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Making Tax Installment Payments

So you’ve started a brand new business and it’s actually turning a profit sooner than you expected.  Things are going well, but something comes to mind..  you haven’t paid any tax on your income yet.  No worries though, the government will reach into your pocket sooner or later and it’s best that you are prepared.

If you are a salaried worker, you’re accustomed to having taxes withheld from your pay check every couple weeks.  However, business income usually does not have tax withheld, which means it’s up to the business to have the cash available when the  tax liability is due.

When my accountant and I filed my business taxes for 2008, I owed a fairly significant amount in taxes.  As the government expects to be paid for any money owed to them on a regular basis, they expect quarterly installment payments in future years.

How do they base these payments?

If you have a net tax owning of greater than $3,000 in the current year and either of the previous two years, then CRA will expect quarterly installment payments.  There are a few choices as to how much is paid which I have listed below.  More details can be found on the CRA website (with examples).

1. No-calculation option – Best if your income/deductions stay the same from year to year.

We will provide the no-calculation option amounts on the instalment reminders that we will send you in February and August 2009. If you choose this option, just pay the amounts shown on the reminders by each due date.

2. Prior-year option – Best if income/deductions are similar to previous year, but substantially varied from 2 years back.  Basically divide last years tax owing by 4 to figure out current year installment payments.

If you choose this option, you have to calculate your instalment payments based on your prior-year (2008) net tax owing and any CPP contributions payable. Use the calculation chart to help you calculate your total instalment amount due and pay one-quarter of this amount on each instalment due date.

3. Current-year option – This option is if the current year income/deductions are significantly different than the previous 2 years.

If you choose this option, you have to calculate your instalment payments based on your estimated current-year (2009) net tax owing and any CPP contributions payable. Use the calculation chart to help you calculate your total instalment amount due and pay one-quarter of this amount on each instalment due date.

A sole proprietor may want to contribute a little more of their business income into an RRSP to reduce taxes owing under the $3,000 threshold. This will eliminate the need for installment payments in the following year.

When are installments due?

Installment payments for 2009 are due March 15, June 15, September 15, and December 15 (every quarter).

How are installments paid?

There are a few ways to pay tax installments, but the easiest is via electronic bill payment online.  Simply login to your online banking site, click bill payment, and do a search for “CRA” as the payee.  From that list, you should see “instalments, arrears, payment on filing”.

Penalties

As with any late payment, there are penalties.  The government is pretty tough when it comes to money owed to them –  too bad they don’t pay interest on tax refunds.  Here are the conditions for penalties when it comes to tax installment payments:

We charge instalment interest if all of the following conditions apply:

  • we send you an instalment reminder in 2009 that shows an amount to pay;
  • you are required to make instalment payments in 2009 (see Who has to pay by instalments?) and
  • you do not make instalment payments, or you make payments that are late or less than the required amount.

We calculate the interest on each instalment that you should have paid using the payment option that calculates the least amount of interest. Then we calculate the interest on each instalment you did pay. We charge the difference between these two amounts only if the difference is more than $25.

Final Notes

There you have it, a brief summary of how income tax installment payments work.  If you owe more than $3,000 in income taxes in the current year and either of the two previous years, then chances are, you will have to make installment payments.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 14 comments… add one }
  • Ramona September 23, 2009, 10:14 am

    Great FT! – also note no instalments calculated and requested until your tax liability has been greater than $3000 for the last 2 tax years. This is important for an entrepreneur to keep in mind for cash flow. It takes discipline to earmark all that tax money! As you say, best to be prepared.

  • Four Pillars September 23, 2009, 10:41 am

    Your criteria isn’t correct – owing more than $3k doesn’t mean you have to do installments. The rule is owing more than $3k in taxes in the current year AND one of the previous 2 years.

    If you have a regular job as well then you can ask your employer to increase your tax withholding to an appropriate amount. This is what I do – I find it a lot easier than quarterly installments.

  • DG September 23, 2009, 11:04 am

    Thanks for the article… very relevant for me as this is my first year of self employment.

    I’ve heard rumors that if you voluntarily make an early installment, say in November, you can avoid being put onto the quarterly plan. Anybody know if there is truth to this?

  • No Debt Guy September 23, 2009, 11:47 am

    I am in the same boat as Four Pillars. Having your employer increase the withholding tax is a good idea. Personally I would like to be sending them a cheque for $2999 every April rather than seeing a refund.

  • OY September 23, 2009, 12:15 pm

    Good Post. Interesting topic to discuss what can be tax deductible for small home based corporation, and how to do it. For example – mortgage interest, maintenance etc.

  • Carmen September 23, 2009, 1:13 pm

    wow thats’ a lot of info to take in. Since i am starting my own business, this will be most helpful. Thaks!

  • FT FrugalTrader September 23, 2009, 2:32 pm

    Thanks for the correction guys, I have fixed the article.

  • Aluminum Case September 23, 2009, 3:53 pm

    I was not even aware of the interest being charged for not making installment payments. I figured that since my side income had decreased I didn’t need to bother making installment payments. I will have to look into this further to see if I am getting gouged by not making installment payments. Installment payments can be a good idea when you might not be able to suddenly pay a big tax bill.

  • Ramona September 23, 2009, 4:35 pm

    @DG – the four instalment payments are one of the options you can use to pay your taxes. If you just wanted to make one payment, you’d have to make the whole year’s payment around Sept 30 – one quarter would be late, but one would be early, thus the interest would offset.

  • zud September 23, 2009, 5:20 pm

    Do you know if CPP is also paid by installments?

    In my first year of self employment I totally forgot about CPP and had to scramble to pay it. Be ye not so silly.

  • Ramona September 23, 2009, 5:59 pm

    @zud – Yep, CPP is included in the instalments, since it forms a part of the tax liability. And my earlier post should have said Sept 15 for a full year payment, not the 30th.

  • Canada Deals September 23, 2009, 7:10 pm

    Thanks for this valuable info. I’d also like to see a post on collecting GST and the criteria for small businesses.

    Note: IMO taking care of the admin stuff is one of the most challenging aspects of owning your own biz.

  • Samson Smith September 28, 2009, 7:47 am

    Great post, as i am having some less knowledge about this, so your post will help me a lot.

  • The Rat October 3, 2009, 3:31 am

    nice post

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