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The risk, however, is that if you calculate incorrectly, you could face arrears interest or even an instalment penalty.
Contrary to what some taxpayers think, paying tax by instalments vs. waiting until you file your return isn’t really an option — it’s required by law if you meet the criteria discussed above. If you choose to ignore the requirement, or pay less than you are told to pay, you could be hit with interest and an instalment penalty.
You will be charged interest if the government sent you an instalment reminder in 2020 that shows an amount to pay, you were required to pay tax by instalments because your net tax owing will be more than $3,000 ($1,800 in Quebec) and you either failed to make instalment payments, or you made payments that were late or were lower than what you were required to pay. Instalment interest is compounded daily at the prescribed interest rate, which is currently five per cent for overdue taxes.
The instalment interest clock starts ticking from the day your instalment was due and runs until your balance due date, or April 30 of the following year. Fortunately, the government chooses the instalment option that results in the least amount of interest.
An instalment penalty can apply when the instalment interest is more than $1,000. The penalty is calculated by subtracting from the instalment interest the greater of either $1,000 or 25 per cent of the instalment interest calculated if no instalment payments had been made for the year. Half of this difference is the amount of the penalty.
If you find yourself late in making an instalment or perhaps you missed an instalment altogether, you can reduce (or even eliminate) the interest charges and penalties by overpaying your next instalment payment or by paying it early. In doing so, you will earn instalment credit interest. This credit interest is not refundable, but it can be used against any interest charges on late payments for the same tax year.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.