If you have outstanding income tax debt with the Canada Revenue Agency (CRA), you should take action to deal with the amount owing sooner rather than later. The government can hit you with penalties and high rates of interest on taxes owed. Luckily, there are options available to help you deal with this debt.

Why do I owe income tax? Common ways to acquire income tax debt

If asked about the debt that you owe, whether on credit cards, lines of credit, or personal loans, you usually can figure out the balance by looking at statements or calling the bank. 

Income tax debt is different. Since you file income taxes only once a year, and typically each year your income varies, the amount of taxes you pay can vary as well. One year you may owe and the next you won’t. And while the CRA can let you know if you have any amounts outstanding for previous years filed, they’re unable to give an accurate amount of debt owed until your returns are filed and assessed.

Income tax debt also doesn’t happen because of purchases, so how do Canadians end up owing at tax time? While everyone’s situation is unique, there are some common scenarios that may result in an unexpected tax bill: 

  • You have multiple sources of income which can place you in an inaccurate tax bracket. When this is the case, each income source takes off enough tax to reflect the tax bracket that you would be in if that was your only income source.  However, with the combined income, you are actually in a higher tax bracket. Neither source is deducting enough taxes from the cheques and you are left with a payable amount at the end of the year.
  • You changed jobs partway through the year. A change in career or pay may result in you moving into a new tax bracket. Each tax bracket has a tax rate and as your income increases the rate of taxes payable increases as well. If there was not sufficient income tax withdrawn by both employers to cover the increase in income, you would end up owing the remaining amount.  
  • You are self-employed and thought ‘cash received equalled income’. This mainly occurs when you are not properly calculating how much to remit to the government and you end up owing money at the end of the year.
  • You withdrew from your RRSP during the year. If you made withdrawals from your RRSP, the added source of income may have moved you into a new tax bracket. If the income taxes that were withheld from your other income sources were not sufficient to cover the withdrawal amount, you will end up owing the CRA.
  • You received a lump-sum payment or unexpected taxable windfall on which no tax was withheld. If you received a lump-sum payment, like a pension payout, and taxes weren’t withheld at source, the gross payment amount will be added to your taxable income and will likely result in income tax owing.
  • You receive pension income and not enough taxes are withdrawn from your pension amounts. If you received income from a pension and not enough taxes were deducted, there will likely be taxes owed and you will be responsible for paying the remaining amount.
  • You don’t file your taxes at all. The biggest mistake you can make is neglecting to file your taxes year after year, letting costs build up to overwhelming amounts. Frequently, the penalties and interest you are charged for not paying your taxes become as much as the tax amount owing.

What happens if I don’t pay income tax?

The Canada Revenue Agency (CRA) has unique privileges in how they can collect debts owed to them. If you owe money to the CRA but do not make your payments, they have the power to obtain any funds owed to them through one or more of the following methods: 

  • Keeping your tax returns and GST/HST cheques*: The most common way the CRA collects its debts is by keeping the money that it owes you. If you owe the CRA, you should expect that they will keep any income tax refunds, GST/HST credit cheques, or any other funds that they may owe you. *Note: The Government of Canada has announced that the CRA will not withhold GST/HST credit cheques or the Child Tax Benefit from anyone who has income tax debt related to a pandemic relief benefit such as the CERB.
  • Garnishing your income: The CRA can send notice to your employer (or anyone that owes you money) requiring that they send your pay or money owed to the CRA instead of you. Generally, the CRA does not garnish your whole paycheque. They typically garnish a percentage of your pay that is based on how much you owe and how much you make. When a garnishment happens, your employer has no choice but to send your pay to the CRA. If your employer fails to comply, by law, they will be held liable for paying the garnished income withheld from the CRA. 
  • Judgment against your property: Like any other creditor, the CRA can obtain a court-appointed judgment for the amount that they are owed. However, the CRA has a benefit over regular creditors in which they can apply to the Federal Court using a streamlined process to get a judgment. This lets them obtain judgments faster and easier than other creditors. Once a judgment is appointed, the CRA can register the judgment against your assets, including any property you own. If the CRA has registered a judgment against your property, they could have the sheriff seize and sell your house (or other assets). Typically, once CRA receives a judgment against your house, they will let the judgment sit on your property and accrue interest, making it very difficult for you in the future if you were to refinance or sell your house. Due to the accruing interest, the longer that CRA’s judgment is registered your property, the more it will cost to pay it out.
  • Make other people pay your tax debt: The last available mechanism the CRA may use for collection is the assessment under section 160 of the Income Tax Act. This section permits the CRA to make other people liable for your tax debt if you transferred assets or made gifts to those people. If this happens, CRA can issue a “Notice of Assessment” for taxes equal to (a) the amount of taxes that you owe, or (b) the value of the asset transferred, whichever is lesser. Once CRA has issued a Notice of Assessment to someone under this section, it will then proceed to use all of its collection powers against that person. 

