Don’t Fear Your Income Taxes (& How To Make Sense of it!)
One of the biggest wins that we gain along our financial education journey is empowerment. The amount of confidence that is gained from new knowledge and skills can be extremely powerful and life changing.
One of the most challenging and overlooked areas of personal finances are income taxes. When learners are confronted with understanding taxes it can quickly seem like an overwhelming system. It also doesn’t help that it can trigger deep seeded emotions or appear to be boring.
Taxes can feel a lot like being in the circus – you have to jump through a bunch of regulatory hoops while at the same time you hope that you don’t get eaten by the CRA lion.
This anxiety and fear can prevent learners from benefiting from understanding how taxes work and how to take advantage of the legal opportunities out there. It can also lead to a tax filing fee every year that could be avoided.
Well, I’m here to say that doesn’t need to happen. In many cases, understanding how income taxes work doesn’t need to be that complicated. You’ll kick those negative emotions to the curb and actually become excited about understanding how taxes work.
The benefits from learning about taxes is massive and will compliment your whole financial journey. Choices like understanding if investing in a TFSA or RRSP is better for you, or comparing the after-tax returns on investments will suddenly make sense.
You’ll also catch yourself randomly making tax savings recommendations to your friends and family. Friend buying a house? There’s a tax credit for that! Sister just had a child? Loads of tax benefits for that.
Doing Your Income Taxes Has Never Been Easier!
Plus, filing your taxes online has never been easier! I still remember filing my taxes through a paper form when I was working at my first job and how tedious it was.
Now, there are so many legal websites that can help you do your taxes for free or for a marginal amount like $30. Very often, companies will offer free filings for students, those with income under $20kish, first time filers and those with just T4s.
It’s so easy to do too! You basically answer a bunch of questions and fill in the boxes from all of your slips. The questions will then prompt you to access available tax credits and deductions.
When it comes to understanding the process, a big strategy is by doing your own income taxes and building off of that.
With that being said, there are many instances where you will have to use an accountant – such as if you have a small business or if you’re just stuck, but in many cases salaried employees can easily do their own taxes and you can even copy what previous year accountants did.
The Income Tax Process
So the first step is to look at the big picture and then work down.
The basic system of taxes is that you first calculate your taxable income which then yields how much you have to pay in income taxes. This tax amount owing includes federal and provincial or territorial taxes.
This tax amount owing is then reduced by tax credits and withheld taxes from your paycheque or installment payments.
If you underpaid, you owe – if you overpaid – you get a refund.
In a sense, tax filing season is more of a time to review if you paid enough taxes or over paid throughout the year.
Digging Deeper Into Your Income Taxes
Going deeper we can look more in detail at each section
You first aggregate all of your taxable income – such as from work, a business, investments and more. This is called your total income. All of the T slips are playing their part here – T4s, T4As, T5s, and so on.
For those that own a small business, the income that would be included here would be after business expenses are deducted.
After we total the income we apply income tax deductions – something that we speak about a lot on the show. The basic idea here is that specific eligible amounts directly reduce your total income that taxes are applied to.
Some of the common examples of income tax deductions are RRSP contributions, childcare expense deductions, work from home expenses, professional dues, in some cases moving expenses, spousal support payments and more.
Once all of these deductions are applied, you have your taxable income. This amount is run through the tax brackets to then see how much you are required to pay in taxes. Which remember, includes federal and provincial or territorial expenses.
The amount owing in taxes is then reduced by your tax credits. The amount is a percentage of the eligible amount – for example, many tax credits in Ontario are 20.05% of the total eligible amount.
The most common tax credits here income a first-time home buyers’ amount, medical expenses, the disability tax credit, the basic personal amount, tuition tax credit and more.
You then will have the final amount of annual taxes owing once these tax credits are applied. This amount is then reduced by the taxes that were withheld from your paycheque or installment payments.
Finally, you’ll get a return if more taxes were withheld from your pay than you own or you’ll owe if the opposite is true.
What is Next?
So that’s the basics on how the process works and you’ll see exactly how the math is done on your tax returns. The biggest ways that most people can save is by maximizing the usage of tax credits and deductions. Those that have a small business can also utilize expenses.
In the show notes we’ve included a link from the CRA that includes all tax credit and deductions. It also explains how to claim them.
Taking a look at these can allow you to take advantage of any during the current year and help you make tax smart moves in future years.
A big source of information also comes from the tax documents that are given to you once you make your filing. They list all of your types of income, tax credits, and deductions that you’ve used.
Having the understanding on how your tax base will then allow you to explore other areas of finance to understand them. This will help you navigate the taxes from investments, how to split income and much more.
Income Tax Resources