Many people find Canada Revenue Agency’s instalment payment arrangements confusing. They get a letter saying they need to make an instalment payment after they have already paid their income tax bill, and don’t understand why CRA is asking for more money, since they have already paid.
In fact, it is because you had to pay income taxes when you filed your previous year’s tax return that you got an instalment payment reminder. If you owed more than $3,000 in income taxes last year, you may be asked to make instalment payments for the upcoming tax year. Instalment payments are a prepayment of income taxes for the current year, not a payment for the year just filed.
Instalment payments put people who don’t have tax deducted from income in the same position as employees who have tax deducted from every paycheque. People who have rental income, business income, investment income, and some types of pension income don’t have any taxes deducted, or not enough taxes deducted, so that when they file their income tax return they owe money.
You will be asked to pay instalments if your net taxes owning were more than $3,000 this year and more than $3,000 in either of the two preceding years. Instalments are normally due on March 15th, June 15th, September 15th and December 15th. The first year you make instalment payments, you usually have only two payments, on September 15th and December 15th.
CRA will calculate the required installment amounts and send an instalment reminder form in advance of each payment date. You can opt to pay one quarter of the net taxes owed last year on each quarterly instalment date, or you can pay one quarter of the estimated taxes based on your estimate of the current year income. Using the estimated current year income can be hazardous.
If you were required to make instalment payments, and you were sent an instalment reminder, and your payments were late or less than the required amount, you may be subject to interest and penalty. If you make payments equal to the amount on the instalment reminder, or equal to last year’s income tax payable, you will not be charged interest or penalized, even if the current year’s taxes exceed the instalment amounts.
If you estimate the current year’s income and pay instalments based on this estimate, you will pay interest on the difference between your instalment payments and the lesser of last year’s taxes, the CRA instalment reminder amounts, and the actual taxes owed. The interest rate is announced every quarter by CRA, and is currently (Aug 2009) 5%.
If the interest on late or deficient instalments is $1,000 or more, a penalty will be charged. The penalty is calculated according to a complex equation that ensures that the penalty is small if the interest amount isn’t too high, but rapidly increases.
Why are there so many options for instalment payments? Because taxpayer’s situations can be complex.
- If your income is pretty much the same from year to year, you can make instalment payments based on last year’s taxes payable, and end up not owing much or overpaying too much when you file your tax returns.
- If your income varies from year to year, and you don’t know until the end of the year how much you will owe, you can use either last year’s taxes payable, or you can use CRA’s figures which are based on a mix of the second prior year and last year.
- If you had an unusual year last year, which you don’t expect to repeat, you can estimate your taxes for the current year rather than having to use the prior year or CRA’s figures. Examples might be the sale of a rental property causing a capital gain, or a large one time payment.
If you are not sure what, if any, instalment payments you should make, talk to your accountant today. Leaving it until you file your tax return can be costly.