Reduce the Taxes Coming Out of Your Paycheque

We are all looking for creative ways to increase our cash flows and either pay down debt, put more money away for retirement, have more buying power, or any combination of these three.  There are a number of ways to do this, but I’m not sure how familiar people are with the strategy I’m about to share because:

1. Everyone hates anything to do with taxes,
2. It requires a little bit of work,
3. It’s not well advertised, and
4. We all love tax refunds.

This is a strategy I used back in 2008 and 2009.  In 2010 my employer made it a little more challenging to implement, so I let it go.  Then life got in the way and I never gave it much thought afterwards.  I also liked getting a lump sum of cash in March (yes I file my taxes early) right around my birthday.  In any event, I started noticing a bit of a cash flow issue in our house as we pay for childcare and try to save for retirement.  That March lump sum was being used to pay off some debt accumulated while Deanne was on maternity leave and taking home less than half her regular salary.  So we decided to implement the strategy once again and will continue to use it going forward.

Basically, what I am rambling on about is Form T1213 – Request to Reduce Income Tax at Source.  I’m not sure if anyone without business education has much information about it (I remember learning about it in the Introduction to Tax class at MUN many years ago) but it’s something that is quite underutilized.  It’s a form that you can fill out and send to the Canada Revenue Agency (CRA).  If you fill it out correctly, you should receive a letter back from CRA in 8 to 12 weeks.  You then send it to your employer and they will reduce the amount of income tax they withhold from your paycheque.  Sounds simple enough, right?  It actually is pretty simple.  If you send it to CRA by November 1st, you can maximize the benefit to you as you would have it back to your employer in time for your first payroll run for the following year.

The types of things you can include are the expected annual amounts for:

1. Childcare expenses.  This one is huge for us right now.
2. Contributions to an RRSP (outside of employer plans that have a deduction on your regular payroll)
3. Child support
4. Employment expenses
5. Medical expenses
6. Donations

A number of these expenses are regularly occurring expenses.  Childcare is a great example here; we pay the same amount per child per week.  It doesn’t change.  So we can tell the government what we expect to pay for the entire year.  Others, like medical expenses, are more variable in our case, so we leave those out of the equation.

The key is, these are estimates.  If you overestimate your expenses, you’ll pay at tax time.  If you underestimate, you get a refund.

I like this strategy because of the impact on biweekly cash flows.  I was late getting my paperwork to payroll this year.  It’s finally implemented for this pay run and I’m actually clearing more than $1100/month vs. what I was before!  $1100/month for 4 1/2 months makes quite a difference.  It would probably be closer to $400/month for a full year, but that still makes a difference in our lives.  That’s $400 we have to put toward paying down debt and our savings per month.  Mind you, we’re giving up a lump sum tax refund to get that.  But we like it because:

1. We are accumulating less interest on our debt if we pay it off now vs. waiting until next March,
2. We are accumulating more growth over contributing to our savings over a 12 month period vs. waiting until next March, and
3. We’d rather have our own money to reduce debt and increase our own wealth than give the Canadian government an interest-free loan over 14 months.

I think number 3 is a selling feature we’ve been told about by financial experts that doesn’t really get much thought.  If you get a lump sum tax refund, you’ve loaned money to the government.  Plain and simple.  If you pay in at tax time, the government loaned you the money.  That’s all fun and games, but what happens when you have debt or you need to save money?

Here’s an example:  If you loan the government $400/month over the course of 2017, you’ll get $4,800 back in March 2018 (or April or May if you don’t file your taxes right away).  Let’s say you have $5,000 on a 5% Line of Credit (LOC) starting on January 1, 2017.  If you make regular monthly payments of $400/month, you’ll have it fully paid off by January 2018.  However, if you wait until March 2018 for your refund, your LOC will be worth $5,300 (due to the compounding nature of interest) and you’ll only have $4,800 to pay.  See the problem?  You still have to find $500 from somewhere else to cover your loan, or let it grow again until tax time in 2019.  Savings work the same way, only we’d treat that $500 as a lost investment opportunity.

Of course, the strategy only works if you’re disciplined enough with the extra money coming in.  I found with the large refund, we were more inclined to use it toward buying things we didn’t really need or catching up on debt accumulated over the prior year.  Now, we’ve got the additional cash flow automatically going toward our debt and savings, so we don’t really the same opportunity to waste it.

If I have you convinced, I’d like to offer some tips in preparing and submitting the T1213 form:

1. Make sure you provide a separate sheet summarizing all of your calculations.  The CRA is full of accountants and accountants love to see calculations.  It also helps them process the request more promptly.  I did mine on an Excel spreadsheet and summarized the amounts I expect to spend on each expense.
2. Provide some documentation for each expense.  It may be as simple as your childcare contract showing the price per day or week, or getting a copy of your pre-authorized payment plan for your RRSP.  You don’t need to document everything (e.g., I don’t have any pre-authorized payment plan for donations, but I do contribute a regular amount every week), but at least try and summarize expenses as best you can.
3. If anything changes from your prior tax year, include your assumptions and calculations.  This one caught me up.  This year I am claiming childcare expenses as I expect Deanne to make more than me.  In prior years Deanne got to claim it.  So the CRA initially denied my request.  I had to resubmit showing what I estimated as both our taxable incomes for 2017 and how I got there.  It took another 8 weeks, but I was finally approved.
4. Don’t be afraid of the math, you don’t need to do complex calculations.  I estimated my taxable income for 2017 as my gross pay per paycheque x 26 pay periods minus my scheduled RRSP contributions and professional fees.  Simple enough.
5. It may take some time to do it the first time.  I built an Excel spreadsheet.  It took me a few hours to get it the way I liked it, but next year I just need to update my sheet.  That should take me no more than a few minutes.
6. Fax it in.  I’m lazy to the point of efficiency.  I have access to a fax machine, so I sent it that way.  I didn’t need to bring all of my papers to the post office and find out how many stamps I needed.

So there you have it.  It’s a bit of work, but you can actually make some material changes to cash flows in your house just by doing a bit of upfront work and keeping more of your own money.