You’re an employee. Your employer diligently withholds tax, Canada Pension Plan (CPP) and Employment Insurance (EI), and remits these to the Canada Revenue Agency (CRA) on your behalf throughout the year, as required. You have just completed filing your taxes for the previous year, and success; you are getting a refund!
But hold the excitement; perhaps it’s time to stop and consider the facts. A tax refund could simply mean that you have overpaid your taxes for the year, and are effectively loaning money, interest-free, to the CRA. Then at tax time, the CRA repays this money to you under the disguise of a “tax refund”!
How did you let this happen? Well, you likely claimed tax credits and deductions on your tax return which your employer did not know about when your taxes were withheld at source. These credits and deductions decreased your taxes payable so that when you filed your tax return, the amount owing was less than what was remitted, resulting in a refund.
So, how does your employer decide how much tax to deduct from your pay cheque in the first place? When you begin employment, you complete Form TD1, Personal Tax Credits Return. Form TD1 assists your employer in calculating the amount of tax to deduct from your pay cheque based on your declaration of the non-refundable tax credits (tuition and education amounts, caregiver amount, spousal amount, amount for dependent children, etc.) to which you are entitled.
Invariably however, your personal circumstances will change. Important life events like getting married or having a baby may increase your credit entitlement, and hence, the amount of tax required to be withheld from your pay can in fact be lower than when you first began your employment. You should always complete a new Form TD1 (within seven days) whenever your personal circumstances change such that you are entitled to additional credits, or are no longer eligible for certain credits (I.e. your child reaches the age of 18 and you are no longer entitled to the amount for dependent children.) In fact, not doing so can result in a penalty of $25 for each day the form is late, with a minimum penalty of $100, and a maximum penalty of $2,500.
If you know you are going to have significant deductions from your income in a certain year: RRSP contributions, child care expenses, rental losses, support payments, employment expenses, carrying charges, charitable donations, etc., you can complete and submit to the CRA Form T1213, Request to Reduce Tax Deductions at Source. This form requests permission from the CRA for your employer to use the deductions you will be entitled to, in order to reduce your tax withholdings in that particular year. If approved, the CRA will provide a Letter of Authority (typically within four to six weeks of submitting Form T1213) that would be provided to your employer as confirmation to reduce tax withholdings. You can also use Form T1213 to request a reduction in tax deductions at source for certain non-refundable tax credits that are not part of Form TD1, such as foreign tax credits, which Form T1213 does not provide implicitly for. Note that the CRA will not usually issue a Letter of Authority if you have a tax balance owing or have not filed outstanding income tax returns.
Reducing your tax withholdings at source effectively increases your net amount of pay, so you get to take home more money every pay cheque throughout the year, when you’ve earned the money, and not at tax time, after the CRA has held this money on your behalf.