What’s the Difference Between a Tax Credit and a Tax Deduction in Canada?

Whenever tax season rolls around in Canada, you’ll see a lot of people scrambling to deal with their taxes at the last minute, or see them paying someone else, like an accountant, to deal with them instead. Because of the hectic nature that can come hand-in-hand with any tax season, there are a few tax credits and deductions that many taxpayers might overlook or don’t realize they can take advantage of. As a result, they won’t end up getting the most out of their income tax returns.

Actually, not everyone even knows about the subtle differences between tax “credits” and tax “deductions” and often think of them as one and the same. However, there are indeed some key distinctions between the two tax issues. 

What is a Tax Bracket?

While this article is not a specific lesson about how to do your taxes, it’s a good idea to understand certain aspects of the tax system in general, if and when you’re having trouble determining the differences between tax credits and tax deductions.

Your “tax bracket” is based on the amount of income that you earn during a single tax year, and how much of that income will be taxed by both the Federal and Provincial/Territorial Governments. The higher tax bracket you’re in, the more you’ll pay in taxes. If, for instance, you earned $60,000 during the year. You will be taxed at a rate of 15% on the first $45,916, but a rate of 20.5% (current tax rate of $45,916 – $91,831) on the remaining $14,084.   The rate at which you are taxed for each tax bracket changes from year to year.

To find out how much you’ll be taxed, please visit the Government of Canada website.

It’s important to note here that though the Federal Tax Rates are the same in every province, the Provincial/Territorial Tax Rate are specific to each Canadian province. 

Just to keep things simplified in this article, however, we’ll stick to discussing the federal tax credits and deductions for a more basic understanding.

For a list of current and previous Federal, Provincial and Territorial Tax Rates, visit the Canada Revenue Agency website.

One of the first differences between tax credits and tax deductions has to do with your tax bracket. When a particular tax credit is approved, the taxpayer who filed for it will receive the same tax reduction, no matter what tax bracket they happen to be in (more information in the section below). Tax deductions, on the other hand, are dependent on your tax bracket, because how much is deducted is based on a taxpayer’s net income.      

Other Notable Differences

As a matter of fact, there are a few more differences between tax credits and tax deductions that can be confusing to a lot of taxpayers, especially when they’re attempting to file their taxes on their own, rather than seeking the help of a professional. Below, we’ve listed a few of the main differences, in hopes that you’ll have an easier time distinguishing them from here on.

Refundable and Non-Refundable Tax Credits

A tax credit is a type of benefit that you can apply for, which will reduce the amount of income taxes that you owe the Federal Government for the year. The amount of taxes reduced by said tax credit, whether the amount is equal to $100 or $1,000, is calculated based on the lowest tax bracket, 15%, no matter what tax bracket you’re actually in.

For example, you’ve become eligible for a $5,000 tax credit. 15% of that $5,000 is equal to $750. So, you’ll owe $750 less in Federal income taxes this year.

There are also 2 different kinds of tax credits you can be eligible for:

• Non-Refundable Tax Credits – help reduce the amount of taxes you owe. However, if your non-refundable tax credit adds up to more than the taxes you owe, you won’t be receiving the difference back on your tax return. Some types of non-refundable tax credits include the spouse/common-law partner credit, medical expenses, public transit passes, charitable donations, etc.  
• Refundable Tax Credits – also reduce the amount you owe in taxes. However, if you claim them on your tax return, any refundable tax credits will earn you back the money that you don’t already owe in taxes. Some types of refundable tax credits include GST/HST (Goods and Services Tax/Harmonized Sales Tax) credits,  the Working Income Tax Benefit, the Children’s Fitness Tax Credit, etc.

Thinking about applying for a loan while qualifying for the Canada Child Benefit? Read this first.      

Tax Deductions

A tax deduction, on the other hand, reduces the amount of taxable income that you need to pay for. One of the most common examples of tax deductions is the RRSP (Registered Retirement Savings Plan). For instance, the more money you contribute to your RRSP, the more will be deducted from your taxable income during tax season.  

For example, let’s say that during the tax year, you earned up to the exact cutoff point for the 15% tax bracket, which is $45,916. This means that the amount you owe in Federal income taxes for the year will be $6,887.40. However, you managed to contribute $5,000 to your RRSP during that year. This contribution will reduce your taxable income to $40,916. 15% of that amount equals $6,137.40. You’ll then have saved $750 in Federal taxes.

For some tax tips, and what to do if you’re earning a low income, read this.

Which is Better For Your Taxes? Deductions or Credits?

In Canada, there are certainly numerous types of federal, provincial, and territorial tax deductions and credits that you can apply for during tax season. Any one of those deductions or credits can result in you receiving a  tax refund.

However, which ones will have the greatest effect on your bank account is based on the amount of income that you tend to generate on a yearly basis. Whatever your income might be, it will certainly work in your favor to start thinking about applying for those tax credits and deductions as early as possible. You definitely shouldn’t wait until the last minute. At the very least, you can contribute regularly to your RRSP as a way to obtain a basic tax deduction. Once you’ve gained a little more information, you can start claiming every credit and deduction possible, and really make the most out of your tax return.