WHY GETTING AN INCOME TAX REFUND IS BAD..
Sounds silly doesn’t it? Why on earth would getting an income tax refund be bad? Well let me tell you why! The only reason you are getting an income tax refund is because you OVERPAID on your taxes throughout the year. Or, put differently, you provided the government with an interest free loan! As a fellow taxpayer, I very much appreciate your nice gesture. In times like these when we have large government deficits every little bit helps after all.
The fact remains though, that if you are getting an income tax refund, you’ve lent your hard earned money to the government, interest free, for as many as 15 months. The reason is this:
Your employer is required to deduct payroll taxes from every pay cheque according to government rules. But what if every year you make a large RRSP contribution reducing the total amount of tax you will owe. Well you don’t get that refund until you file your income tax return.
What if I told you that there is a way to get your income tax refund instantly and not have to wait up to 15 months for it. In many situations, you can apply to Canada Revenue Agency to have your employer reduce the amount of tax they are required to deduct from your pay cheque.
Lets try out an example. Suppose you make $60,000 from employment in Ontario and get paid every two weeks (gross pay would be $2,307 per pay). Your employer would deduct about $450 per pay for income taxes. Assuming this is your only source of income and you had no other deductions, the amount withheld by your employer will come pretty close to what you actually owe in income taxes when you file your income tax return by April 30 the following year (which will be about $11,800).
However, suppose you make an RRSP contribution through automatic withdrawal from your bank account every pay day equal to 10% of your annual salary or $6,000 per year (which works out to $231 per pay). This $6,000 RRSP contribution would drop your annual income tax bill from approximately $11,800 to about $9,900, or save you $1,900 in taxes. Perfect, just wait to file your income tax return (due April 30th of the following year) and the government will send you your $1,900 a few weeks after you’ve filed your tax return. Remember when you made that first RRSP contribution that helped generate that tax refund? If you do it every pay cheque, the first contribution would have been in March. You don’t get the refund from that contribution until over a year later when you file your tax return.
What if your employer, instead of deducting $450 per pay for income taxes, deducted $375 per pay? That would increase your “take home” pay every two weeks by $75, or about $1,900 annually (that’s funny, wasn’t that the same amount as our income tax refund?). Now when you go to file your taxes, you’re total tax bill for the year will be about $9,900, and your employer would have withheld about $9,900 from your pay cheque, so generally you won’t owe anything or you won’t get a refund (other than maybe small amounts either way). In this case, you got your ‘income tax refund’ through your pay cheque every two weeks. No waiting for your money. No interest free loan to the government.
Assuming you are being a good little taxpayer and will pay your appropriate amount of taxes based on your income, prudent tax planning would say that you will always want to have a net zero income tax return. Some would even argue that owing money to the government for the current year is a way for the government to loan you money interest free (if you owe more than $3,000 though, they will ask you to make installment payments through the year, so I don’t recommend this strategy).
In many cases, this ‘instant refund’ can substantially increase your take home pay. You have to remember though, that the onus is on you to save accordingly because you don’t have that big lump sum income tax refund coming when you file your tax return. You could take the extra pay every two weeks and put it into your credit cards, line of credit, mortgage, car loans, etc. or you could invest it back into your RRSP or TFSA.
If you have one of the following deductions, you may be eligible for reduced income tax withholding from your employer:
- RRSP Contributions
- Childcare Expenses
- Employment Expenses
- Moving expenses
- Losses from a Business (Sole Proprietorship) or rental property
- Charitable Donations
You must prepare form T1213- Request to Reduce Tax Deductions at Source (click here to go to CRA’s website to download the form) and send it to CRA. They will send you a reply after a few weeks advising you whether you were approved or not. If you were, simply provide a copy of the letter to your payroll department and you’re done!
If you have any questions about this or any other income tax issues, don’t hesitate to contact us @ chris@cjaps.ca or 905-334-6674.
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