September 30 is a critical deadline for many Canadians. Over the summer, the Canada Revenue Agency further extended the payment due date to Sept. 30 for taxes owing on 2019 personal tax returns, which are ordinarily due by April 30.
But, 2020 being no ordinary year, the government, as part of its COVID-19 relief programs, has confirmed that penalties and interest won’t be charged as long as payment is made (and returns are filed) by the new, extended Sept. 30 deadline.
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Sept. 30 also marks the deadline for making both the June 15 and Sept. 15 quarterly personal tax instalments. According to the CRA, approximately 1.8 million individuals in 2019 were required to pay income tax by instalments.
But before rushing out to make those instalment payments (or logging in to pay them online), you may want to take a few moments this weekend to determine whether such payments are even required for 2020, especially if your income has significantly declined in 2020 versus the prior year as a result of the COVID pandemic.
Under the Income Tax Act, quarterly tax instalments are required for 2020 if your “net tax owing” this year will be more than $3,000 ($1,800 for Quebec tax filers) and was also greater than $3,000 ($1,800 for Quebec) in either 2019 or 2018.
The definition of net tax owing is a bit convoluted, but essentially refers to your net federal and provincial taxes, less income tax withheld at source, plus any Canada Pension Plan contributions and Employment Insurance premiums on self-employment earnings (if applicable), as well as adjustments for certain other credits and social benefit repayments.
There are three options that may be used to determine how much you need to pay each quarter: the no-calculation option, prior-year option and current-year option. Individuals can choose the option that results in the lowest payments.
Under the no-calculation option, the CRA calculated your March 2020 and June 2020 instalments based on 25 per cent of the net tax owing on your 2018 assessed return. The Sept. 15 and Dec. 15 instalments are then calculated based on the net tax owing from your recently filed (and hopefully assessed) 2019 return, less the March and June instalments already paid.
Provided you stick to the amounts the CRA tells you to pay and your instalments are remitted on time, no interest or penalties will be assessed, even if you do end up owing some additional tax when you file your 2020 tax return, in the spring of 2021.
This is the simplest option for you if your income, deductions and credits didn’t vary much in 2020 compared to the prior two years.
By contrast, the prior-year option bases the calculation solely on last year’s (2019) income. The 2020 instalments are based on your 2019 tax owing and you simply need to pay 25 per cent of the amount on each instalment date. This option is best if your 2020 income, deductions and credits will be similar to 2019, but significantly different than 2018.
How could this occur? Let’s say in 2018 that you sold your vacation property and reported a large capital gain, which wasn’t sheltered by the principal residence exemption. Your 2018 net tax owing would have been significant, but, since you presumably didn’t sell another vacation home in 2019, your 2019 net tax owing would have been significantly less (all other things being equal.)
Current year option
Finally, under the current-year method, you simply base your 2020 instalments on the amount of estimated tax you think you will owe for this year. You pay one-quarter of the estimated amount on each instalment date.
This option is useful if the income source that gave rise to instalments in a prior year no longer applies. For example, if you did a major rebalancing of your non-registered portfolio at the end of 2019 that triggered capital gains tax, but you expect to have all your 2020 income subject to tax deductions at source, you may not need to make any 2020 instalments, despite receiving an instalment reminder from the CRA. This may also be the best option if you are self-employed and your income significantly dropped in 2020 due to COVID.
The risk, however, is that if you calculate incorrectly, you could face arrears interest or even an instalment penalty.
Contrary to what some taxpayers think, paying tax by instalments vs. waiting until you file your return isn’t really an option — it’s required by law if you meet the criteria discussed above. If you choose to ignore the requirement, or pay less than you are told to pay, you could be hit with interest and an instalment penalty.
You will be charged interest if the government sent you an instalment reminder in 2020 that shows an amount to pay, you were required to pay tax by instalments because your net tax owing will be more than $3,000 ($1,800 in Quebec) and you either failed to make instalment payments, or you made payments that were late or were lower than what you were required to pay. Instalment interest is compounded daily at the prescribed interest rate, which is currently five per cent for overdue taxes.
The instalment interest clock starts ticking from the day your instalment was due and runs until your balance due date, or April 30 of the following year. Fortunately, the government chooses the instalment option that results in the least amount of interest.
An instalment penalty can apply when the instalment interest is more than $1,000. The penalty is calculated by subtracting from the instalment interest the greater of either $1,000 or 25 per cent of the instalment interest calculated if no instalment payments had been made for the year. Half of this difference is the amount of the penalty.
If you find yourself late in making an instalment or perhaps you missed an instalment altogether, you can reduce (or even eliminate) the interest charges and penalties by overpaying your next instalment payment or by paying it early. In doing so, you will earn instalment credit interest. This credit interest is not refundable, but it can be used against any interest charges on late payments for the same tax year.