Whether you do your own tax returns or use an expert, one of the easiest way to reduce your tax burden is knowing all the deductions you are entitled to.
While some deductions reduce the income that is taxable (Tax deductions), others directly reduce the actual tax owed (Tax credit).
We’ll go into details below on the difference between the two.
What is a Tax Deduction?
A tax deduction is an amount that you subtract from your taxable income to lower your tax bill. Since taxes are paid on your taxable income, a deduction effectively reduces how much of your income is subject to taxes and may increase your tax refund.
Examples of tax deductions allowed by CRA are:
- Child care expenses
- RRSP deduction
- Disability support deduction
Imagine a taxpayer with an income of $40,000 and a tax rate of 20%: tax due to the government will be $8,000. A $5,000 deduction reduces the taxable income to $35,000 with $7,000 due as tax. This translates to a tax savings of $1,000.
This is just a simplified illustration. CRA uses a progressive tax system, with different tax rates applied to income in the different tax brackets.
So what is a Tax Credit?
Though similar to tax deductions, tax credits are a dollar for dollar reduction in the taxes owed. That is, a tax credit will not reduce your taxable income or change your tax bracket.
Taxes will still be calculated on your gross taxable income but the tax credit reduces how much you will have to pay.
Examples of tax credits in Canada are:
- Basic personal amount
- Age amount
- Home buyers’ amount
- Canada employment amount
Refundable vs non-refundable Tax credits
If a tax credit is higher than the tax payable, a refundable tax credit will reduce the tax due below zero. The difference will be received as a tax refund.
On the other hand, a non-refundable tax credit can only bring your tax liability to zero. It can not trigger a tax refund from the government.
Unfortunately, many tax credits are non-refundable.
Given a tax deduction and a tax credit with the same dollar amount, a tax credit will result in a higher tax savings as illustrated below (ignoring the progressive tax system):
| Tax Credit | Tax Deduction | |
|---|---|---|
| Annual Total Income | $80,000 | $80,000 |
| Less tax deduction | ($5,000) | |
| Taxable Income | $80,000 | $75,000 |
| Tax rate | 20% | 20% |
| Expected tax | $16,000 | $15,000 |
| Less tax credit | ($5,000) | |
| Taxes Payable | $11,000 | $15,000 |
In this illustration, the choice is between a $5,000 tax credit and a tax deduction of the same amount.
As shown in the table, the tax-payer will pay $4,000 less tax if they receive a tax credit instead of a deduction.
Provincial and Territorial Tax Deductions and Credits
There are provincial and territorial tax deductions and credits in addition to the ones at the federal level.
Though CRA administers taxes for the provinces and territories (except Quebec), each government develop their own tax laws. So, there are differences in the allowable credits and deductions.
CRA has a page with links to information for all the provinces and territories. It is a quick resource to check the specific tax credits available for each.
Where can I find a list of all deductions and credits?
Taxes can be complicated. Like we wrote in this post about going DIY vs using a tax professional, sometimes it’s in your best interest to leave it to the tax experts. They are trained to spot all deductions and credits you can claim to reduce your taxes.
If you choose to go the DIY route for your personal income tax return, knowing what you can claim will be of immense benefit to you. CRA has a handy table for this.
You can simply scroll through or filter for specific topics; for example Pension in the picture below.
Each link goes into details of who qualifies, how to calculate and claim the deductions, expenses that can and can not be deducted, etc.
Conclusion
We hope this post helps to clarify the differences between tax credits and deductions. If yes, then be on the lookout for more posts containing tax tips and explanation of the grey areas in taxes.
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