To understand tax instalment requirements imposed by CRA this article will tell a story about Pam who was employed and earned a bonus from her employer that she used to invest in the stock market. She sold some stocks and earned a $30,000 capital gain during the year and had to pay $4,500 of tax on the gain when she filed her tax return. The next year she sold more of the stock and earned a $40,000 capital gain that she had to pay $6,000 of tax on the gain when she filed her return. She was then shocked when her accountant told her she not only owed $6,000 of taxes for the year, but that the CRA also required her to make instalment payments for the next year.
Why do I have to pay tax instalments?
The reason Pam is required to pay tax instalments is that taxpayers whose net tax owing is greater than $3,000 twice within a 3-year period are required to make instalments for the coming tax year. These instalments are prepayments of tax, similar to payroll taxes being remitted throughout the year on wages earned from employment, that would normally be paid when the annual tax return is filed.
How are tax instalments calculated?
There are three options of calculating tax instalments, no-calculation options, prior-year option and current-year option.
The no-calculation option is best used when your income, deductions and credits are similar from year to year. The CRA will determine the instalment amount based on details from your last tax return and they will send out a reminder to provide those details.
The prior-year option is best used when you expect your current years income, deductions, and credits to be similar to the prior year, but different from the year before that. You determine your instalment amounts based on the total payable from the prior year. If you make payments before the instalment deadlines you will not be charged instalment interest or a penalty, unless the instalment payments actually made are too low.
The current-year option is best used when your income, deductions and credits will be significantly different than the prior two years. You determine your estimated income for the current year and pay instalments based your estimated taxes owing for the year. If you make payments before the instalment deadlines, you will not be charged instalment interest or penalty, unless the instalment payments made are too low.
Payment due date
Tax instalments are required on a quarterly basis on March 15, June 15, September 15 and December 15. If this is the first time you’ve been required to make tax instalment payments, you’ll be required to make your first payment June 15 and your last payment March 15 of the following year.
If your instalment payments are late or too low, you may have to pay instalment interest and penalties when you file your tax return for the year.
How to make a payment
Instalment payments can be made using the same options as paying your annual taxes; online, in person or by mail.
You can make an instalment online from your financial institution. To make a payment you log into your bank account, setup CRA as a payee using the “CRA(Revenue) Tax Instalment” option and enter your social insurance number as the account number. The processing time can be up to five business days so payments should be initiated well before the deadline.
You can make an installment payment in person at your bank; however, you will require a printed personalized remittance voucher. The voucher is mailed to you by CRA with the instalment schedule.
You can make an instalment payment by mailing your personalized remittance voucher with a Canadian cheque or money order
What happens if I don’t pay my tax instalments
If you don’t pay your tax instalments, you could be subject to interest and penalties. To illustrate this, we’ll provide different scenarios using Pam’s situation discussed at the beginning of this article.
Pam was informed by her accountant and CRA that she is required to pay $1,500 on June 15, September 15, December 15 and March 15 of the following year, for a total of $6,000. Pam decides not to make these payments and during the year she purchased a rental property and earned rental income. This rental income resulted in additional tax owing of $2,300 when she filed her annual tax return.
To avoid instalment interest, she should have paid $575 ($2,300/4) per quarter. The tax instalment interest is then calculated from the day each payment of $575 was due, until the balance due date (or April 30th) using the prescribed interest rate at the time.
She would also be subject to a penalty. Assuming her total instalment interest for unpaid instalments was $300, the penalty would be 25% x $300 / 2 = $37.50. Therefore, her total interest and penalty for not making any instalment payments would be $337.50.
Pam was informed by her accountant and CRA that she is required to pay $1,500 on June 15, September 15, December 15 and March 15 of the following year. Pam forgets to make the June 15th payment, but when she pays the September 15th payment, she pays $3,000. She then makes the remaining payments on time. When she files her annual tax return the $2,300 net taxes from her rental income is offset by the $6,000 instalment payments she made, and she obtains a refund of $3,700. Even though she missed the first tax instalment payment, the catch-up payment made the following quarter eliminated or significantly reduced any instalment interest CRA would have charged.
Pam was informed by her accountant and CRA that she is required to pay $5,500 on June 15, September 15, December 15 and March 15 of the following year for a total of $22,000. Pam decides not to make these payments and during the year she purchases a rental property and earns rental income. This rental income results in additional tax owing of $33,000 when she files her annual tax return.
To avoid instalment interest, she should have paid $22,000 ($5,500/4) per quarter. It does not matter that her actual taxes owing was more. She will only be subject to tax on the instalments CRA expected her to pay. The tax instalment interest is then calculated from the day each payment of $5,500 was due, until the balance due date (or April 30th) using the prescribed interest rate at the time.
She would also be subject to a penalty. Assuming her total instalment interest for unpaid instalments was $3,000, the penalty would be the higher of 25% x $3,000 / 2 = $375 or $3,000 – $1,000 / 2 = $2,000. Therefore, her total interest and penalty for not making any instalment payments would be $5,000.
Contact Argento CPA today if you have any questions or looking for expert advice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.