With most taxpayers having already filed their 2020 tax returns (self-employed workers and their spouses or partners have until June 15 to file), the next tax event is the second quarterly tax instalment for 2021. In February, the Canada Revenue Agency (CRA) sent out reminders to taxpayers who are required to pay quarterly tax instalments. The first instalment was due March 15 and the second is due June 15. According to the CRA, approximately 1.8 million individuals are required to pay income tax by instalments annually.
Under the Income Tax Act, quarterly tax instalments are required for this tax year if a taxpayer’s “net tax owing” for 2021 will be more than $3,000, and they also owed more than $3,000 in either 2020 or 2019. (For tax filers in Quebec, the threshold is $1,800 owing.)
The definition of net tax owing is somewhat complex, but it essentially refers to net federal and provincial taxes, less income tax withheld at source, plus any Canada Pension Plan contributions and employment insurance premiums on self-employment earnings (if applicable), as well as adjustments for certain credits and social benefit repayments.
There are three options that may be used to determine how much taxpayers need to pay each quarter: the no-calculation option, the prior-year option and the current-year option. Clients can choose the option that results in the lowest payments.
Under the no-calculation option, the CRA calculated the March 2021 and June 2021 instalments based on 25% of the net tax owing on the 2019 assessed return. The Sept. 15 and Dec. 15 instalments will then be calculated based on the net tax owing from the recently filed 2020 return, less the March and June instalments already paid.
By contrast, the prior-year option is based solely on last year’s (2020) income. The 2021 instalments are based on the 2020 tax owing, and taxpayers simply need to pay one-quarter of the amount on each instalment date. This option is best if the individual’s 2021 income, deductions and credits will be similar to 2020 but significantly different from 2019, perhaps because they sold securities in 2019 and reported significant capital gains.
This option may also suit self-employed workers whose income dropped in 2020 due to the Covid-19 pandemic, and who continue to be affected this year.
Finally, under the current-year method, taxpayers simply base their 2021 instalments on the estimated amount of tax owing for this year and pay one-quarter of that estimated amount on each instalment date. This option is useful if the taxpayer’s 2021 income will be significantly less than 2020 (perhaps due to Covid or sales of securities in 2020, for example).
Provided taxpayers make the required instalments and they are remitted on time, no interest or penalties will be assessed. Taxpayers who ignore the instalment reminders could be charged instalment interest and, in some cases, an instalment penalty.
Instalment interest is compounded daily at the prescribed interest rate, which is currently 5% for overdue taxes. The instalment interest clock starts ticking from the day the instalment was due until it’s paid (or, if unpaid, until April 30, 2022). Fortunately, the government chooses the instalment option that results in the least amount of interest. And, if clients pay future instalments early, they may be able to offset interest on other instalments that were paid late.
An instalment penalty may also apply if the instalment interest is more than $1,000. The penalty is calculated by subtracting from the instalment interest the greater of either $1,000 or 25% of the instalment interest calculated if no instalment payments had been made for the year. Half of this difference is the amount of the penalty.
Financial advisors can play an important role when it comes to instalments, both in discussing instalment requirements for 2021 that may be based on isolated high-income events (like the sale of stock), as well as by ensuring clients have sufficient cash or liquidity on each instalment date to make the required payments on time.
Jamie Golombek, CA, CPA, CFP, CLU, TEP, is managing director, tax and estate planning, at CIBC Private Wealth Management in Toronto