Written by Preet Banerjee
Friday, March 20th, 2015
There are few things more taxing than trying to figure out the tax laws in Canada. For example, a tax deduction and a tax credit may sound like the same thing, but they're slightly different.
Deduction vs. credit
A tax deduction reduces the amount of income that is subject to income tax, but a tax credit reduces the amount of tax owing. Again, that sounds like it might be the same thing, but it's best to demonstrate with an example.
Since each province or territory has slightly different tax rates, for the purpose of this example, we'll only look at the federal portion of income taxes payable. But note that deductions and credits can also apply to various provincial and territorial income taxes as well.
The federal portion of income tax is calculated as follows (2019 tax year):
15% - Up to $47,630
20.5% - $47,630 up to $95,259
26% - $95,259 up to $147,667
29% - $147,667 up to $210,371
33% - Amount over $210,371
If someone earned exactly $47,630 (the cut-off for the 15% tax bracket), they would be subject to $7,144.50 in federal income tax. If someone was earning $75,000, that puts them into the 20.5% federal income tax bracket, but the first $47,630 will still be subject to tax at the 15% rate. Only the amount over $47,630 would be subject to the higher income tax rate.
Based on this schedule, if someone were earning $150,000, they would owe $31,211 in federal income tax.
Now let's look at how a $10,000 tax deduction would reduce the final tax owing, and compare that to a $10,000 tax credit.
A $10,000 tax deduction would reduce the amount of income subject to tax by $10,000. So our $150,000 income earner would now only have $140,000 of income subject to tax. Instead of paying $31,211 in federal income tax, they only pay $28,541. They have saved $2,670 in tax.
Probably the best known example of a tax deduction would be an RRSP contribution. In the above example, a $10,000 RRSP contribution would generate the $2,670 in federal tax savings and there would be similar tax savings at the provincial or territorial level.
A $10,000 tax credit amount requires an extra step before we can figure out the actual tax credit. Any amount eligible for a tax credit generally creates a federal tax savings based on the lowest tax bracket, 15%. So a $10,000 tax credit amount will generate a $1,500 actual tax credit against federal taxes owing, which means your tax bill is lower by $1,500 ($10,000 x 15% = $1,500). This calculation is the same no matter what tax bracket you're in.
An example of a tax credit would be the medical expense tax credit. If your eligible medical expenses are more than $2,302 or 3% of your net income (whichever is lower), you may be able to claim the medical expense tax credit on the portion of those expenses above that threshold. So if your eligible expenses exceeded the threshold by $1,000 the federal tax savings would be $150, or 15% of the $1,000 eligible amount.
A tax deduction is more valuable if your income is higher since it reduces tax at your marginal tax rate. But if you're in the lowest tax bracket, a deduction and a tax credit are essentially the same since the 15% rate used to calculate the credit is the same as the lowest federal tax bracket.
Non-refundable vs. refundable tax credit
One last point: tax credits may be refundable or non-refundable. A non-refundable tax credit can only reduce any taxes owing. So if you had a $1,500 actual tax credit, but only owed $1,000 in taxes, it would reduce your tax bill to $0. If that actual tax credit was refundable, you would additionally receive a $500 tax refund.