Tuesday, August 28, 2012

A Tax Installments Question

A reader, C.M., asks the following (lightly-edited) question about tax installments: 
I have a Canadian Tax question for you.

Question: Let says John pays $3685 as his amount owing on his 2011 tax return, and in May 2012 John gets a Notice of Assessment that says his Final Balance is Nil which is what he expects because he paid all the tax he owed that year.

Now John gets a letter in the mail August 18th from CRA saying out of nowhere he has to now pay tax installments of $1843 due September 15th and December 15th for the 2012 tax season, but this makes absolutely no sense as John already paid his tax owing in 2011 in full and you have until April 2012 to file your 2012 tax return.

History: John has been in the workforce for 25 years and never missed paying taxes once when they were owed and has never had a mistake on his returns.

To me this looks like a cash grab by the Canadian government well before the tax due date of April 30th, 2012. What does it matter to the government as long as you pay what you owe, if you owe any taxes by the tax deadline?

Thanks for any suggestions you can pass on.
Few people like tax installments; they feel like some sort of punishment. An important thing to keep in mind is that installments are not an extra tax. Whatever you pay in installments will reduce the amount owing at the end of the year.

In the example above, John is being asked to pay installments because he owed more than $3000 on his 2011 taxes, and he owed more than $3000 on either his 2009 or 2010 taxes. That’s all it takes to trigger CRA to ask for installments. It has nothing to do with your record of paying your taxes on time over the years.

That said, the reason why installments exist has to do with the government making sure it gets paid. Imagine if payroll taxes didn’t exist and CRA tried to collect from everyone at the end of the year. Millions of Canadians wouldn’t have enough money to pay their taxes and CRA would have an impossible job of debt collecting.

The goal of payroll taxes is to collect the right amount through the year so that each taxpayer owes or is owed little at the end of the year. However, there are many types of income not subject to payroll taxes, such as investment income. The installment system exists to smooth out the collection of taxes owing through the year instead of trying to collect everything at the end of the year.

The fact that a particular taxpayer, like John, is able to plan properly and pay his taxes owing at the end of the year is not considered. If he owes more than $3000 one year and also in one of the two previous years, then installments are triggered. Note that the installment amount CRA is asking John to pay adds up to his taxes owing for 2011. However, the installments go toward John’s 2012 taxes owing. The presumption is that his 2012 income will look similar to his 2011 income.

Depending on John’s income for 2012, he may not have to pay the installment amounts asked for by CRA. To understand how installments work and how much you actually have to pay, see a previous post on understanding income tax installments.


  1. So can you avoid mandatory tax installments by arranging to make voluntary extra payments throughout the year so you owe less than $3k in April?

  2. @Patrick: CRA ignores tax instalment payments for the purpose of determining whether you should pay instalments the next year. Perhaps they are clever enough to ignore voluntary extra payments as well.

    Employees can be more subtle about voluntary extra payments by choosing how to fill out their TD1 forms. I suppose that you could cleverly keep your final tax owing just under $3000 each year (or even 2 years out of 3 to avoid triggering instalments), but this sounds like a lot of trouble for minimal gain. Also, things may not go well if a CRA employee figures out what you are doing.

  3. It's also rather amusing that while many Canadians delight in getting a large tax return, the government is not willing to let somebody else hold onto their money interest free for an entire year.

  4. This is off topic but I thought you'd like it because I know you like loopholes and finance:

  5. @Lewin: That was a fascinating story. Caramadre is no angel, but I think the insurance companies have nobody to blame but themselves. Their response should be to change their products and to fire some of their people for gross incompetence.

  6. ^^Agree completely. I love the judge that dismissed the civil cases. "Are you really arguing that you didn't know your own contracts, ones you wrote?"