As if 2020 wasn't hard enough, tax season is here to create one more hurdle for Canadians financially affected by COIVD-19. In early March 2020, the Government of Canada was quick to provide support for individuals in the form of the Canada Emergency Response Benefit (CERB). These payments of $2,000 a month created a safety net for Canadians during a time of unprecedented uncertainty. For some Canadians, CERB was a short bridge program that kept them afloat until they returned to work. For others, it was, and continues to be a necessary income replacement due to widespread layoffs and mandatory shutdowns. No matter how you long you collected CERB, it will have an impact on your upcoming tax return. These payments will be taxable and without proper planning, could have significant consequences on your financial situation. That being said, there are ways to minimize the incoming tax bill and as the title states, that is the topic of today's blog.
I understand that the only thing more boring than income tax is reading about income tax so I am going to leave this short summary here. I encourage everyone to read the blog but if it will cause you to slip into a boredom coma, I want to make sure you get this info first. If you collected CERB, you should contact a tax advisor who can use your year-end paystub and the amount of CERB you collected to give you an approximate projection of your tax balance this year. It is NOT too late to take action to reduce your tax bill.
For Canadian's that worked the majority of the year but had to collect CERB for part of the 2020 calendar year, the likelihood of you owing taxes is fairly high. Anytime you collect a paycheque from work, they automatically deduct the correct tax amount based on the hours worked in that pay period. In a typical year, the payroll professionals in your company will aim to make your income tax refund as close to zero as possible. This means that you were able to maximize the amount in your pocket throughout the year without owing a large sum at tax time. Some employees opt to have more taxes deduct off of each pay which essentially creates a forced savings program and usually results in them getting a large tax refund (it is important to note that in both scenarios, the amount of actual tax paid throughout the year is the same). Now that we know that in a perfect world our tax refund should be approximately zero, let's take a look at what happens we add the CERB payments into the picture. The CERB payments were issued to Canadians with zero tax withheld. In other words, nobody paid any taxes on these payments when they were issued (it would be as if you worked a full pay period and had no taxes deducted... you would of course owe money at the end of the year) because the Government of Canada wanted to get as much money into people's pockets as soon as possible. For every dollar of CERB you collected, you will be charged tax based on your marginal tax rate (a fancy name for the tax bracket your top dollar of income is in). This means that higher earners will end up paying back more of their CERB payments than lower income earners will. If someone in a 15% tax bracket collected $2,000 of CERB, they can expect their tax balance to be $300 higher than it would normally be. Someone in a 33% tax bracket would owe $660 in taxes on that same $2,000 payment. As you can see, if you worked the majority of the year, your income will likely be high enough that these small CERB payments will create significant tax bills.
The most common way to reduce tax balances is by contributing money to an RRSP (Registered Retirement Savings Plan). Contributions to your RRSP reduce your taxable income (you do not have to pay income tax on money that is put into an RRSP) while allowing to save that money for retirement. For example, if you collected $2,000 of CERB but contributed $2,000 into an RRSP, you would essentially break even when you filed your taxes. As you can see, in many cases it is beneficial to allocate money into an RRSP instead of just paying extra tax on each paycheque. Paying additional tax on your paycheque will not improve your tax situation, it will only prevent you from having more money in your pocket throughout the year!
One drawback to the RRSP is that Canadians in the lowest tax bracket are not actually getting a tax benefit but are rather deferring their tax balance to retirement (since they will have to pay tax to pull the money out of their RRSP). Consulting a financial advisor who has real tax experience can help you assess if an RRSP is right for you. Contrary to popular belief, any RRSP contributions made in the first 60 days of the calendar year are actually used to reduce the previous years taxable income. This is good news for Canadians who have not yet made arrangements to reduce their tax bill this year. A tax advisor in your area should be able to use your year-end paystub and the amount of CERB you collected to give you an approximate projection of your tax refund/balance. As always, every Canadian's situation is going to vary so it is best to call a tax advisor you trust and figure out the best way forward for your individual scenario.
Commentaires