A very common misconception that people have is they believe that tax credits are a tax deduction. It is important to distinguish between the two as both have very different and unique benefits to the calculation of your income taxes.

A tax deduction is a reduction in the gross amount on which tax is calculated. In other words, a deduction against your net income for the year to arrive at your taxable income. In Canada, your calculated taxable income is used as the basis in determining the amount of taxes owing. The amount of taxes that you owe is dependent on which tax bracket your income level falls under. As you may or may not know, Canada uses a tiered system to calculate your taxes. This means that each segment of your income level is taxed at a different rate. For 2013, the federal tax rates are as follows:

  • 15% on the first $43,561 of taxable income, +
  • 22% on the next $43,562 of taxable income (on the portion of taxable income over $43,561 up to $87,123), +
  • 26% on the next $47,931 of taxable income (on the portion of taxable income over $87,123 up to $135,054), +
  • 29% of taxable income over $135,054.

As a general example, if you have taxable income of $50,000, the first $43,561 will be taxed at 15% plus your provincial tax rate(in Alberta, this is 10%). The next $6,439 will be taxed at 22% plus your provincial tax rate.

This is the basic calculation. To further reduce your tax obligation, the government gives you entitlements to non-refundable tax credits. These tax credits differ from tax deductions. Tax credits reduce your tax payable. Tax deductions reduce your taxable income base as discussed above. Generally speaking, for every dollar you are allowed in tax credits for the year, 15% of this plus your provincial rate(in Alberta, this is 10%) will be applied against your calculated tax liability. Therefore, it is quite clear where the savings can lie. Overall, you will save more money dollar for dollar with a tax deduction rather than a tax credit.

 

In the coming weeks we will discuss some of the different tax credits and tax deductions available to you and how and why you should take advantage of them. So please keep checking back and follow us on Facebook, GooglePlus, and Twitter!

 

If you would like more information on the above we would gladly be able to assist you with your needs.