Many Canadians look forward to receiving a big tax refund when they file there taxes every year.
According to the data provided by Canada Revenue Agency on the individual tax returns processed in 2020, 2 out of every 3 tax-filer received a tax refund.
At an average of $1,800 per tax-filer, that is some good change that can be used to pay down debt or invest.
But should you be too excited about getting a sizeable tax refund? Probably not.
Getting a tax refund simply means you’ve paid too much tax, or your payroll deductions were too high over the course of the year.
You have overpaid your tax liabilities and effectively given the government a tax-free loan.
Jamie Golombek, Managing Director, Tax & Estate Planning at CIBC, coined the term intaxication to describe the short-term euphoria people feel when they find out they are getting a tax-refund, but quickly realize it was their money all along.
This post looks at how tax refunds work and outlines four simple ways to reduce your tax refund and keep more of your income.
How Tax Refunds Work
Tax refunds are simply the difference between what you’ve paid in taxes and your actual tax liability, calculated when you file your taxes.
Every year during tax time, each tax-filer will prepare their taxes by aggregating all their taxable income, deductible expenses (tax deductions) and credits to arrive at the actual tax owing to CRA.
The figure is then compared to whatever tax they’ve paid throughout the year.
If you’re an employee, your employer would have deducted taxes at source and remitted it to the government for each paycheck you receive. Once you prepare your taxes, you’ll either have a tax owing or receive a tax refund.
If you get a refund, it means your employer has deducted more money than is required from your pay.
For self-employed individuals, taxes are either paid at the end of the year or paid in installments during the year. You may receive a tax refund if the total of all the installments are more than the actual tax due.
In either case, any tax owing must be remitted to CRA by April 30th.
4 Simple Ways To Reduce Tax Refund
So how can you keep more of your money during the year, rather than wait till tax season every year?
Here are four simple ways to consider:
1. Provide Correct Information To Your Employer
The first and easiest way to ensure the correct taxes are being deducted from your taxes is to give your employer the correct or accurate information.
You would have filled a TD1 Personal Tax Credit Return form for both federal and your provincial or territorial government when you started the job.
In addition to the Basic personal amount credit that every Canadian resident is entitled to, the form also allows you to specify many other tax deductions or tax credits you may qualify for.
Examples include: Age amount, tuition, caregiver amount, spouse or common-law partner amount and so on.
Your employer will calculate your payroll tax deductions based on the information you provided in the form.
That means you may be paying more than is necessary if you don’t complete the form accurately.
2. Update Your Information Whenever There Is A Change
A change in your personal situation or circumstances may affect how much taxes you’re liable to pay.
Depending on the change, you may have to fill another TD1 Personal Tax Credit Form or write to CRA to receive an approval letter that allows your employer to apply the additional deductions.
With the first alternative, simply submit an up-to-date TD1 to your employer with the latest changes.
Examples of deductions that qualify for this are tuition and spouse/common-law partner amount. Check the TD1 form for the other tax deductions and credits you can add using the form.
For other deductions not specifically provided on the form, you’ll need to contact CRA first. See below for how to go about it.
3. Ask CRA For A Reduced Tax Deduction At Source
CRA Allows you to reduce or increase how much is deducted from your paycheck.
If you want additional tax to be deducted, you can do so using CRA’s TD1 form from above. This is a good way to reduce the tax you’ll owe at the end of the year if you have other sources of income outside of your employment.
On the other hand, you must provide a letter of authority from CRA to your employer to reduce how much is deducted from your pay.
The letter can be gotten through any tax office close to you by sending a written request or filling Form T1213, Request to Reduce Tax Deductions at Source.
Some of the deductions and credits that you can apply for includes:
- RRSP contributions
- Child-care expenses
- Medical Expenses
- Support payments
- Rental Loss and so on
RRSP contributions are one of the common reasons why Canadian receive tax refunds. But if you have an idea of how much you want to contribute in a year (outside of the ones your employer already deducts), you can get an approval to have it deducted from your income early.
All it takes is proper planning and not waiting till the RRSP deadline to contribute to your RRSP
Related Post: 10 RRSP Mistakes and How to Avoid them
4. Work With A CPA Or Tax Professional
Paying too much in taxes through out the year could be a sign of poor or non-existent tax planning.
A tax professional can help you do an assessment of your unique tax circumstance and come up with strategies to minimize your overall tax liabilities.
Of course, you may not need a CPA if your tax situation is simple. For example, you only receive employment income and have few tax deductions.
For more complicated tax situations like rental income or loss, investment income, capital gain or loss and so on, working with a tax professional will ensure you’re not paying more than is necessary and minimize the chances of making a costly mistake.
A tax professional may not necessarily reduce your tax refund. You may even get a higher refund afterwards. The refund amount on its own is meaningless; your total tax liability is more important.
So your goal should always be paying lower taxes using legal means.
An experienced tax professional will help you do just that.
Benefits Of Reducing Your Tax Refund
Here are some of the benefits of reducing your tax refund:
- Receive more of your pay upfront
This is the obvious benefit of planning your taxes to receive a lower tax refund. What isn’t obvious is how you choose to use the extra pay you receive with each paycheck.
Would you save, invest, or simply spend it?
- More cash to save and invest monthly
Let’s say you receive $2,400 in tax refund; we can estimate the extra cash you will receive monthly by dividing it by 12. The extra $200 can be invested in your TFSA or RESP every month. Or use it to top up your emergency fund.
Related Post: 10 Ways To Start Investing With Little Money
But this assumes you’ll be disciplined enough to actually use the extra money wisely. If you’re struggling with saving or investing, a bulk payment may be a better motivator to save or use the money responsibly.
Setting up a direct deposit or pre-authorized transfer to your savings or investment account may help you stay on track.
When Tax Refunds Are Okay
Receiving a big tax refund is not necessarily a bad thing – as long you’re using the money responsibly. For example: if you take the money and put it towards some of your financial goals, rather than spend on non-essential items.
A lump sum cash of $2,400 could be easier to invest or used to pay down a mortgage loan for example, than an extra $200 monthly.
So you should consider your personal circumstances when deciding what is best for you.
What is the maximum tax refund you can get in Canada?
There’s technically no cap on the amount you can receive as tax refund when you file your taxes in Canada. You’ll be able to receive all the refundable tax credit you’re eligible for or the difference between what you’ve paid and your actual tax liability.
Non-refundable credits may reduce your tax owing down to zero but you won’t get a refund on any unused balance.
For example, the federal personal amount for 2021 was $13,808, with the tax credit at $2,071 (15% of $13,808). If your total tax liability works out to $2,000, you’ll effectively pay no taxes for the year but you won’t get a refund the balance of $71.
In general, it takes 2 weeks for taxes filed online or up to 8 weeks for paper returns.
Tax Refunds are simply the difference between your actual tax, as calculated by the tax software you’re using, and the amount you’ve paid all through the year.
By taking charge of your taxes, you will avoid the usual temptation of treating tax refunds as free money or “windfall” when you file annually.
Whether you choose to receive more of your income upfront or get a big tax refund, just make sure you’re making an informed choice and doing what’s best for your personal situation.