April 24th, 2007
Blurb: Last year the federal government paid out billions of dollars in tax refunds. But not all recipients should be gleeful.
Why tax refunds are not always a good thing
By Peter Diekmeyer • Bankrate.com
With tax season in full steam, mailboxes across the country are currently being stuffed with refund checks and assessment forms, a process that will only accelerate as we move closer to the April 30th filing deadline. Clearly, Canadians who will be getting refunds will be happier than those who are told they need to pay more. However according to one expert, they should not be too gleeful.
“In many cases, if you are getting a tax refund, it’s because you paid too much money to the government to begin with,” said Aurele Courcelles, a senior specialist, (tax & estate planning) with Investors Group. “Remitting too much through excess source deductions or tax installments is like making a credit card pre-payment, even though you don’t owe anything. It’s like giving the government an interest free loan”
How tax refunds work
Excess tax payments to government are no small matter. According to the Canada Revenue Agency, close to $22 billion was refunded to 16.4 million Canadians last year. A good chuck of those excess payments could have been avoided, if the recipients had managed their financial affairs properly.
According to Courcelles, one of the primary causes of tax refunds, excess remittances to governments, originate from several sources. “One common reason is if your tax status changes during the year and your employer is not notified,” says Courcelles. “For example if you or your spouse gives birth during the year, you are likely entitled to a reduction in the source deductions made from your weekly pay. A similar situation occurs when an individual makes a lump sum RRSP contribution.”
According to Beatrice Fenelon, a spokesperson with CRA, not all of the refunds that Canadians get are due to excess source deductions. “If tax reductions, new deductions or other changes are announced in a federal budget that is released during the taxation year, it could affect your refund,” says Fenelon, “especially if those changes take effect immediately.”
All salaried employees in Canada need to fill out a form called the TD1, which provides their employer’s payroll department information that it uses to estimate the amount of taxes that are deducted from their paychecks. When calculating those taxes, the employer make some reductions in respect to tax credits or deductions that you can claim when you file your return, such as for the basic personal amount, which is automatic and applies to all Canadians. Other reductions from the total taxes withdrawn from your paycheck, such as the age, pension and disability amounts are only available to certain individuals.
Employer withheld RRSP contributions
Courcelles’ concerns regarding the interest free loans that many Canadian tax refund beneficiaries make to the federal government are not due merely altruistic. Like many mutual fund companies, Investors Group uses the “interest free loan,” argument, to market a service by which employers can deduct RRSP contributions from individual employees’ paychecks directly. If that happens, the amount of federal and provincial tax that is deducted from their paychecks is reduced accordingly.
For example to make a lump sum $5,000 RRSP contribution, an ordinary Canadian needs to save $100 a week for 50 weeks. If he is in the 40% combined federal/provincial tax bracket, his tax refund, related to that contribution will be $2,000. However, through an employer RRSP plan, the contributions are deducted from his paycheck each week and his paycheck is reduced by only $60 per week, not $100.
According to Courcelles, advancing RRSP contributions to a weekly, instead of a lump-sum basis, can yield impressive savings. If you contribute $500 per month for 30 years into an RRSP, instead of making lump sum annual payments for 30 years, your RRSP will be worth close to $12,500 more at the end of the period says Courcelles ($202,500 instead $190,900). That’s not too bad.
Other ways to reduce tax refunds
Of course traditional TD1 claims and specialized RRSP employee deduction plans are not the only way to reduce the amount of tax that you prepay to governments. Individual Canadians can also make a direct waiver request, for reduced source deductions, to the CRA. However to do so, they must provide evidence that the amount currently being deducted from their paychecks will be more than enough than what is required to fulfill their tax obligations.
If you are paying out significant amounts of money for childcare or employment expenses, are incurring rental property losses, paying alimony or making substantial charitable donations, you may be eligible to have your source deductions reduced. To do so you need to file a T1213 form with CRA.
Of course reducing the amount that you advance governments isn’t a panacea. Many Canadians regards their lump-sum tax refunds as a sort of forced savings plan, which they spend on special items such as vacations or furniture when the checks come in.
For them, getting one check at the end of the year is a lot easier than it is to put aside a small amount of cash each week. They may lose out on the interest while the government is sitting on the cash. But at least the money is there at the end of the year.
Peter Diekmeyer (www.peterdiekmeyer.com) a freelance business and economics writer.
|© 2007 Peter Diekmeyer Communications Inc.|