No one likes paying income taxes, and no one likes paying interest and penalties. However, if your net taxes owing after filing were more than $3,000, you may be requested by the Canada Revenue Agency (CRA) to pay income tax instalments, or else you could owe interest and penalties.
We see many cases with individuals who have sold a rental property or business or have investments which generates a significant capital gain. Items such as this represent a one-time spike in income, which are not going to necessarily repeat. One of the flaws with instalment notices is that it is simply an automated process based on the $3,000 threshold noted above and outlined in more detail below. The year after you have a one-off spike in income, many people are asked to make instalment payments.
You do not have to pay your income tax by instalments for 2022 if you know your net tax owing for 2022 will be $3,000 or less in British Columbia, even if you received an instalment reminder in 2022. Therefore, common sense should determine whether you pay instalments, not the CRA. It is always recommended to check with your accountant before skipping instalment payments or paying amounts that differ from what CRA has requested.
How instalments work
Twice a year, CRA sends out instalment reminder letters to those taxpayers who are asked to make payments. The February letter outlines the required payments on, or before, March 15 and June 15. The August letter outlines the requested payment amounts due on, or before, September 15 and December 15.
The February 2022 notice is based on your 2020 tax return. If you owed more than $3,000 in taxes in 2020, then you will be asked by CRA to make instalments on March 15 and June 15 through the February 2022 notice. CRA would not know what your income was for 2021 by the time the February notices are sent. Nor will they know what your income will be for the current year (2022).
The August 2022 notice enables CRA to adjust the numbers based on your actual 2021 net tax owing. If your net tax owing was less than $3,000 in 2021 then you will not be asked to make instalment payments on September 15 and December 15.
It is important to note that you will be requested to pay your income tax by instalments for 2022 if both of the following apply:
• your net tax owing for 2022 will be above $3,000 in British Columbia, and
• your net tax owing in either 2021 or 2020 was above $3,000 in British Columbia.
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 designed so that taxes are paid throughout the calendar year while you are earning the taxable income.
Common areas triggering instalment notices
If you are an employee, and have no other sources of income, you likely do not have to worry about making instalment payments. Your employer has an obligation to withhold appropriate income tax from your earned 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 you do have two jobs, when both incomes are combined you are likely in a higher tax bracket than the payroll table. This will normally result in taxes being owed at the end of the year. You can always request that your employer withholds a higher level of tax on a voluntary basis.
There are situations where taxpayers 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. This often impacts individuals who have multiple forms of income.
Examples of situations that can result in instalment payments include: self-employment income, Registered Retirement Income Fund (RRIF) payments, Old Age Security (OAS) payments, Canada Pension Plan (CPP) benefits, rental income, certain pension income, capital gains, and other investment income.
Speaking with a Portfolio Manager and tax advisor 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 withholding tax on certain forms of income on an automated basis. You can withhold tax on your RRIF income by talking to your Portfolio Manager. Another common strategy is to complete the “Request for Voluntary Federal Income Tax Deduction” form to have tax withheld on CPP and OAS.
Interest and penalties
For some people making the instalment payments is not a big deal, they simply make the four remittances a year on time. In order to make these instalment payments on time you have to be organized, have the funds previously set aside, and remit them to CRA on or before the required dates.
If taxpayers do not make the required instalments then they may have to pay interest and penalty charges. CRA charges instalment interest on all late or insufficient instalment payments. Instalment interest is charged at the posted prescribed rate (changes every three months) and compounds daily. CRA may also charge penalties if the taxpayer makes payments that are late or less than the requested amounts. Penalties normally apply when your interest charges are more than $1,000.
The worst part about these types of interest and penalty charges are that taxpayers cannot deduct these on their tax return – this is an absolute cost that is permanently lost.
Notice of assessments
One of the services we provide to clients is a review of their tax returns. 18 years ago we would ask clients to bring in tax returns and notices of assessment. For over 18 years we have been able to proactively get this information online, directly from CRA. One of the first documents that we read every year is the client’s notice of assessments. With respect to instalments, we look for three things:
1) Do they have a requirement to make instalment payments?
2) Were any interest or penalties assessed in previous years for not paying required instalments?
3) How can we help the client automate the process?
In some cases withholding tax on RRIF, CPP and OAS is not enough. Some clients do not wish to voluntarily send CRA any money ahead of time. One of the services we provide for clients with a non-registered account is the ability for us to pay their required instalment amounts directly from their investment account. We have access to the numbers on the CRA website and if a client has provided consent then we can take care of those payments on their behalf. This is particularly valuable for our clients who are busy, travelling, or aging. It is just another service that can be provided by a full-service brokerage team.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138, email email@example.com, or visit greenardgroup.com