What's the difference between a tax deduction and a tax credit?
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;
|X marginal tax rates i.e.||$20,000|
|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
- family tax cut
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.Top of page