax free.  Limits exist to establish how much you can contribute to the plan for each beneficiary.

Here is an overview of how an RESP generally works:

  1. A subscriber enters into an RESP contract with the promoter and names one or more beneficiaries under the plan.
  2. The subscriber makes contributions to the RESP. Government grants (if applicable) will be paid to the RESP. These grants can be the Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), or any designated provincial education savings program.  The subscriber cannot deduct their contributions from their income on their tax return. 
  3. The promoter of the RESP administers all amounts paid into the RESP. As long as the income stays in the RESP, it is not taxable. The promoter also makes sure payments from the RESP are made according to the terms of the RESP.
  4. When the payments are ultimately made to help finance the student’s post-secondary education, they are made as follows:
    • A return of the subscriber's contributions tax-free.
    • Accumulated income (known as educational assistance payments or EAPs), which is required to be included in the student’s income in the year in which it is received.

A Registered Retirement Savings Plan (RRSP) is a plan that is established to help people save for their retirement.  The plan is registered with the government, and allows you, or your spouse or common-law partner to contribute to it.  RRSP contributions can be used to reduce your taxable income.  Any income earned in the RRSP is usually exempt from tax as long as the funds remain in the plan.  However, when you withdraw the funds during retirement, you have to pay tax on the entire amount withdrawn from the plan.

When we have limited resources, it is always difficult to decide where to put those extra dollars – do we save for retirement, or save for our children’s education?  My recommendation is usually to do both if you can.   I am an advocate of paying yourself first, so I believe that you should just make it part of your monthly plan and budget to contribute to both your RRSP and RESP, saving for both the future of your children and your future retirement.   It is always easy to find other places where you can spend money, but it is so very important to save for the future.

The chart below outlines the similarities and differences between an RRSP and an RESP:

  RRSP (Registered Retirement Savings Plan) RESP (Registered Education Savings Plan)
Limits

Annually you can contribute up to 18% of your earned income, plus any unused contributions carried forward

Maximum annual limit for 2014: $24,270

No annual limit

Lifetime contribution is maximum $50,000
Contributor Contributor Subscriber
Beneficiary Contributor or the annuitant (which can be your spouse) Must be a Canadian resident at the time of the contribution, and have a Social Insurance Number.  This would be the student – can be a specific student or a family plan if you have more than one child.
Withdrawals Full taxed

Consists of:

Educational Assistance payments (EAPs) – taxable

Accumulated income payments (AIP) – taxable

Refund of contributions to the subscriber or beneficiary – not taxable
Government incentives Deduction in the year of contributions (reduces your taxable income thereby reducing the income tax you owe)

No deductions when you make contributions.

Canada Education Savings Grant (CESG) = 20% of your annual contributions to a maximum of $500, lifetime limit of $7,200

Canada Learning Bond – additional benefits if you receive the National Child Benefit Supplement.
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As a new registrant, I’m worried about how to budget now that I’m self-employed. How much of my earnings should I be saving to pay my taxes? How can I properly calculate my income versus my expenses?

Tagged: Budgets Financial Planning Saving Taxes

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Congratulations on becoming a new registrant, and on joining the self-employment world.  No one likes the dreaded ‘B’ word – budget - but now that you are self-employed, your ability to budget will be very helpful in preventing surprises when you file your tax return.

In order to determine how much you should be saving for your taxes, you do have to prepare some type of budget to determine how much money you plan to make, and therefore how much tax you need to pay.

Taxes are determined based on your net income for the calendar year – January 1st to December 31st.

First, you must estimate how many courses of care, and therefore how much income you will earn in the calendar year.  This will represent your total professional revenue.  The next step is to determine the expenses you expect to incur during the course of the same period.  There are always expenses that will be fixed (for example, your membership dues, professional fees, accounting fees, professional development and training courses will generally always be around the same amount no matter how many courses of care you bill).  Then there will be expenses that will vary based on how busy you are – car expenses, meals and entertainment, office supplies, and other supplies, which may be more discretionary.

Once you have calculated your revenues, less expenses, consider if you have any other sources of income – interest, dividends or other employment income. Are you making additional RRSP contributions that will reduce your income? Calculate all the income, less all deductions and now you have your taxable income.

Canada has multiple tax brackets, which have increasing amounts of tax the more money you earn.  This is called marginal tax.  The more you earn, the more tax you pay.  In 2014, the tax brackets in Ontario are as follows (the information below has been updated to reflect 2015 tax rates, combined Ontario and federal tax rates as noted here:

Tax Bracket Rate
Up to $40,922 20.05%
$40,923 to $44,701 24.15%
$44,702 to $72,064 31.15%
$72,065 to $81,847 32.98%
$81,848 to $84,902 35.39%
$84,903 to $89,401 39.41%
$89,402 to $138,586 43.41%
$138,587 to $150,000 46.41%
$150,001 to $220,000 47.97%
$220,001 and Over 49.53%

So based on the above, you should save accordingly.

The biggest surprise when someone first becomes self-employed, is the requirement to contribute both the employer and employee portion of Canada Pension Plan as part of your personal tax filing.

The maximum CPP contribution amount for a self-employed person in 2015 is $4,959.90.  If you earn less, you pay less. If you earn more, this is the maximum you will pay.  Although you get a non-refundable tax credit for half of it, it is still an amount that you must pay – so it should be part of your budget as well (updated to reflect 2015 amounts).

The second year of self-employment does get easier, in that CRA will begin to request installment payments. These are quarterly payments wherein they ask you to pre-pay the taxes you owe. This way, you don’t have to wait until the each April to pay. CRA will request payments on March 15th, June 15th, September 15th and December 15th. However, if your income fluctuates, the ability to budget for how much you owe will still serve you well so you don’t have to pre-pay too much.  A warning to those who choose not to pay their taxes on a timely basis – the penalties and interest can be quite costly.

Remember, it is important to obtain tax advice whenever you deal with the CRA. Be sure to contact your tax adviser for assistance if you have any questions about your tax installment requirements. - RMI

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