Understanding the Difference Between Tax Deductions and Tax Credits
When it comes to optimizing your tax return, understanding the difference between tax deductions and tax credits is important. Both can reduce your overall tax bill, but they do so in different ways-and knowing how to use each effectively can put more money back in your pocket.
What’s the Difference?
Tax Deductions reduce your taxable income. The lower your taxable income, the less tax you owe. Think of deductions as a way to lower the amount of income the government considers “taxable.”
Tax Credits, on the other hand, directly reduce the amount of tax you owe - dollar for dollar.
Deductions:
RRSP Contributions lower your taxable income now while allowing investments to grow tax deferred. For example, suppose you earn $80,000 and contribute $10,000 to your RRSP. If you’re in a 33% tax bracket, your savings would be: $10,000 × 33% = $3,300 in tax saved.
Other examples of deductions include Childcare Expenses that can be deducted (usually by the lower-income spouse) to reduce taxable income or Self-Employment Expenses, like home office costs or supplies, reduce income if you’re running a business.
Credits:
The Tuition Tax Credit is a non-refundable credit that can be claimed by students or transferred to a parent or spouse. For example, suppose you paid $5,000 in eligible tuition. The Federal tax credit is 15%, and most provinces offer around 5–10% extra. Assuming 20% combined: $5,000 × 20% = $1,000 in tax savings. Other examples of credits include the Disability Tax Credit (DTC), which reduces tax owed for individuals with qualifying disabilities or their caregivers and the Canada Workers Benefit (CWB), which is a credit for low-income workers that can increase your refund.
Note: Non-refundable credits reduce tax owing but can’t create a refund if you owe no tax, while refundable credits can result in a refund even with no tax payable.
Tips to Maximize Both
- Contribute to your RRSP to reduce income and grow savings tax-deferred.
- Keep receipts for medical, donation, and childcare expenses.
- File your return, even with no income-you may still qualify for refundable credits.
- Work with an advisor to catch opportunities you might miss on your own.
Final Thoughts
Understanding the mechanics of deductions versus credits is an essential tool when it comes to tax planning. While deductions help reduce the amount of income you’re taxed on, credits cut directly into the amount you owe, making both powerful options when used strategically.
At Green Private Wealth, we help clients make informed decisions throughout the year-not just at tax time. Whether it’s optimizing retirement contributions, managing taxable investments, or planning around income, we’re here to guide you.
Alex Gilmour
Investment Advisor
Green Private Wealth
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