What is a tax deduction?
Tax deductions are eligible expenses you can claim to reduce your taxable income. For example, if you made $65,000 last year and claimed $5,000 in approved deductions, you would only have to pay tax on a reduced taxable income of $60,000.
You’re probably already familiar with the Registered Retirement Savings Plan (RRSP) Deduction as one of the best tax-saving strategies in Canada. The more you contribute to your RRSP, the more you can deduct from your taxable income come tax time.
You may be eligible for some of these other common tax deductions, including:
- Union, Professional, or Like Dues, if you paid for dues related to your employment.
- Child Care Expenses, if you incurred child care expenses for the purpose of earning a living or going to school.
- Support Payments Made, if you made spousal support payments.
- Moving Expenses, if you moved more than 40kms for work or to attend school.
- Other Employment Expenses, if your employer required you to pay your own expenses and you’ve received a T2200 – Declaration of Conditions of Employment form.
- Carrying Charges and Interest Expenses, if you’ve incurred these expenses to earn business or investment income.
What is a tax credit?
After you’ve added up all your deductions and calculated your reduced taxable income, you can further reduce your taxes with tax credits. There are two types of tax credits: non-refundable and refundable.
Non-refundable tax credits
Non-refundable tax credits help you reduce the taxes you owe. They are subtracted from your tax amount payable and are considered non-refundable because these credits don’t count towards a tax refund. If your total non-refundable credits are more than the taxes you owe, you will not get a refund for the difference.
For example, if you owe $1,000 in taxes and qualify for $250 in non-refundable tax credits, you would only owe $750 in taxes. If you owe $1,000 in taxes and qualify for $1,200 in non-refundable tax credits, you would owe $0 in taxes and the extra $200 would not be refunded.
The best example of the non-refundable tax credit is the Basic Personal Amount (BPA). Every Canadian is entitled to claim a non-refundable $13,808 BPA credit for the 2021 tax year to reduce your taxes owed, once applied.
You may be eligible for some of these other common non-refundable tax credits:
- Canada Caregiver Credit, if you are a caregiver to someone with a disability.
- The Home Buyers’ Amount, if you’re a first-time homebuyer or a homebuyer with a disability.
- Home Accessibility Expenses, if you renovated your home to be safer or more accessible for seniors or the disabled.
- Interest Paid on Your Student Loans, if you paid interest on your student loan in the current tax year or the preceding 5 years.
- Tuition, Education, and Textbook Amounts, if you made tuition or education-related payments in the tax year.
- Eligible Medical Expenses, if your medical expenses are more than the lesser of either 3% of your net income or $2,352.
- Donations and Gifts, if you made charitable or political donations.
Refundable tax credits
Refundable tax credits are credits that the government will pay you if you qualify for them, even if you don’t owe any taxes. They’re considered refundable because if the amount of the credit is more than the taxes you owe, you will get a refund for the difference.
For example, if you owe $1,000 in taxes and qualify for $1,200 in refundable tax credits, you would be issued a refund of $200.
Governments may pass on these refundable credits to you in a series of payments throughout the year to help with living expenses, like the tax-free quarterly GST/HST Credit payment that helps individuals and families with low incomes offset the GST and HST that they pay. To continue getting payments, you need to do your taxes every year, even if you have no income at all.
Other common refundable tax credits can include:
- CPP Overpayment, or EI Overpayment, if you’ve overpaid your CPP or EI obligations.
- Climate Action Incentive, for residents of Alberta, Saskatchewan, Manitoba, and Ontario.
- Canada Workers Benefit (CWB), if you’re an eligible low-income individual or family in the workforce.
- Canada Child Benefit (CCB), if you’re an eligible family with children under 18 years of age.
How do tax deduction and tax credits actually work?
Canada uses a progressive income tax system, which means low-income earners are taxed at a lower rate than higher-income earners. We pay a combination of both federal and provincial income taxes. Let’s take a practical look at how your tax deductions and credits actually work using the federal tax brackets.
