The Canada Revenue Agency (CRA) asks for tax installments when you establish a tendency to owe tax at the end of the year. But sometimes life gets in the way, income is low or expenses are high, and you don’t get around to paying the tax installments requested by CRA. So what happens if you don’t pay CRA installments?
Don’t panic if you don’t pay tax installments
The first thing to know is that you’re not in any serious trouble of you can’t, or don’t, pay your installments. The worst that will happen if you don’t pay installments is that you’ll end up paying some interest* on the unpaid amounts, back dated to when the installment was due.
Why CRA is asking for installments
As mentioned, the request for installment payments begins with a track record of owing tax. Generally, you tend to owe income tax when no tax is being withheld on some of your income. People with freelance income are often in this position. Since a freelancer’s clients aren’t withholding any tax on their payments, the freelancer ends up paying it at the end of the year.
A Track Record of Owing Tax
If your tax bill exceeds $3,000 for two out of three consecutive years, you get a request for installment payments. The requested installments for a given year add up to the tax you owed the year before. For example, if you had a $4,000 tax bill last year, your requested installments would typically be $1,000, spread out over four quarterly payments.
Sometimes not paying CRA installments is okay
Installment payment requirements and requested amounts are all based on the prior year’s income tax return. But the interest on unpaid installments is not based on the prior year, but on the current year during which the income is earned.
If You Know Your Income is Down
For example, say your tax bill last year was $4,000. But this year your income dropped and you expect your total tax bill to come to only $2,000. Since only tax bills in excess of $3,000 require tax by installments, you wouldn’t actually owe the installment payments. CRA finds that out when you file your return. In that case, they wouldn’t charge any interest on the ‘missed’ installments because in hindsight those installments are not required.
If You Know Your Income is Up
Here’s another interesting fact: say last year’s tax bill was $4,000 and you paid your four $1,000 installments as required. What happens if upon filing it turns out you actually owe even more tax? Once again, CRA would not charge you interest on the shortfall, because the additional installment wasn’t required; only the requested amount was.
In short: to avoid interest pay the requested installments or enough to cover your tax bill, whichever is less.
You Don’t Have To Go With CRA’s Requested Amounts
You know more about your income in the current year than CRA does (they won’t know until you file your return). So go ahead and set your own installment payments. Or don’t, if you don’t mind paying interest.
If on the other hand you hate interest, pay the installments or more – if you overpay, CRA will refund the excess.
*Note that CRA’s interest rate is fairly modest. Most years it’s around 5% per annum, but it can shift with general interest rate trends. Check here to see the current rate.