While both deductions and tax credits reduce the overall amount of tax you will be pay, they have different application. Tax credits directly reduce the amount of tax you pay while tax deductions reduce your taxable income.
A tax deduction is deducted from your taxable income while a tax credit is a dollar-for-dollar reduction in the amount of income tax payable. The value of the tax credit is the same for everyone while a tax deduction can be worth more to those in higher tax brackets: those in a higher marginal rate tax bracket can deduct enough to move to a lower tax bracket.
For example, if you earned $125,000 last year and you are able to deduct $10,000, your taxable income would be reduced to $115,000. If you lived in Ontario, your deduction would save you just over $4,000 in taxes. On the other hand, a $10,000 non-refundable tax credit would only be worth $2,105.
Deductions for Self-Employed individuals:
A T2125 Statement of Business Activities is used to calculate your business or professional income as a self-employed person. Use it if you are the only person in the business (sole proprietorship) or if you are in business with one to five other people (partnership).
You are self-employed if you control the time, place, and manner of performing your activities; supply your own equipment and tools, and assume the rental and maintenance costs; make a profit or incur a loss, and cover operating costs; and integrate your client’s activities into your own business activities.
The following deductions are available to those who are self-employed:
- Deductions for CPP or OPP contributions on self-employment earnings.
- Deductions for provincial parental insurance plan (PPIP) premiums on self-employment income
- CCA – capital cost allowance for buildings, furniture and equipment (including owned vehicles) that you use in your business or professional activities that depreciate over time.
- Home business tax deductions when you operate your business out of your residence (either owned or rented)
- Vehicle costs (where the vehicle is used to earn income)
- Business operating expenses, include the following:
- Advertising fees
- Start-up costs (including interest and fees on money borrowed for your business)
- Delivery or shipping costs
- Legal, accounting and similar professional fees
- Office supplies
- Telephone, Mobile phone and Internet (where used for business)
- Utility costs
Deductions for Individuals :
There are deductions that all Canadians can utilize, regardless of whether they are employed, are self-employed, or operate a business through a corporation. These include the following:
- Registered pension plan (RRP) deduction
- Deduction for elected split-pension amount
- Disability support deduction
- Social benefits
- Annual union or professional dues
- Child care expenses
- Moving expenses
- Support payments
- Carrying charges and interest expenses
- Medical expenses
- Charitable donations
Tax Credits are by and large non-refundable; meaning that the government will refund to a maximum of what you paid in taxes, but not more. You will not get a refund for the difference.
For example, if your basic federal tax as reported was $5,500 and your total non-refundable personal tax credits totalled $6,000, your tax payable would only be reduced to zero and you would not get a refund of the $500.00 difference.
Personal Tax Credit
In 2019, every Canadian is entitled to claim a non-refundable personal tax credit of 15% of the basic personal amount of $12,069 ($1,810.35), and, in Ontario, one can claim a tax credit of 5.05% of a basic personal amount of $10,582 ($534.39) for a total tax credit of $2,344.74.
Tax Credits for Businesses and Corporations
There are many tax credits available to those operating a business or corporation that will reduce the amount of tax you will have to pay.
Tax Credits for Businesses and Corporations include the following:
- SR&ED: Scientific Research and Experimental Development Tax Credit
- Investment tax credit (iTC) for expenditures and acquisitions related to the investment
- Apprenticeship job creation tax credit for hiring an apprenticeship, who is working in the first 2 years of his/her apprenticeship program.
- Investment tax credit for creating child care spaces in your place of business for your employees
Tax Credits for All Canadians
There are various other tax credits available to all Canadians, regardless of their employment status. These include the following:
- Allowable amounts for medical expenses for self, spouse, and dependants
- Allowable amounts for an eligible dependant
- Allowable amounts transferred from your spouse and common law partner
- Disability amounts
- Donations and gifts
- Interest on student loans
Calculating Your After-Tax Income
Now that we know the difference between a deduction and credit, how do we apply these to calculating your after-tax income?
- Subtract any tax deductions available to you from your gross income for the calendar year
- A marginal tax rate that corresponds to your reduced gross income is then applied to determine your tax obligation.
- Your tax obligation can then be reduced by available tax credits, which will lower the amount of tax you owe.
- Your after-tax income is calculated by subtracting the amount of tax payable from your gross income for the calendar year.
The calculation for your after-tax income is found below:
After-Tax Income = Gross Income –Tax Payable [(Gross Income – Tax Deductions) X Marginal Tax Rate)] – Tax Credits]
For more about how to calculate after tax income, click here. If you would like guidance on how the difference between deductions and credits as well as how to maximize the deductions and credits you are entitled, contact us to speak with one of our tax lawyers.
-Shira Kalfa, BA, JD, Partner and Founder
© Kalfa Law 2019