According to the Canada Revenue Agency (CRA), the federal portion of income tax for 2021 is calculated at the following rates:
15% on the first $49,020 of taxable income, plus
20.5% on the portion of taxable income over $49,020 up to $98,040, plus
26% on the portion of taxable income over $98,040 up to $151,978, plus
29% on the portion of taxable income over $151,978 up to $216,511, plus
33% of taxable income over $216,511
If you earned $49,020, you would fall into the 15% tax bracket and be subject to $7,353 in federal income tax. If you earned $49,020 up to $98,040, the first $49,020 you earn would still be subject to 15% in tax, and your next $49,020 would be subject to the 20.5% income tax rate. Based on this schedule, someone earning $65,000 would owe $10,628.90
Total Income: $65,000.00
Taxable Income x 15% (on first $49,020, plus): $7,353.00
Taxable Income x 20.5% (over $49,020 up to $97,069): $3,275.90
Total Taxes Payable: $10,628.90
How to calculate a tax deduction
A tax deduction will reduce your taxable income. As an eligible tax deduction, a $5,000 RRSP contribution would reduce the income subject to tax by $5,000. Your $65,000 income would now be considered $60,000 for your tax calculation. Instead of paying $10,628.90 in federal income tax, you’d now only owe $9,603.90. Your RRSP contribution would have generated $1,025 in tax savings and you’d experience similar tax savings at the provincial or territorial level.
| Total Income | $65,000.00 |
|---|---|
| Minus RRSP Contribution | $5,000 |
| Taxable Income | $60,000 |
| Taxable Income x 15% (on first $49,020, plus) | $7,353.00 |
| Taxable Income x 20.5% (over $49,020 up to $98,040) | $2,250.90 |
| Total Taxes Payable | $9,603.90 |
| Tax Savings | $1,025.00 |
How to calculate a tax credit
Now let’s compare that with how a tax credit will reduce your tax payable. Tax credits typically generate federal tax savings based on the lowest tax bracket (15%). A $500 charitable donation tax credit will generate $75 (= $500 x 15%) in credit against your taxes owing, regardless of your income bracket.
| Total Income | $65,000.00 |
|---|---|
| Minus RRSP Contribution | $5,000 |
| Taxable Income | $60,000 |
| Taxable Income x 15% (on first $49,020, plus) | $7,353.00 |
| Taxable Income x 20.5% (over $49,020 up to $98,040) | $2,250.90 |
| Minus Charitable Contribution Credit | $75 |
| Total Taxes Payable | $9,528.90 |
Take advantage of tax credits and tax deductions
If you’re in the lowest tax bracket, the value of a tax deduction is equal to the value of a tax credit, both are calculated at the 15% rate (the lowest federal tax bracket). Tax deductions become more valuable than tax credits when your income increases since deductions reduce your taxable income at your marginal tax rate.
Your non-refundable credits and deductions may leave you without any taxes due. Additional refundable credits may mean that you’re in for a refund from the CRA. For example, if you end up with no taxes due and qualify for a $1,000 refundable tax credit, you would receive the entire amount as a refund. With that in mind, it’s common practice to calculate your refundable credits after you’ve factored in all eligible deductions and non-refundable credits.
The availability of tax credits and deductions change from year to year. Just because they were available one year doesn’t mean they’ll be there the next — they are not guaranteed. For example, the 2020 tax year introduced a $400 deduction to cover home and office expenses for Canadians working from home due to the COVID-19 pandemic.
All said and done, there are 95 different deductions, credits, and expenses that you can claim to reduce your taxes but unless you’re a full-time tax accountant, it’s nearly impossible to know if you’re making the most from your tax return. It’s hard enough to keep track of your eligibility, much less understand the information and forms you need to fill out. The right tax software, like Wealthsimple Tax or TurboTax, can go a long way in helping to optimize your return.
For example, Wealthsimple’s Refund Optimizer will run thousands of calculations to maximize your credits and deductions to reduce your tax payable. Once you’ve run the numbers, you can submit your return to the CRA for free or pay what you want to support a Canadian small business.
Tax deductions and credits are your best bet to reducing your taxes, and may even generate a tax refund. Just remember you’ll need receipts to back up your claims. You won’t need to send them in with your tax filing but you should keep them for six years just in case the taxman comes knocking for an audit.
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More: All you need to know about tax returns
