During the month of August, millions of Canadians received unexpected mail from the Canada Revenue Agency (CRA) containing an unfamiliar form—a 2014 Instalment Reminder. On that form, the CRA suggested to the recipient that he or she should make instalment payments of income tax on September 15 and December 15, 2014, and identified the amount which should be paid on each date.
Someone who has never before received an instalment reminder (or, quite possibly, doesn’t even know what a tax instalment is) and who receives mail from the CRA suggesting that tax monies are owed might well be both surprised and worried. The fact is, however, tax instalments are just another way of paying tax throughout the year, rather than when the tax return for that year is filed.
The reason that most Canadians are unfamiliar with instalment payments of tax is that most of them work as employees throughout their working life and income tax is deducted from their pay “at source”. Their employer deducts an amount for income tax from their gross pay, before any paycheque is issued, and remits that amount to the CRA on their behalf. When the individual files a tax return the following spring, he or she is credited with those tax payments which were remitted to the CRA on his or her behalf throughout the year. However, for those who are self-employed or, frequently, those who are retired, no such deduction is automatically made from their income, and the issuance of an Instalment Reminder by the CRA may be the result.
Canadian tax rules provide that where the amount of tax owed when a return is filed by a taxpayer is more than $3,000 ($1,800 for Quebec residents) in the current year and either of the two previous years, that taxpayer may be required to pay income tax by instalments.
The reason that first instalment reminders are issued in August has to do with the schedule on which Canadians file their tax returns. The figure for the immediate prior year can’t be known until the tax return for that year has been received and assessed by the CRA. The tax return filing deadline for individuals is April 30 (or June 15 for self-employed taxpayers and their spouses). Consequently, by the end of July, the CRA will have the information needed to determine whether a particular taxpayer should receive a first instalment reminder. In many cases, a first instalment reminder is triggered where an individual has retired within the past two years.
Take, for instance, the example of an individual who retired at the end of 2012 from employment in which tax deductions were automatically taken from his or her paycheque. Beginning January 1, 2013, that individual’s sources of income changed from employment income to Canada Pension Plan and Old Age Security benefits, and monthly withdrawals from an RRSP or RRIF, or pension payments from the former employer. In order for the amounts withheld from such income to match the taxpayer’s actually tax liability for the year, the taxpayer would have to have calculated the amount of that tax liability and made arrangements for withholdings to be made from one or more of the three or four income sources, to total that overall tax liability amount. For most taxpayers, that’s not a very likely scenario. Consequently, it would be almost inevitable that correct withholdings would not be made and that tax of more than $3,000 would be owed when the 2013 tax return was filed. Where the taxpayer’s income levels and withholding amounts are unchanged for 2014, and it is expected that, once again, more than $3,000 will be owed on filing the 2014 return, the criteria for the instalment requirement would be met, and a tax instalment reminder would be issued for the taxpayer after the 2013 return is assessed.
There is a reason that the form received by taxpayers is entitled Instalment Reminder, as those who receive it are not actually required to make instalment payments of tax. There are, in fact, three options open to the taxpayer who receives an Instalment Reminder, each with its own benefits and risks.
First, the taxpayer can pay the amounts specified on the Reminder, by the respective due dates of September 15 and December 15. A taxpayer who does so can be certain that he or she will not face any interest or penalty charges. If the instalments paid turn out to be more than the taxpayer’s tax liability for 2014, he or she will, of course, receive a refund on filing.
Second, the taxpayer can make instalment payments based on the total amount of tax which was paid for the 2013 tax year. Where a taxpayer’s income has not changed between 2013 and 2014 and his or her available deductions and credits remain the same, the likelihood is that total tax liability for 2014 will be the same or slightly less than it was in 2013, owing to the indexation of tax brackets and tax credit amounts.
Third, the taxpayer can estimate the amount of tax which he or she will owe for 2014 and can pay instalments based on that estimate. Where a taxpayer’s income has dropped from 2013 to 2014 and there will consequently be a reduction in tax payable, this option may be worth considering. Taxpayers who wish to pursue this approach can obtain the information needed to estimate current year taxes (provincial and federal tax rates and brackets) on the CRA website at http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html.
Many taxpayers who receive an Instalment Reminder are less than pleased about the fact that they are being asked to, as they see it, pre-pay their taxes for the year. But, in fact, in almost all cases they have been “pre-paying” taxes throughout their working lives, by means of source deductions. Source deductions are, however, more or less invisible to the taxpayer, as they are taken before any paycheque is issued, and actually writing a cheque or making an e-payment to the CRA for taxes feels much different.
However, while no one actually likes paying taxes, by any method, making tax payments by instalments can actually help taxpayers, particularly those who are juggling multiple income sources for the first time, with budgeting and managing cash flow. Because most Canadians don’t have to think about setting money aside for income taxes during their working lives, they don’t always include them (or include them in sufficient amounts) when planning a budget when they first retire. There are few financial surprises more unwelcome than finding out that a large amount is owed when the tax return for the year is filed. For most, it’s an annoyance and an aggravation. For those who live on a fixed income, however, being faced with a significant bill for taxes owed on filing can create real financial hardship. Receiving an instalment payment reminder is, in effect, a reminder that if taxes are not being withheld from income amounts paid to the taxpayer throughout the year it is necessary to make some provision for those taxes, in order to avoid having to come up with the entire amount when the return for the year is filed the following spring.
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation