It’s a terrible experience: you go to your tax preparer with your hopes high, and you get handed an income tax bill. It’s even worse when your income has dropped in the past year, or was modest or even low. How can you owe tax?

The problem is that an income tax bill isn’t necessarily triggered by high income. It’s triggered by a difference between what you owe, and what’s been paid on your behalf in advance.

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During the year, some people put an amount for tax in the hands of the Canada Revenue Agency in advance of doing their tax return. This can happen when your employer withholds tax for you; or if you make a withdrawal from your RRSP and the bank withholds tax; or if you pay your tax by instalments during the year.

All these forms of tax withholding or payment are essentially estimates of taxes owing, made before the tax return has been completed and filed. It is the act of completing your tax return that reveals the actual tax you owe for the year.

An income tax bill isn’t necessarily triggered by high income. It’s triggered by a difference between what you owe, and what’s been paid on your behalf in advance.

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If you’re lucky, the amount set aside for you exceeds the amount you owe. Consequently, you get a refund of the excess amount.

If you’re unlucky, the amount set aside isn’t enough to cover the tax owed. The result is that you have to pay the difference.

Some common situations that can result in an unexpected tax bill:

    You’re self-employed, so no one is withholding tax for you
    You changed jobs partway through the year*
    You made several small RRSP withdrawals to avoid the tax withholding on a large aggregate withdrawal
    You got a lump sum payment or unexpected taxable windfall on which no tax was withheld
It’s important to remember that high income (alone) does not necessarily result in a tax bill, and low income doesn’t necessarily result in a refund.

* Each individual is allowed an amount of earnings before having to pay tax, called an exemption. When two different employers are issuing slips for the same person, sometimes each employer assumes the first portion of the income they pay you is exempt. The result is that twice as much income is treated as if it’s exempt, so some taxable income has no associated tax withheld on it.