Tax Credit vs Tax Deduction
Canada’s Federal and provincial governments use income tax deductions or credits to reduce the tax for some taxpayers and promote certain beneficial activities. As a taxpayer, you should be aware of the two ways to reduce the amount of tax you pay: by claiming deductions and by claiming tax credits.
So, let’s start with understanding the fundamental difference between Tax Deductions and a Tax credit?
A tax credit gives you a dollar-for-dollar reduction of the tax you owe, while a tax deduction lowers your taxable income for the year.
So basically, a tax deduction reduces your taxable income while tax credits reduce your tax payable.
Now let’s dig a little deeper into what each of these terms means.
What are Tax Deductions?
A tax deduction reduces your taxable income. You can directly subtract these amounts from your income to reduce your taxable income.
For example, if you have a gross income of $50,000 and have contributed to RRSP for $5,000 (which is one of the tax deductions), you will get a taxable income of $45,000. Now you will pay reduced taxes on $45,000.The more you contribute to RRSP more you can deduct from your taxable income.
Some of the eligible tax deductions are listed as follows:
- Childcare expenses
- Union and professional dues
- Support payments made
- Moving expenses
- Registered Retirement Savings Plan (RRSP)
- Registered Pension Plan
What are Tax Credits?
After reducing the deductions and calculating the tax on taxable income, now it’s the turn to minimize taxes with tax credits.
The federal, provincial and territorial governments each provide tax credits, which you can use to lower your taxes.
Tax credits are further two types: Refundable and Non-refundable tax credits
- Non -refundable tax credits: You can use these credits to reduce your tax payable to zero but cannot claim any refund in case of an excess amount. Say if you owe taxes for $1,000 and you get a non-refundable tax credit of $200, you will owe taxes for $800. Suppose your non-refundable tax credits are $1,200; you will owe $0 in taxes and not get a refund of excess of $200.
Some of the common non-refundable credits are:
- The home buyer amount
- Interest paid on student loan expenses
- Tuition, education, and textbook amounts
- Canada caregiver amounts.
- Charitable donations
2. Refundable tax credits: These are the tax credit that generates a refund. When the total of these credits is more than the tax due or if there is no tax due because the deductions have reduced it to zero, these credits help you get a refund.
Now say in the above example, if you owe taxes of $1,000 and you have a refundable tax credit of $1,200, the excess will be issued as a refund to you.
Common refundable tax credits are:
- CPP overpayment or EI overpayment
- Climate action incentive
- GST/HST credits
- Canada worker benefits
- Provincial or Territorial Tax Credits
Each province or territory offers different credits for that province. These are based on the province you resided in on December 31st of the tax year.
The list may seem exhaustive and overwhelming as far as these tax deductions and tax credits are concerned.
For a better understanding of the same, do make a call to us.
We at Rav Bhatia CPA Professional Corporation will be glad to assist you and steer you out of confusion regarding your taxes.