Tax Deductions versus Tax Credits
Both can be claimed by Taxpayers to reduce their tax liability – however they work in different ways. Deductions reduce the taxable income resulting in reduced taxes based on the tax brackets. Tax Credits are calculated based on one’s personal situation. Once tax is calculated – these credits are applied to reduce taxes. Total the Non-refundable Tax Credits and 15% credit is applied to reduce tax payable. Refundable Tax Credits are credits that are allowed to taxpayers even if they are not taxable.
To summarize, Tax Deductions reduce Taxable Income and Tax Credits reduce Tax Payable.
Example of Tax Deductions:
John Doe has a total income of $50,000. He contributed to RRSP a total of $2,500 and paid $750 as Professional Dues. So his net income is $46,750 after deducting a total of $3,250 (total of RRSP and Dues).
John received Workers Compensation Benefit of $2,000. Since this is income – it is included in Total and Net Income. However, since it is non-taxable income; it must be deducted to calculate Taxable Income – $44,750.
So Tax Deductions reduce Taxable Income from $50,000 to $44,750.
Example of Tax Credits:
John’s basic personal amount is $15,000 and Canada employment amount is $1,368 = total $16,368. Non-refundable Tax Credit is calculated at 15%; therefore, non-refundable tax credit is $2,455.20.
His tax payable is $44750 at 15% = $6,712.50. He can reduce his tax payable by non-refundable tax credits and his tax payable is now calculated at $4,257.30
So Tax Credits reduce Tax Payable from $6,712.50 to $4,257.30
Example of Refundable Tax Credit is Educator Credit or Refundable Medical Credit – These reduce tax payable or increase refund even if a taxpayer is not taxable.
