Most people who are employed with one company, and have no other sources of income, do not have to worry about making instalment payments. Employers have an obligation to withhold appropriate income tax from their employees. At the end of the year, the T4 slips report the total income earned along with the total amount of income tax already withheld by the employer at source and periodically remitted to Canada Revenue Agency (CRA).
There are situations where individuals have income from activities other than employment. In many of these cases, tax is not withheld at source, meaning that you may have to pay tax at the end of the year. Examples of situations that can result in instalment payments include: self-employment income, RRIF payments, Old Age Security payments, Canada Pension Plan (CPP) benefits, rental income, certain pension income, and investment income. Individuals who work more than one job may also have an insufficient amount of tax withheld, as each employer has based the withholding tax on payroll tables and income from the one job.
If the above sources of income do not create a tax liability, then no instalments are necessary. If however, your net tax owing is more than $3,000 in the current year, or in either the previous two income tax years, chances are CRA will be sending you an instalment reminder notice. The notice will map out the required income tax payments that CRA requests on the following dates: March 15, June 15, September 15, and December 15. If these payments are missed, and taxes are owed at the end of the year, then interest and penalties may apply.
The instalment payments are to cover tax that you would otherwise have to pay in a lump sum on April 30 of the following year. Instalments are not paid to CRA in advance, but are paid throughout the calendar year (on the dates noted above) in which you are earning the taxable income. The tax instalments are requested because either no tax is withheld on some of your income or the income tax is being withheld is not sufficient.
Speaking with a financial advisor and accountant about instalment payments can often result in some helpful tips on ways to reduce your net tax owing, or even eliminate the need to make the CRA scheduled instalment payments. The easiest way to reduce your net tax owing is by voluntarily making instalments in those years where you know you owe tax. Other easy ways include having tax withheld, or by increasing the amount of tax withheld, from certain types of income. We will use three different individuals (John, Susan, Wayne) to illustrate three ways to avoid the scheduled CRA instalment payments.
John is turning 65 and he will soon collect both Canada Pension Plan (CPP) and Old Age Security (OAS). In talking to John we explained to him that the monthly CPP and OAS payments will be automatically deposited into his bank account on set dates near the end of each month. We also discussed with John that the default for these monthly payments is to receive the gross amount each month. We will assume for illustration purposes that the gross monthly CPP and OAS amounts are $600 and $550, respectively. Combined, this will increase John’s income by $1,150 per month or $13,800 per year. He is in the 30 per cent income tax bracket and the projected additional tax will be $4,140. One option John has is to visit a Service Canada office and request Form ISP-3520, Request for Voluntary Federal Income Tax Deductions Canada Pension Plan (CPP) and Old Age Security (OAS). A copy of this form can also be obtained by calling toll-free 1-800-277-9914. On this form, John can request that Service Canada deduct a specific amount, or percentage, of income deducted from each monthly payment. Form ISP-3520 can also be used to change the amount or the percentage at a later date. The form takes one or two minutes to complete. As an example, John can request that 30 per cent be withheld from both the gross amounts of $600 (CPP) and $550 (OAS) for income tax. Every month, John would receive net amounts of $420 (CPP) and $385 (OAS), which is net of income tax withheld. At the end of the year, both the CPP and OAS income tax slips would show a combined $4,140 of income tax withheld. John doesn’t have to scramble the following April to find money for income taxes, and also eliminates the need for John to make quarterly instalments the following year.
Susan is a very busy realtor but like many realtors has good and bad years. Some years, her income is very high and in other years her income drops significantly. Budgeting is critical for Susan because of her cyclical earnings. She is self employed and the commissions she earns on her real estate transactions can result in a significant income tax liability at the end of the year. Susan and her accountant have mapped out a good system that estimates the amount of tax that she will pay on her net income. Proactively Susan sends in payments to be applied to her instalment account for the current year to reduce her net tax owing to less then $3,000. This is Susan’s method of ensuring tax is set aside and also eliminates the need to make quarterly instalments the following year.
Wayne turned 71 last year and converted his Registered Retirement Savings Account (RRSP) to a Registered Retirement Income Fund (RRIF). Wayne’s RRIF account value at December 31 last year was $500,000 and his minimum RRIF payment this year is 7.48 per cent of $500,000 or $37,400 ($3,116.67 monthly). In talking to Wayne, we explained to him that the minimum RRIF payment is not subject to income tax at source but is taxable at the end of the year. Wayne is in the 30 per cent income tax bracket and we estimate that at the end of the year he will have $11,200 of income tax to pay ($37,400 x 30 per cent). This would trigger Wayne to come up with the lump sum tax by April 30 and he would also receive an instalment reminder to make instalments in the same year on March 15, June 15, September 15, and December 15. We recommended that Wayne have us withhold 30 percent of his monthly RRIF payments for income tax purposes. No specific form needs to be completed for the withholding to be set up, just verbal authorization from the client to the advisor. Wayne would receive $2,181.67 each month. At the end of the year, Wayne would receive a T4RIF income tax slip showing gross RRIF income of $37,400 and income deducted of $11,220. By setting up a set withholding amount (which does not have to be 30 per cent) then Wayne avoids having to make quarterly CRA instalment payments. Wayne can also cancel or change the withholding at a later date.