Most people look forward to the tax season for income tax refunds, while others dread the taxes they have to pay the Canada Revenue Agency (CRA).
Did you know you could increase or reduce your income tax refund by making adjustments to your salary deductions?
If you’ve never paid attention to your paycheque, here’s how it works and how you can get a bigger income tax refund when you file your tax return.
What are the normal payroll income deductions?
When you receive your employment letter, what you would typically see is your gross salary. On payday, you’ll notice that your paycheque doesn’t quite match up to what your gross salary should be. That’s because your employer deducts an amount and remits that money to the CRA on your behalf.
Your payroll deductions generally include amounts for:
- Federal taxes
- Provincial and territorial taxes
- Employment Insurance (EI)
- Canada Pension Plan (CPP)
How much will be deducted?
To determine how much taxes to deduct, your employer’s payroll team will ask you to fill out and submit a TD1 Personal Tax Credits Returns form. This form specifies some tax credits and deductions you can claim from the payroll source.
Your base income tax amount is calculated by applying your marginal tax rate to your taxable income.
You can use an income tax calculator to estimate how much your base tax amount is.
Every Canadian resident can claim a federal basic personal amount of up to $15,000. If your income from all sources is greater than$165,430 and you claim the maximum basic personal amount of $15,000, you may pay more taxes.
The TD1 form allows you to assess your tax situation and decide if you would rather:
- Pay more taxes upfront and receive a larger tax refund
- Pay less taxes from your paycheque and receive no tax refund
- Pay taxes owing when you file your tax return
How your income tax deductions affect your tax refund
Income tax deductions reduce your taxable income and, in turn, increase the amount paid on your tax return. You may be eligible for some tax credits and deductions, which you can claim when you file your tax return.
Alternatively, you can claim some deductions before tax season. For example, education, disability and caregiver deductions can all be claimed early.
If you do not claim these tax deductions upfront, more taxes are taken off your paycheck. Consequently, your regular paycheque will be lower than if you had claimed the deductions upfront. However, during tax season, you will get a higher tax refund based on your tax rate.
The TD1 form also includes a section to indicate if you want your employer to increase or reduce the amount of taxes taken from your paycheque.
Some elect to have additional taxes deducted because they have other sources of income, such as a pension or self-employment.
When you file your personal income taxes, you will submit a T1 Income tax and benefits return. This form reports all your income and allowable tax credits and deductions.
The CRA will review your tax submission and compare it to the taxes your employer has remitted on your behalf.
If the CRA assesses that your employer has remitted more taxes than your actual taxes payable, they will issue you a tax refund.
On the other hand, if you have paid less tax than you should have you’re required to pay the additional taxes owed.
Make sure to claim all your eligible income tax deductions. This will reduce your taxable income and increase your income tax refund when filing your tax return.
What to consider before changing your payroll deductions
Not many people know they can make changes to their payroll deductions. You can elect to have more or less tax deducted from the amount deducted from your paycheque. Your decision to reduce your income taxes from source will depend on many factors.
You may want to increase your payroll taxes to avoid owing the CRA when the time to file your income tax and benefit returns come. Increasing your taxes through the TD1 Personal Tax Credits Returns form can result in a higher tax refund.
Alternatively, you could reduce the taxes taken from your paycheque. For example, not all tax credits and deductions are listed on the TD1 form. If you are eligible for one of them, you may want to reduce the amount of tax deducted from your regular pay. That way you will have the money in your pocket now instead of after tax season.
Another example is if you contribute to your Registered Retirement Savings Plan (RRSP) you can request to reduce the amount of taxes taken off your pay. Using this method, any employer-proved group RRSPs, or charity donations would have to be excluded.
To do this, you need to get a letter from your tax services office by filling and submitting Form T1213, Request to Reduce Tax Deductions at Source.
When you elect to reduce your taxes from your regular paycheque, your tax refund will reduce. Also, if the CRA assesses higher taxes payable than you have paid, you will have a tax amount owing.
To change your income tax deductions, you need to submit a new TD1 form to your employer.
Making salary deduction changes can impact your personal income taxes payable and tax refund. Sometimes, it may be better to increase your income taxes through your employer to get a higher tax refund. On the other hand, reducing your taxes means you will get a higher take-home pay, but you risk owing taxes in tax season or having a lower tax refund.
To estimate your personal income taxes, you need to know your marginal tax rate and your taxable income. Once you know that, you can calculate an estimate of how much you will owe in income tax. That will help you decide whether it’s worth increasing or reducing your regular payroll deductions.
If you’re struggling financially because you were surprised with a big tax bill we can help! Contact us today to learn more about how we can set you up with a plan to get out of debt.