Tax Deduction vs. Tax Credit
One of the most common questions accountants receive is:
“What’s the difference between a tax deduction and tax credit?”
As personal tax season is around the corner, we’ve summarized the differences below:
Tax Credit
Tax credits directly reduce the amount of taxes you owe. For example, if you qualify for a $1,000 tax credit, your tax owing will be reduced by this amount.
Typically each tax credit has a base amount, which is multiplied by the lowest tax rate in Canada (Federal - 15%) to determine the actual reduction of taxes owing. For example, the basic personal amount in Canada is $13,808, which means ($13,808 * 15%) a reduction in taxes owing of $2,071 for every taxpayer.
Some tax credits are non-refundable. That means, these tax credits can only be used to reduce federal/provincial taxes to zero.
Common examples of tax credits include - Basic personal amount, Spouse or Common Law Partner amount, age amount (65+), medical tax credit, tuition tax credit, donation tax credit, disability amount, and the First Time Home Buyers Credit.
Tax Deduction
A tax deduction, on the other hand, reduces your taxable income for the year. This taxable income is then multiplied by your effective tax rate to determine taxes owing.
Common examples of tax deductions include, but are not limited to: RRSP deduction, professional or union dues, child care expenses, moving expenses, and home office expenses.
Conclusion
Given that many tax credits are non-refundable, it is important that you work with your CPA to strategically plan to ensure all tax credits can be utilized to the extent possible. This holds true whether you are incorporated, work as a sole proprietor, or an employee.
Both a tax credit and tax deduction reduce the amount of taxes you owe; but they do so in different ways.
A good tax accountant will also offer insights on potential tax deductions that are available to you.
Reach out to your Partners at Evolve CPAs to optimize your after-tax cash position.
