Tax credit vs. tax deduction? If you’ve ever filed your own income taxes, you’ve probably contemplated the difference between the two.
The good news? Both help offset the amount of taxes you pay during the year. This means it’s important that we all understand what a tax deduction is and what a tax credit is.
Key Takeaways: Tax Credit vs. Tax Deduction
- Tax Credits and tax deductions are not the same.
- Tax deductions reduce your total taxable income, while tax credits directly lower taxes owed to the government.
- Tax credits can be refundable or non-refundable. Non-refundable tax credits can lower your tax payable to a maximum of zero. Refundable tax credits can result in a tax refund.
Tax Credit vs. Tax Deduction In Canada
Understanding the difference between a tax credit and a tax deduction is essential when filing your tax return. It can not only reduce your taxable income but can reduce your tax payable.
What Is A Tax Credit?
A tax credit can be a refundable or non-refundable credit that reduces your payable income taxes dollar-for-dollar.
For example, if you owe $2,000 in income taxes and you qualify for a $500 tax credit, it’ll reduce your income tax liability to $1,500.
Note: If you end up owing the government a significant amount of money, you can set up a payment plan with installment payments, similar to a personal loan.
Refundable and Non-Refundable Tax Credits
There are two different kinds of tax credits you can be eligible for:
- Non-Refundable Tax Credits – This helps reduce your tax bill to zero. 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 – This tax credit not only reduces your tax bill but can help maximize your tax return. Some types of refundable tax credits include GST/HST credits and the Canada Workers Benefit (CWB).
Types Of Tax Credits
There are many types of tax credits you can claim when filing your taxes, including the following:
GST/HST Tax Credit
The GST/HST is a refundable tax credit for low-income families and individuals in Canada. It’s meant to offset the sales tax paid on goods and services.
Ontario Trillium Benefit (OTB)
The OTB is a refundable tax credit for low-income families and individuals who live in Ontario. This credit combines three different tax programs including the Northern Ontario Energy Credit (NOEC), the Ontario Energy and Property Tax Credit (OEPTC), and the Ontario Sales Tax Credit (OSTC).
These programs are meant to help offset costs associated with property taxes, energy and sales tax.
Canada’s Worker Benefit (CWB)
The CWB is another refundable tax credit for families and individuals who have a low income. This tax credit is meant to help individuals and families deal with the rising cost of living.
Basic Personal Amount (BPA)
The BPA is a non-refundable tax credit that allows individuals to waive all federal income tax charges when they have an income below the BPA. Canadians with an income above the BPA can receive a partial deduction on their federal income tax bill.
Disability Tax Credit (DTC)
The disability tax credit is another non-refundable tax credit. It allows individuals and families living with a disability to reduce the amount of tax they may owe.
Home Buyer’s Amount
If you bought a home, you may qualify for the Home Buyer’s Amount. This non-refundable tax credit can reduce your taxable income by $10,000. If you have a spouse or common-law partner, you may split the amount with them.
What Is A Tax Deduction?
A tax deduction, on the other hand, reduces your taxable income. 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 fell in the lowest tax bracket by eaning $40,000 living in BC. This means that the amount you owe in income taxes (including CPP/EI premiums) for the year will be $7,220. However, if you manage to contribute $7,200 to your RRSP during that year, this contribution will reduce your taxable income to $32,800. As such, your income tax obligation would be reduced to $5,584.
Types Of Tax Deductions
- RRSP – As mentioned above, you can use your RRSP contributions to reduce the amount of income taxes you have to pay.
- FHSA: Contributions to a First Home Savings Plan (FHSA) reduce your taxable income the same way as RRSP contributions do.
- RPP – Any contributions made to a registered pension plan through your employer can be used to reduce your taxable income.
- Employment Insurance Premiums – If part of your income goes towards an employment insurance plan, you can use the premiums as a tax deduction.
- CPP Contributions – Contributions to the Canada Pension Plan (CPP) can also be used as a tax deduction.
- Child Care – Certain child care expenses can be claimed as well.
- Work From Home – You can reduce your taxable income by claiming home office expenses.
- Business Expenses – If you’re self-employed, you can claim certain business expenses to reduce your total taxable income. Business expenses include advertising, office supplies, bank fees, and home office expenses.
How To Claim A Tax Deduction
The great thing about filing your income tax return in 2024 is all the tax software that exists. Tax software like Turbotax will guide you through all potential tax credits and deductions you may qualify for. All you need to do is simply follow the prompts they provide.
Calculate Total Income For The Year
When you start your income tax return, the tax software you choose will ask you to fill out all the information you have about where you receive your income from. For many people that will be a T4 from their full or part-time job. But this might also include income from investments, a second job, pension, etc.
Deduct Eligible Tax Deductions
Once you have calculated your total income for the year, your tax software will then go through all the possible tax deductions that you may qualify for. The software usually asks you a series of questions to understand what deductions you’re eligible for. Once all the deductions have been subtracted from your total income, you’ll know what your net income is.
There are a few specific tax deductions that the majority of Canadians won’t need to worry about, for example, if you’re part of the Canadian Forces. But if you are eligible for any of these, the next step will be to deduct those.
Arrive At Your Taxable Income
After all that tax deductions have been subtracted from your total income you will arrive at a number that is your taxable income.
How To Claim A Tax Credit
Claiming a tax credit follows a similar process to claiming a tax deduction. During the process of filing your tax return, your tax software will ask you a series of questions to determine if you’re eligible for any federal or provincial tax credits.
The government knows what credits you qualify for based on your income. Don’t try to claim any that you aren’t eligible to claim.
The major difference between claiming a tax credit and claiming a tax deduction is that a credit reduces the amount of income tax you owe the government. A tax deduction reduces your total taxable income.
How Does Your Tax Bracket Affect The Tax Credits And Deductions You Can Claim?
Your “tax rate” is based on the amount of income that you earn during a single tax year. The higher the tax bracket you’re in, the more you’ll pay in taxes.
The higher your taxable income, the less likely you’ll qualify for refundable tax credits like the GST/HST credit or the Canada Workers Benefit (CWB). Canadians with higher incomes will generally find more opportunities to reduce their taxes through tax deductions such as an RRSP.
To find out how much you’ll be taxed, please visit the Government of Canada website.
Federal vs. Provincial Tax Rates
It’s important to note here that the federal tax rates are the same in every province. But, the Provincial/Territorial tax rates are specific to each Canadian province.
Which Is Better For Your Taxes? Deductions or Credits?
In Canada, there are numerous federal, provincial, and territorial tax deductions and credits that you can apply for. Any one of those deductions or credits can result in you receiving a tax refund. However, the ones that will have the greatest effect are based on your income. Whatever your income, you should start thinking about applying for those tax credits and deductions as early as possible. At the very least, you can contribute regularly to your RRSP as a way to obtain a basic tax deduction. When it comes to filing your taxes, knowledge is power.
