How Tax Refunds Work and When You Can Expect to Receive One
When filing tax returns, one of the few things Canadians look forward to is the opportunity to get a tax refund. After all, who doesn’t like receiving extra money? But many people don’t realize why they get a refund or how it’s calculated. In this article, I explain how income tax refunds work by answering common questions many people ask.
What Is an Income Tax Refund?
An income tax refund is an amount of money returned to a taxpayer, representing an overpayment of the previous year’s income taxes. The refund will be the difference between the income taxes paid and the income taxes owed.
Several things can cause you to overpay your taxes. Your employer may have deducted too much tax from your regular pay cheque during the year, or your taxes may be lower due to various deductions and credits you claimed when you filed your taxes.
Examples incline RRSP deductions, charitable donations, medical or tuition expenses claimed, business expenses, etc.
When Will I Receive My Tax Refund?
In most cases, you will receive your tax refund shortly after you file your tax return with the Canada Revenue Agency (CRA). If you file online using NETFILE and have direct deposit set up with the CRA, you may receive your refund as soon as eight business days after filing. If your refund is mailed, it can take four to six weeks.
Can the Government Deny My Tax Refund?
In some situations, the CRA may decide to withhold part or all of your tax refund, but only if you owe them other monies. According to the CRA, here are some scenarios where your tax refund might be withheld:
- Your refund is $2 or less (no point in wasting money on postage)
- You owe or are about to owe an amount to the CRA.
- You have other outstanding federal, provincial, or territorial government debts, e.g., student loans, EI and social assistance overpayments, immigration loans, and training allowance overpayments.
- Outstanding GST/HST returns from a small business (sole proprietorship or partnership)
Ways to Use Your Tax Refund
If you expect a large tax refund shortly, you may wonder how to make best use of the money. Yes, you could splurge on that big-ticket item you’ve been looking at, but there may be better uses for the money. Here are some ideas for how to spend your tax refund.
1. Add to your emergency fund – Building an emergency fund is one of the most important things you can do to break the paycheque-to-paycheque lifestyle and avoid getting into trouble with credit card debt. If you’re struggling to set aside enough money in your emergency fund, consider using your tax refund to boost your savings.
2. Pay off high-interest credit card debt – If you’re carrying a balance on one or more credit cards, consider using your income tax refund to pay off the balance to avoid paying the interest charges.
3. Put towards a house down payment – One of the most significant barriers to homeownership is coming up with a down payment, especially considering the prices of homes in many parts of Canada. Using your tax refund money can help boost your downpayment savings and accelerate your home purchase plans.
4. Top up your RRSP – One of the best ways to supercharge your retirement savings is by making RRSP contributions throughout the year and using your tax refund amount to increase your RRSP further. I don’t recommend this strategy if you haven’t built an emergency fund or paid off your credit card debt – those should be top priorities – but if you have, adding money to your tax-sheltered investment accounts is a solid decision.
5. Lump Sum mortgage payment – It’s an age-old question. When you receive extra cash, is it better to invest it or use the money to pay down your mortgage? When interest rates were hovering around 2% for several years, you could easily argue that investing was smarter. But all good things come to an end, and in the past 18 months, mortgage interest rates have skyrocketed.
If you have a substantial mortgage and are worried that you might be paying a much higher interest rate in the future, you should tackle the problem head-on by applying your tax refund as a lump-sum payment on the principal. Even a couple thousand dollars per year can result in thousands of dollars saved over the life of your mortgage.
What Happens if I Have Taxes Owing?
Only some get a refund after filing their income tax return. There are several reasons you may owe taxes. Your employer may deduct an accurate amount of income tax from each paycheque.
You may need to claim more tax deductions or tax credits to receive a refund. Many sole proprietors must pay taxes as they don’t have an employer withholding tax from their paycheque every two weeks.
If you owe taxes, you must pay the balance in full by the tax deadline, which is April 30th each year, unless April 30th lands on the weekend. You may be subject to interest penalties and late filing fees if you don’t pay the balance owed by the deadline.
Is it a Good Thing to Receive a Tax Refund?
Whether getting a tax refund is a good thing or not is a matter that’s up for debate in personal finance circles. Many financial advisors instruct their clients to do what they can to avoid getting an income tax refund by having their employer take less income tax off their paycheques throughout the year or through other means.
The reason is that if you’re getting hundreds or thousands of dollars back as a tax refund, the government has been holding onto money that belongs to you throughout the year, and you don’t have it to invest or pay down debt.
But on the flip side, others believe that getting a tax refund is a positive thing because it acts as a type of forced savings. They feel that if the government wasn’t holding on to the extra money, many would struggle to set it aside and would end up spending it throughout the year on things they don’t need.
The explanation of why you might have a balance due on your tax return missed the most common situation – that you earned more investment income this year than the prior year. The article talks about withholdings from employment earnings, but that is not relevant to most retirees. Tax is not withheld on investment income and you have to request that tax be withheld on CPP and other pension income. So most retirees, unless they have very modest incomes, have to pay quarterly tax instalments based on the prior year tax payable. If their income rises the following year, they will owe money at tax time.
Pre-retirement, I collected my provincial pension and using a corporation I contracted back to provide services to the department I previously worked for. My wife continued to work and this allowed us to build the value of the corporation. Our accountant encouraged paying extra tax on the pension income as it gave more flexibility to share income while using dividends from the company to pay down our mortgage the allowed 10% each year. As a result we were mortgage free in 5 years.
Using shared pension contributions, and RRSP contributions to my wife’s account, we averaged a refund which was about double the $3,000 I paid in taxes associated with the dividends (which were used to invest in RRSPs). Since my wife had no pension plan through her work this assured her pension future.
As I am now collecting CPP & OAS along with the dividend from the company which has not been earning income since 2019, we have been maximizing my wife’s RRSP contributions in advance of her anticipated retirement in another 3-5 years. I should note that between 2012 and this year we have taken 2 week vacations every year in tropical climates except during 2020 – 2022.
I believe If you are clergy who wish to have the Clergy Residence Deduction from each paycheque, you must make sure you get a refund at the end of the year. If you owe at the end of the year, the CRA may decline your ability to take the Clergy Residence Deduction with each paycheque, and you’ll have to pay the extra income tax (and CPP) throughout the year and then receive a massive tax refund when you finally claim the Clergy Residence Deduction for the full year.