Canada: What you need to know about Personal Income Tax instalments
24 February 2015
Posted by: Author: Ali Toyserkani
Author: Ali Toyserkani (Crowe Soberman LLP)
When we first meet with young health professionals, many are surprised when we inform them that they will owe personal income taxes come the following April. They are even more shocked when they learn that they are obligated to make quarterly income tax instalments on a go-forward basis. Let's explain why self-employed health professionals are required to make quarterly income tax instalments.
Medical residents and part-time workers are generally considered employees. The remuneration received is paid by an employer, who is legally obligated to withhold payroll source deductions (i.e. Employment Insurance premiums and Canada Pension Plan premiums) and personal income tax from the amounts paid. This is why your gross income may be, for example, $1,000 per week but you only receive $750 deposited into your bank account. When you receive your annual T4 slip it shows the total gross amount of income you earned in the prior year and the taxes and other deductions that were withheld at source. The deductions that your employer has withheld throughout the year have been remitted to the Canada Revenue Agency (CRA) as a prepayment of your personal taxes. As a result, when you prepare your personal income tax return, your personal tax liability is, more often than not, covered and you may be entitled to a refund (especially if you made RRSP contributions or have tuition, education or other tax credits available).
When you transition to practicing your health profession after graduating or after finishing your medical residency, you will likely be self-employed. In other words, you will be billing fee-for-service, receiving some form of compensation through an Alternative Funding Plan or will be an associate in a practice. As a self-employed practitioner, there is no employer that deducts payroll source deductions and personal income taxes from the remuneration you receive throughout the calendar year. This is why, after the first full year of being a self-employed health professional, there is usually a significant personal income tax liability owing by the following April.
An obligation to prepay the majority of your personal income tax by quarterly instalments for the following year will arise if your net tax owing is more than $3,000 in the current year and in either the prior year or the year prior to last year. For example, you can expect to have a quarterly income tax instalment obligation in 2015 if you had more than $3,000 in net tax owing both in 2014 and either in 2013 or 2012.
Instalment payments for a particular year are due on March 15, June 15, September 15, and December 15. Often the CRA will mail you a remittance form, which can be used to pay the instalments at your financial institution or by mailing a cheque to them. You can also make your personal income tax instalments online via the CRA's website or through online banking.
There are three methods for calculating the instalment amounts that are owed. An individual may choose the method which results in the smallest instalment obligation:
Calculating based on an average of the amount of taxes owed in the prior two years. This is the CRA default option and will be the amount that shows up on the instalment reminders they send you.
Calculating based on the amount of taxes owed in the prior year. This option will result in the lowest instalment obligation if your current year income will be greater than your prior year's amount, but lower than the amount in the year prior to last; or
Calculating based on what you estimate will be your current year taxes owed. This option will result in the lowest instalment obligation if your current year income will be lower than those in the last two years. However, if you miscalculate the amount of expected taxes owed and you have remitted an amount which is less than the actual amount of taxes that are owed for the current year or an amount which is less than what your instalment obligation would have been under the lesser of Option 1 and Option 2, you will be subject to interest and possibly penalties for the insufficient instalments remitted.
Failing to remit instalments on time can be costly. The CRA charges interest on the deficient amounts at a prescribed rate (currently five per cent). If this interest charge adds up to more than $1,000, an additional penalty is added.
Transitioning to becoming a practicing health professional and launching your career is an exciting time in your life. As your life circumstances and finances change, it is important that you remain aware of your new tax obligations. The Crowe Soberman Health Care Group can guide you through calculating the correct amount of personal income tax instalments for the upcoming year and can help you plan for these payment obligations.
This article first appeared on mondaq.com.