You’ve likely been told “Save that receipt. You can deduct that.” But what does that mean? What’s the difference between a credit and a deduction and how do they affect your bottom line?
Basically, a deduction reduces your taxable income, while credits reduce your tax.
Deductions – The Details
Before any credits are applied to your tax return, you first calculate your net income and then calculate your taxable income. These are both important for different reasons.
Your Net Income is used to:
- Determine eligibility for some government benefits such as the Canada Child Benefit, GST/HST rebate, etc.
- Determine eligibility for credits on your tax return such as the eligible dependant amount, caregiver amount, medical expenses, etc.
Your Taxable Income determines your tax rate and how much tax you pay – in other words, how much income you’re being taxed on and how high the rate will be. The higher your taxable income; the higher your tax bracket and tax payable.
Deductions can lower both of these amounts. Common Net Income Deductions include:
- Childcare expenses
- Registered Retirement Savings Plans (RRSPs)
- Employment expenses
Once these deductions are applied, Taxable Income Deductions follow. Taxable income deductions include the Northern Residents deduction, military and police personnel deduction, and losses from previous years.
Example:
Adrian’s total income for 2017 was $65,000. This included employment income and bank account interest. He contributed $6,000 to his RRSP, had $3,000 in eligible childcare expenses, and incurred an unused loss in 2016 from a failed business venture of $12,000.
His net and taxable incomes were as follows:
Total Income $65,000
Minus RRSP contributions and childcare expenses $9,000
Net Income $56,000
Minus unused loss from 2016 $12,000
Taxable Income $44,000
After deductions, Adrian’s income for tax purposes was $44,000. His deductions reduced his income to the lowest tax bracket. His net income, $56,000 is the figure used to determine his eligibility for the GST/HST credit, as well as other federal and provincial programs.
Non-Refundable Credits
Non-refundable credits lower your tax payable. They are named “non-refundable” as these credits cannot, by themselves, get you a refund. Once your non-refundable credits are totaled, they’re subtracted from your tax payable. Every taxpayer is entitled to at least one non-refundable credit. Depending on your situation, you may have many more. Common non-refundable credits include:
- Tuition
- Disability amount
- Caregiver amount
- First time home buyers amount
In some cases, your non-refundable credits may be more than your taxable income, especially if you’re a student or are entitled to claim the disability amount. Imagine you are a full-time university student with zero taxable income. Because tuition credits are non-refundable and you have no tax owing, the tuition credits you’ve accumulated will not result in a refund. Luckily, tuition credits are one of the few credits that can be carried-forward or “banked” for future years.
Refundable Credits
After your federal tax calculation has been made, the final step in doing your taxes is to apply your refundable amounts. These amounts include the amount of income tax you’ve had deducted from your pay each week, any Canada Pension Plan (CPP)/Employment Insurance (EI) overpayments made, and other refundable credits such as the medical supplement. Even if you had no tax payable from using non-refundable credits, these refundable amounts would result in a refund on their own.
The newest federal refundable credit is for teachers and early childhood educators. If you’re a teacher who pays for your classroom supplies out of your own pocket, you could be in line for a refund of up to $150.
References and Resources