How to negotiate with the CRA

You may be able to explain your financial situation to CRA and try to negotiate a payment plan. For example, if you owe $1,000, you may offer to pay $100 per month for the next ten months. But, even if the CRA accepts your payment arrangement, you will continue to be charged penalties and interest until your debt is paid in full. Even if you come to an arrangement with CRA, they have the ability to rescind or modify this arrangement. If you’re unable to successfully negotiate terms, the CRA may withhold tax refunds and GST credits, garnish your wages or accounts receivables, take funds from your bank account, and even place a lien on your home or other real property.

More formal options for addressing your tax debt

Filing a consumer proposal with a licensed insolvency trustee will stop both collection action and interest and penalties. Normally a proposal is for less than 100% of the debt you owe, however, CRA has specific criteria regarding proposals. Another option is declaring personal bankruptcy. It’s a common misconception that personal income tax debt is not discharged by bankruptcy. In fact, personal income taxes are covered by bankruptcy.

How to avoid income tax debt

To avoid any issues surrounding income tax debt, it’s best to be organized when it comes to your taxes.

  • The best thing you can do is to file your taxes on time. This way you will avoid any penalties and interest if you do end up owing CRA money. It’s also important to be aware of the filing deadlines and which one applies to you. While most individual income tax returns are due at the end of April, self-employed persons have an extended deadline of June 15th.
  • File any returns for years that you have missed. This will help you reduce any further penalties and interest for those tax years.
  • If you aren’t comfortable preparing your taxes, or you get overwhelmed at tax time, seek help from a professional. Accountants and tax preparers will be able to help you understand the process, find all applicable deductions and give you sound professional advice.
  • Most people that owe income taxes are self-employed or own a small business. If this is the case, consider seeking the help of a bookkeeper to keep you on track going forward.
  • If you do owe money to the CRA, make your payments on time and in full to avoid any further penalties and interest.

Self-employed income tax debt

As a self-employed individual, it is your responsibility to withhold your own income taxes, as well as keep track of employment-related expenses that can be claimed when preparing your taxes. If you misjudge the amount of income tax to withhold for the year, you may end up owing at tax time.

If you are self-employed, here are a few key ways to avoid tax debt: 

  • Sign up for the CRA’s “My Account” and “My Business Account” so you can closely follow your tax filings and important dates 
  • Maintain books and records to make filing your income taxes easier. Additionally, a CRA audit requires paperwork for a minimum of six years, so you’ll want to keep good records as soon as you start your self-employment
  • File your taxes on time to avoid penalties that can add up to a maximum of 17% over the course of a year on the balance you owe
  • Earmark 20-25% of your income for taxes

For more information, explore this article on how to avoid income tax debt when you are self-employed

If you are struggling with income tax debt and aren’t sure about the best way to proceed, meet with a Grant Thornton debt professional for a free, confidential consultation to learn more about your options.

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