Tax Credits cannot be used to reduce taxes dollar to dollar? huh?

[fuc847]

i may have misunderstood tax credits for a long time and i want to clarify it today.

so heres the situation (please correct me in any area if i'm wrong):
Person A has $50,000 income and has $10,000 education tuition credits carried over from last year.

Assuming nothing else and he has a avg tax rate of 20% (for simplicity sake, no exmemptions etc.), his tax payable is going to be $10,000. And this amount is already deducted in his T4. So basically when he files a tax return, he will not receive a refund nor pay any thing.

BUT, so now we add in the tuition credits, what I THOUGHT is that he will receive a full $10,000 refund back b/c of the credits, but instead i was told that he will only get $10,000 * 15% = $1500 back.

the explaination was that tax credits in canada are not used dollar for dollar and have to been multiplied by the lwoest tax bracket rate for that tax year.

so.. does this make a tax deduction of the same amount much better than tax credit?

because to add to that example, if istead of a $10,000 tax credit, it was a $10,000 tax deduction. Then his tax payable would be $40000 * 20% = $8000, and therefore he would receive $2000 refund , which is MORE than the $1500 in previous case.

someone please.. explain

[ZxExN]

I always thought it reduce the overall income by the credit amount.

[AllWheelDrift]

It's a bit more complicated than that even, since the refund for a tax deduction is based on the person's marginal tax rate, not average tax rate. Using just the federal tax rates (since that's where you seem to have got the 15% from) the tax on the 10k was actually 22% so you'd get $2200 back for a tax deduction of $10,000 (with an income of $50,000) and only $1500 back for a tax credit of $10,000.

The reason you don't get the whole $10,000 back for a tax credit is because the government is essentially saying you shouldn't have to pay the 15% tax on the money you spent on your education, not that they will pay for you education (which would be the case if you got the full $10,000 back.)

On the other hand, a tax deduction reduces your income for tax purposes and since marginal tax rates are increasing it is more beneficial than a tax credit once you are above the lowest tax bracket.

[noname]

Generally, deductions are better then credits since deductions (like RRSP, moving expenses, union dues) are subtracted from total income before arriving at your taxable income. This results in a reduction in taxes at your marginal rate.

Credits (eduction, EI, CPP paid etc) are reductions in taxes owing, and are calculated at the lowest tax bracket.

[83_gemini]

Per the CRA:

The amount of the tuition tax credit is determined by multiplying the lowest personal tax rate percentage (e.g., 17% for 1996) by the amount of eligible tuition fees paid for the year.

Therefore the CRA notes:

Thus, for example, if an amount of $2,000 has been paid for eligible tuition fees for 1996, the student is entitled to a tuition tax credit of $340 for 1996 determined as follows: $2,000 x 17%.

Regarding the Education Credit:
The amount of the education tax credit is determined by multiplying the lowest personal tax rate percentage (17% since 1988) for the year by $80 and by the number of months in the year during which the individual was enrolled as a full-time student, or in some circumstances, as a part-time student, in a qualifying educational program at a designated educational institution.

But if you have already received the credits and banked the credits, as it were, that full $10k should be available.

See IT-515R2 (Education Credit):
http://www.cra-arc.gc.ca/E/pub/tp/it515r2/it515r2-e.html

See IT-516R2 (Tuition Credit):

http://www.cra-arc.gc.ca/E/pub/tp/it516r2/it516r2-e.html

A deduction reduces the tax base (i.e. if you had $50k in taxable income, your $10k deduction reduces your taxable income to $40k--this is what RRSPs do) resulting in a lower tax bill. A tax credit is calculated according to the bulletins and taken off your tax payable. But again if the credits have already been determined and are simply available to reduce your tax bill, then they can do so. This is certainly possible if you've been in school a long time and the bils are high (such as if you're in a professional program).

[fuc847]

wow, thnx guys. i really didnt know.

i had the preconception that (just b/c almost every friend, academic books, articles online, even wikipedia says it is) tax credits are always better than tax deductions.

[83_gemini]

Generally tax credits are seen as more equitable. That's because deductions obviously help the rich more then the poor (by reducing their taxable income). With a tax credit the rich get fully taxed on their income, and then have their tax bill appropriately reduced.

There is some debate over this (arguably deductions help take a better picture of the proper tax base). Regardless most personal deductions have been turned into credits in the past few decades, probably based on the equality argument (it has also been suggested the shift allowed a disguised increase in tax rates).

[AllWheelDrift]

wow, thnx guys. i really didnt know.

i had the preconception that (just b/c almost every friend, academic books, articles online, even wikipedia says it is) tax credits are always better than tax deductions.
Yeah, that's because they are commenting on the system in the US. Also, technically the $10,000 isn't a tax credit, the $1,500 ($10,000 x 15%) is the tax credit, and clearly a $1,500 tax credit is much better than a $1,500 tax deduction would be.

[TopTaxGuy]

83 gemeni has nailed this one.

A credit is dollar for dollar worth what it is whereas the deduction reduces taxable income. I have a summary of deductions verus credits (http://taxresource.ca/rates_stats/credits_vs_deductions.html).