Manage Quarterly Instalments and Maximize Investment Opportunity
by Evelyn Jacks
Several years ago an elderly gentleman came to me with a simple question:
“Is there anything
I can do to reduce my quarterly instalment payments to the tax department?”
In his hand was a billing notice from the Canada Revenue Agency (CRA)
with a stunning number on it: $80,000, the amount of his next instalment
payment. It turns out that this pensioner had sold shares in his small
business the previous year, recording a large one-time capital gain. However,
the CRA assumed his income would be the same the following year and was
billing him accordingly.
Indeed, the gentleman had already made one $80,000 payment to the CRA,
effectively giving the government an interest-free loan of money that
he could have been investing. He didn’t know that he had the ability
to reduce his instalments to reflect his current income situation. All
it took was some paperwork to straighten out this situation.
If you are concerned about the size of your instalment payments, or think
you might be overpaying, there are three things you need to know to maximize
your rights to pay only the correct amount of tax throughout the year:
Step 1: Understand the Instalment Options.
CRA will have automatically generated a bill for quarterly instalment
payments (called the “no calc option”) if you owed more than
$2000 in the current tax year (2003) and in either of the two preceding
tax years (2002 or 2001) when you filed your 2003 tax return.
In the first year you fall into the instalment payment profile, you will
get only one notice in August and it will ask for 50% of the taxes you
owed on last year’s income to be paid on each of September 15 and
December 15. Ouch!
In subsequent years, you will receive two reminders: one in February,
reminding you of your remittance requirements on March 15 and June 15;
and one more in August, to tee up for the September 15 and December 15
payments. (Farmers may make only one instalment payment, on December 31.)
CRA’s billing notice serves as an important reminder for you to
pay tax or visit your financial advisor or tax expert. You should ask
for a calculation of an up-to-date projection of the taxes you will owe
for the current year. You can then do a little tax and investment planning
to reduce those instalments owing before year end by choosing one of the
two other options for meeting your obligations: 1) the prior year option;
or 2) the current year option.
Under the prior year option, your instalment payments are based on last
year’s income source and level. In notifying CRA to adjust its records,
you are indicating that you are expecting a level of income similar to
last year’s, but one that also decreased over what was reported
in the previous two years. Your new quarterly instalments are then based
on the 2003 taxes. On each instalment due date, one-quarter of last year’s
tax and Canada Pension Plan liability is remitted. (In the first year
you fall into the profile, remember, you will need to remit one-half of
your taxes on September 15 and one-half on December 15.)
CRA will not charge any interest under this option even if it turns out
you’re short on your instalments when you actually file your 2004
tax return next spring. You will, however, be charged instalment interest
if the instalments are late or less than what they should be under the
prior year option. Those interest payments are charged at the prescribed
rate of interest and compound daily, so you’ll want to avoid them.
Prepaying your next instalment or overpaying it can offset interest charges.
Under the current year option, you can estimate the actual income you
expect to report this year, as well as your net taxes owing for 2004,
and add to this any Canada Pension Plan contributions you may have to
make. However, this time, even if you pay your instalments on time and
in full based on this calculation method, CRA will charge you interest
if you owe more when you actually file your 2004 tax return.
It is important to keep a copy of your cancelled cheques or other notices
of payment in a safe place, as it can happen that CRA credits your account
for the wrong taxation year or otherwise incorrectly records your payment.
A summary of your instalments will then be sent in February 2005. This
is an important document that is the source of the instalment tax credit
that offsets taxes owing on your 2004 tax return, so keep it with your
To help you compute your instalment payments under the current or prior
year methods, CRA provides a chart in its publication P110 Paying Your
Income Taxes by Instalment (see sample below). However, it will likely
pay to ask your advisor for help with this, as there may be more you can
do by year-end to minimize your taxable income.
Step 2: Concept and Action.
There can be many reasons you may find yourself in an instalment payment
profile now or when you file your return next spring. Perhaps you don’t
have enough taxes withheld at source, as is the case with many pensioners,
investors, new alimony recipients, and rental property and unincorporated
small business owners. Or you may become aware of an unusual receipt of
income between now and the end of 2004, as was the case with the elderly
gentleman who sold his business.
In other cases, the increase can come from unexpected bonuses from employment
or investment income, a lump-sum withdrawal of RRSP or RRIF amounts, or
even having several jobs during the year.
You can minimize your exposure to the instalment tax profile by focusing
now on reducing taxes owing at April 30, 2005. Ask your advisor about
specific strategies for your income and family filing profile and these
questions in particular:
- What is my estimated taxable income for the year and estimated federal
and provincial taxes payable?
- Have I remitted enough tax at source or through instalments?
- If not, do I have any additional RRSP contribution room to offset unusual
income? (If so, plan to make the contribution before March 1, 2005.)
- Should I consider the addition of Labour- Sponsored Venture Capital
Tax Credits for additional tax offsets?
- Should we be considering year-end tax loss selling to offset capital
- Do I have any capital loss carry forward balances to use against capital
- Can we control the timing of investment income?
- Is there an opportunity for income splitting with a spouse?
- Should new medical expenses such as dental work or new glasses, or
political or charitable donations, be initiated before December 31?
- In the case of a commissioned salesperson or a proprietor, can net
income be reduced by generating operating expenditures and/ or capital
acquisitions before year-end?
Step 3: Invest, Save Tax Dollars and Create
Any time is a good time to review your instalment payment profile, but
the second half of the tax year is prime time – before the September
15 and December 15 payments. Never overpay your quarterly tax instalments.
Use planning to stay out of the instalment profile if possible. If not,
pay only the correct amount – not one dime more – and invest
Calculation Chart for Estimation of 2004 Instalment
Source: P110 Paying Your Income Taxes by Instalment from CRA website.
Note: The line references are from the General Return or Notice of Assessment
or Notice of Reassessment.
Net federal tax (line 420) $ _____ 1
Old Age Security (OAS) repayment (from line 422) + _____ 2
Provincial or territorial tax (line 428) + _____ 3
First Nations tax (line 432) + _____ 4
Total payable (add lines 1 to 4) = _____ 5
Total income tax deducted (line 437)
(Quebec residents use line 439) _____ 6
Refundable abatements (line 440 plus line 441) + _____ 7
Refundable medical expense supplement (line 452) + _____ 8
Refund of investment tax credit (line 454) + _____ 9
Part XII.2 trust tax credit (line 456) + _____ 10
Provincial or territorial tax credits (line 479) + _____ 11
Total credits (add lines 6 to 11) + _____ 12
Net tax owing (line 5 minus line 12) = _____ 13
CPP contributions payable (line 421) + _____ 14
Total instalment amount due (lines 13 plus line 14) = $_____ 15
Evelyn Jacks is the author of 30 best-selling books on the subject of personal income taxation, and the President of Knowledge Bureau, Inc., Canada’s leading professional education publisher in the tax and financial services industry, specializing in delivering courseware and information services to knowledge-based practices. For more information call toll free 1-866-953-4769 or visit www.knowledgebureau.com.
This article is written to be of a general nature and neither the author, her company, employees, subcontractors or others associated with The Knowledge Bureau can take responsibility for any results, positive or negative, taken by any persons. While the author received a fee to write this article, she is not in the business of providing advice on investment products and is not registered and licensed to do so, nor does the author have any compensatory relationship, or beneficial ownership
regarding the sale of investment products discussed herein