Tax season is upon us, and navigating the maze of tax jargon can be daunting. One common confusion is the difference between tax credits and tax deductions. Let’s demystify these terms!
Tax Deductions:
Think of tax deductions as a way to reduce your taxable income. In Canada, deductions like RRSP/FHSA contributions, union or professional dues, childcare expenses, moving expenses and employment expenses can be subtracted from your total income, ultimately lowering the amount of income subject to taxation. So, if you earned $50,000 and had $5,000 in eligible deductions, you'd only be taxed on $45,000.
Tax Credits:
Tax credits, on the other hand, directly reduce the amount of tax owed. They are applied after your taxable income has been determined. There are two main types: non-refundable and refundable tax credits. Non-refundable tax credits, like the charitable donation tax credit or the tuition tax credit, can only reduce your taxes owed to zero. Refundable tax credits, such as the Canada Child Benefit or Canada Training Credit, can result in a refund if the credit amount exceeds the taxes owed.
Key Differences:
1. Timing of Application in the Calculation: Deductions are applied before calculating your taxable income, while tax credits are applied after your tax liability has been determined.
2. Impact on Tax Liability: Deductions reduce the amount of income subject to taxation, whereas tax credits directly reduce the amount of tax owed. Deductions reduce tax owing at your marginal rate, while credits are typically applied at the lowest marginal rate (i.e. in general, deductions save more tax than credits)
3. Types of Expenses: Deductions are based on eligible expenses incurred throughout the year, such as moving expenses. Tax credits, on the other hand, may be based on a variety of factors including income level, family status, or specific expenditures.
4. Refundability: While most tax credits can only reduce your tax liability to zero, some refundable tax credits can result in a refund if they exceed the taxes owed.
Choosing Wisely: 💡
Understanding the distinction between tax deductions and tax credits is crucial for optimizing your tax strategy. Considerations such as your income level, eligible expenses, and potential refunds can all influence your decision-making process. Additionally, staying informed about changes to tax laws and seeking advice from financial professionals can further enhance your tax planning efforts.
As tax season unfolds, empower yourself with knowledge and make informed decisions to maximize your tax savings. Remember, every dollar saved through deductions or credits is a step closer to achieving your financial goals.
