Paying taxes in installments can bring trouble with the CRA

Paying taxes in installments – The fourth and final 2022 tax installment is due on December 15 for about two million Canadians. There are three options to choose from when figuring out how much you must pay each quarter, but picking the incorrect one can result in arrears interest and even instalment penalties, as one couple discovered in a case recently decided in Tax Court.

But first, let’s discuss the tax instalment system before getting into the specifics of the case. If your net tax owed for 2022 will be more than $3,000 ($1,800 for Quebec tax filers) and it was more than $3,000 ($1,800 for Quebec) in either 2021 or 2020, you are required to make quarterly tax payments for this tax year under the Income Tax Act.

The three options include the no-calculation option, the prior-year option, and the current-year option for figuring out how much you must pay each quarter. The approach that yields the lowest payments is up to the discretion of the taxpayer. However, if you choose to pay less than the option with no calculation, you can be subject to instalment interest and a fine if your instalment amounts are excessively low or paid late.

The Canada Revenue Agency determines your March 2022 and June 2022 instalments under the no-calculation option using 25% of the net tax due from your assessed 2020 return. The net tax due from your 2021 return, less the March and June payments, is then used to determine the Sept. 15 and Dec. 15, 2022, instalments.

The 2022 instalments are based on you paying one-quarter of the 2021 tax due on each instalment date using the prior-year option, which bases the computation exclusively on last year’s income. This choice is ideal if your income, deductions, and credits in 2022 are comparable to those in 2021 but notably different from those in 2020.

Last but not least, the current-year method enables you to base this year’s instalments on the estimated tax liability you anticipate having for the current year. You pay one quarter of the estimated tax liability on each instalment date.

If your income in 2022 will be much less than it was in 2021, this option may be helpful. However, it is also the riskiest approach since if you use it, you run the risk of being charged daily compounded instalment interest (currently 7% for past-due taxes) and even an instalment penalty if the instalment interest exceeds $1,000. That is what took place in this most recent instance involving a couple from Alberta.

Due to their combined net tax liabilities exceeding $3,000 over the previous three tax years, the husband and wife were individually compelled to pay instalments for the 2019 tax year. The three instalment alternatives were described in written instalment reminders that they received from the CRA.

Paying taxes in installments

The couple utilized the current-year technique instead of the no-calculation option based on an estimation of their 2019 income and projected tax liability. However, the couple’s holding firm announced a dividend in the amount of $600,000, or $300,000 for each of them, in late November 2019. Due to “budget buzz… regarding the potential modification of (the) tax treatment of Canadian dividend income,” they declared this dividend to themselves.

The judge stated that in some cases, a taxpayer may be able to show they had a reasonable basis for believing their annual income would be less than the amount not calculated, and that the event that resulted in the insufficient quarterly instalments was “beyond foreseeability and impossible to discern until occurrence.” This upholds the dictum “lex non cogit ad impossibilia,” which states that a law cannot be applied to demand the impossibly difficult.

The following adage unfortunately did not apply to this couple because they “were not challenged to perform the impossible.” Instead, they deliberately decided to issue the dividend, and they had full control over that decision. “A textbook, end-of-year provisional tax plan,” the sizeable year-end dividend was. It wasn’t inescapable or unneededly circumstantial.