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Smart Investor Tip of the Day
No one likes to pay taxes and so most look to ways to reduce such burdens. The most popular ways is to exercise tax credits and tax deductions. However, most people don’t know the difference.
A tax deduction lowers your income for that year and can potentially net you a refund from the government. The most popular form of tax deduction is an RRSP contribution. These types of tax deductions have a pre-set limit each year as determined by your earned income from the prior year (plus any available unused space from past years).
Now, non-refundable tax credits are a bit different. Instead of lowering your taxable income a non-refundable tax credit actually lowers the amount of taxes you would owe. So in other words if your credits outweigh your taxes owing you will not get back a refund cheque. These types of tax credits are determined by the amount being claimed against the lower marginal rate.
Although tax credits are good in most cases if a tax deduction is an alternative option one should seek to exhaust that first. A good example would be claiming a tax credit for a medical expense versus as a tax deductable business expense. If you own a business you can potentially claim virtually any medical bill as a business expense. As a small business there is a pre-set dollar limit each year that is tax deductible. Corporations do not have a set limit. If, alternatively, one had looked to write it off as a medical expense on a personal income tax form the amount saved would not only be claimed against the lowest marginal rate but would first need to exceed a minimum amount before the remaining is eligible for the credit.
So which is better? As discussed one would be best advised to look to combine both types together when available. But if it’s one or the other then try to make use of all tax deductible avenues first.