Tax deductions and tax credits are both ways to reduce the amount of taxes you owe, but they work differently:
- Tax Deduction:
- A tax deduction reduces your taxable income. This means you subtract the amount of the deduction from your total income, BEFORE you calculate your taxes.
- Deductions are often based on expenses you’ve incurred throughout the year, such as union or professional dues, child care expenses, moving expenses, RRSP contributions, employment expenses, or other permitted expenses.
- The realized value of a tax deduction depends on your actual tax bracket. The deduction lowers your income and can potentially take you into a lower tax bracket, making the deduction the more valuable because it reduces your taxable income at that higher rate.
- Tax Credit:
- A tax credit directly reduces the amount of tax you owe. For example, if you owe $1,000 in taxes and you have a $200 tax credit, you only have to pay $800 in taxes.
- Tax credits are usually offered as incentives for specific situations or expenditures, such as home accessibility expenses, adopting children, or pursuing education.
- Most tax credits in Canada are non-refundable. (some provincial credits are refundable, but not all). Non-refundable tax credits can only reduce your tax liability to zero; any excess credit is not refunded. However, you could receive a refund if you had taxes paid into CRA on your behalf and your tax credits reduced your taxes owing.
In Canada, there are various tax credits available to individuals and businesses. Here are some common ones:
- Basic Personal Amount: Every Canadian resident can claim a basic personal amount, which reduces the amount of income subject to federal tax.
- Age Amount Tax Credit: This is a federal non-refundable tax credit for individuals who are 65 years of age or older at the end of the tax year. The amount of the credit depends on your income and is designed to provide relief for seniors.
- Pension Income Tax Credit: Seniors who receive eligible pension income may qualify for a federal tax credit.
- Spousal Amount Tax Credit: If your spouse or common-law partner has limited income, you may be able to claim their unused tax credits on your tax return, through a transfer of credits.
- Home Accessibility Tax Credit: This credit is for individuals (and dependents) with disabilities who have incurred expenses to make their homes more accessible or functional.
- Disability Tax Credit: Individuals who qualify for the Disability Tax Credit can use this tax credit annually. Please note that CRA must verify, through a completed T2201 form, signed by a medical practitioner, that the individuals have a severe and prolonged impairment that significantly affects their ability to perform daily activities. This credit can be applied for retro-actively (up to 10 previous years). See my other posts for more information about the DTC.
- Medical Expenses Tax Credit: Canadians can claim eligible medical expenses that exceed a certain threshold.
- Charitable Donations Tax Credit: Individuals can claim tax credits for eligible charitable donations made throughout the year.
- Tuition Tax Credit: Students enrolled in eligible educational institutions can claim tax credits for tuition fees paid.
- First-Time Home Buyers’ Tax Credit: This credit assists first-time homebuyers with the costs associated with purchasing a home.
- Interest paid on Student Loans: Canadians who have paid interest on student loans may be eligible for a tax credit equal to the amount of interest paid in a year. This does not apply to the principal payments.
These are just a few examples of the various tax credits available in Canada. It’s important to review the eligibility criteria and any specific requirements for each credit before claiming them on your tax return. It’s also essential to check the Canada Revenue Agency (CRA) website or consult with a tax professional for the most up-to-date information on tax credits and benefits, as these can change.
In summary, while both deductions and credits can lower your tax bill, deductions reduce the amount of income subject to taxation, while credits directly reduce the amount of tax owed.