Income taxes are a mystery to many Canadians. The Income Tax Act is over four-inches thick, making it nearly impossible to know everything about Canadian taxes, even for professional accountants. How much do you know about the taxes you pay? Here's a list of 10 Canadian tax questions to test your knowledge.
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1. Who has to file a tax return?
Not everyone has to file an income tax return, but you will if you have any of the following situations: You owe taxes, you sold capital property, you are splitting pension income with your spouse, you have to pay towards the Canadian pension plan (CPP) on self-employment earnings, you have to repay part of your Old-Age Security benefits, you still have amounts owing under the Home Buyers Plan or the Lifelong Learning Plan, or if you received certain advanced benefits. Even if you don't have to file, though, there are often good reasons to do so if you qualify for refundable tax credits.
2. Which spouse must claim the child-care deduction?
The deduction for day care, camp and other child-care fees must be claimed by the spouse with the least amount of taxable income. If the other spouse is a full-time student or a full-time inmate in prison, however, the higher income spouse can claim the deduction. (Yields in excess of 10% aren't rare, but these unique investments need to be chosen very carefully, see An Introduction To Canadian Income Trusts.)
3. What happens if your medical expenses aren't high enough to claim?
Claiming medical expenses requires some planning. One spouse may claim all of the medical expenses, including those from themselves, their spouse and their dependent children. The challenge is that the sum of those expenses must be over 3% of your net income or $1,926, whichever is less. Claiming the deduction on the spouses' income tax return with the least income allows you to take the largest advantage. Also, you can choose your period of time if it is a 12-month period ending in the year. Choose the period with the most expenses.
4. Does being audited mean you have done something wrong?
There are many types of tax audits and most of them simply require that you provide proof or clarify information on amounts that you have claimed on your return. If you have kept all of your documentation and have only claimed expenses and credits for which you are eligible, there is nothing to fear from a CRA audit.
5. How many years back can CRA audit you?
You are required to keep your tax records and documentation for six years plus the current one. CRA can go back and audit the past three years under normal circumstances. However, if they think that there is fraud or deception happening, they can go back indefinitely.
6. Is it better to get a tax credit or a tax deduction?
A tax deduction reduces your taxable income at the highest marginal tax rate that you are subject to. For example, if you have $53,000 in taxable income, you are in the 22% tax bracket. Your deduction reduces your taxable income at that rate. A tax credit gives everyone a reduction of taxable income at the lowest tax rate (15%) so that everyone gets the same benefit regardless of their tax bracket. If you are in any tax bracket except the lowest, a tax deduction gives you more money back. (Find out how to get a tax benefit from your mortgage like many Americans have, check out Creating A Tax-Deductible Canadian Mortgage.)
7. If you earn more income, is it possible to pay more in taxes than the extra you make?
This enduring myth has been responsible for all kinds of odd behavior, such as turning down overtime hours at work because of the worry that it will result in a net decrease in one's paycheck. Canada works on a marginal tax rate system, which means that you pay an increasing percentage of your income to federal and provincial tax authorities as your income rises. However, it is always a percentage and will never be more than the income itself. In 2010, the top federal tax rate was 29%.
8. Are lottery winnings taxable?
In Canada, lottery winnings are not considered to be taxable income. There are a few exceptions to the rule, however, for those who earn their living by placing bets. CRA considers that business income. If your ticket wins the big prize, though, you do not have to pay taxes on it.
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9. Can you claim your pets as dependants?
You can never claim a pet as a dependent. Dependents must be human. You may, however, be able to claim the costs of purchasing and maintaining a service animal if you require one to help you due to vision or other disability issues.
10. What are the penalties for filing returns or paying taxes late?
CRA charges interest on all taxes due at its prescribed rate that changes quarterly. If you have already filed your return and have not yet paid the balance, interest will continue to accrue until you pay it. If you file your return late, CRA charges a late-filing penalty of 5% of the balance owing plus 1% extra for every month or part-month the return isn't filed. If it is your second offense in four years, CRA has little sympathy. The penalties double to 10% plus 2% per month.
The Bottom Line
Remember, you don't need to memorize the Income Tax Act to file your own taxes. But by knowing the answers to the previous questions, you'll be able to prepare yourself for tax time throughout the year and not find yourself scrambling for information and receipts come tax-deadline day.
(For more Canadian tax tips, check out Tax-Saving Tips For Canadian Taxpayers.)