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 consumers 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”. They are often thought of as one and the same. However, there are indeed some key distinctions between the two tax issues. 

What Is A Tax Bracket?

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 the 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.

Federal vs. Provincial Tax Rates

It’s important to note here that although the federal tax rates are the same in every province, the Provincial/Territorial Tax Rates 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.

Tax Credits vs. Tax Deductions In Canada

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. 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.      

Tax Credits (Refundable and Non-Refundable)

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 that 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 that 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 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 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 earned up to the exact cutoff point for the 15% tax bracket, which is $50,197. This means that the amount you owe in federal income taxes for the year will be $7,529.55. However, you managed to contribute $5,000 to your RRSP during that year. This contribution will reduce your taxable income to $45,197. 15% of that amount equals $6779.55 You’ll then have saved $750 in federal taxes.

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How To Claim A Tax Deduction 

The great thing about filing your income tax return in 2022 is all the tax software that exists. When you go through the steps that, for example, Turbotax lays out for you, a section will be devoted to all the possible deductions you can claim.

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.

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.  
• 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. Recently, due to COVID-19, the government introduced a new method to deduct your home office expenses called the “temporary flat rate method”. 
• 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 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, so you shouldn’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 reduced your total taxable income. 

Types Of Tax Credits

• GST/HST Tax Credit – The GST/HST tax credit is a tax-free payment for low-income families and individuals in Canada. 
• 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). 
• Canada’s Worker Benefit (CWB) – The CWB is another refundable tax credit for families and individuals who have a low income. 

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 favour 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.