What’s a Tax Deduction? What’s a Tax Credit?
By PAIP Canada staff
We’ve all heard these terms at some point, and in spite of knowing that they’re beneficial for us as taxpayers, most don’t fully appreciate the differences between these two items.
To begin with, a tax deduction is an amount that allows a taxpayer to reduce the amount of taxable income they report to the government. As an example, if a taxpayer earned income of $100,000 and contributed $10,000 into a retirement savings Plan (RSP), then they would be subject to tax on income of $90,000 for the year. The amount deducted to arrive at one’s income is referred to as a deduction.
Regarding tax credits, once a taxpayer computes their tax liability (after applying the rates of tax to their taxable income), the net tax liability would be arrived at after applying the tax credits to which they’re entitled. As an example, if a taxpayer is entitled to claim a tax credit on a base of $1,000, then the amount would generally be multiplied by a conversion factor of 15%, to determine how much they can reduce their taxes payable by. Tax credits provide relief against the amount of taxes that one must pay.
Essentially, a tax credit of one dollar ($1) is worth 15 cents in tax savings.
Returning to deductions, a tax deduction of one dollar allows each taxpayer a savings in the amount of their marginal rate of tax (MRT). As an example, if a taxpayer faces a 40% MRT, then a $1 tax deduction provides a savings of 40 cents.
For working Canadians with a MRT greater than 15%, they will enjoy a greater benefit from a tax deduction than a tax credit, but let’s not forget that both are beneficial.
As a reminder, the deadline to file one’s personal tax return is April 30th, but certain exceptions apply for those who are self-employed.