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Some of you may be receiving letters from the Canada Revenue Agency (“CRA”) titled Instalment Reminder. This may not agree with what the letter attached to your personal income tax return for the previous year said you had to pay. What are these letters and why should I care?
What are personal tax instalments? It is the amount of money that should be prepaid to the CRA to account for the tax on income not subject to withholding tax. Common sources include: pension income, investment income, capital gains, rental income and self-employment income. The amount is an estimate of the tax to be paid on such income.
You will be required to make instalments if you owed more than $3,000 for each of the past two taxation years. Instalments are to be remitted on a quarterly basis: March 15, June 15, September 15 and December 15. If an instalment reminder was not provided for March and June, 75% of the amount should be paid by September 15 and the remaining 25% paid by December 15.
How are personal tax instalment payments calculated? There are three options to calculate instalments payable:
No-Calculation Option: The amounts are automatically calculated by the CRA based on information in your latest assessed tax return. CRA’s option looks at your historical tax situation and does not account for any changes in your current tax situation.
Prior-year Option: Instalments are based on the prior year’s taxes owing. This would be a good method if income is similar to last year and is significantly different from other years.
Current-year Option: You estimate the current year tax balance owing to determine the personal tax instalment requirements.
The method not listed on the CRA’s instalment reminders is the second prior year option. This option calculates the first two instalments based on the second preceding year and the last two instalments based on the most recent year. This is the option your accountant will mostly likely recommend as it ensures no installment interest will be charged if the payments were made on time.
Personal tax Instalment interest will be charged if there were insufficient or late instalments made during the year. Interest is usually calculated on the balance due based on the payment option that results in the least amount of interest.
For both the Prior-year and the Current-year option, personal tax instalment interest will not be charged if payments are made by the due dates unless the amounts estimated were too low.
What should I do? Paying the amounts on the instalment reminders will guarantee no instalment interest will be charged. Should your income be lower than prior years, it may result in an excessive instalment balance. With proper tax planning, selecting the right option can optimize the amount of personal tax instalments to pay to minimize the balance owing or payable. You do not need to notify the CRA on which method you select.