Tax return teaches you a lot

With RRSP season now behind us, this weekend marks the unofficial start of tax season, which can be a source of pain and frustration for many Canadians but, apparently, not for everyone.

Believe it or not, some Canadians enjoy filing their tax returns according to a new national survey commissioned by Thomson Reuters, the makers of the tax software program UFile. The survey found that 41% of Canadians enjoy filing their tax returns, but the majority still do not.

Of those who dread the process, Canadians surveyed cited “confusion, time restrictions and too many receipts to keep track of ” as the top three reasons they dislike tax time.

The survey also asked Canadians how they will do their 2012 returns. While 49% said they would use an accountant or professional taxpreparation service, 31% said they would do it themselves using a tax software package on their computer or via the Internet. Only 14% said they would do it the old-fashioned way, “by hand.”

But even if you ultimately plan to go to an accountant or tax preparer to file your return, taking a stab at your own tax return preparation can prove to be a very useful educational exercise, whether you use the software or try to do it by hand.

In fact, each year I have my Schulich MBA students who take my Personal Financial Management course prepare a simple tax return by hand, using only a pencil and calculator. By walking through the forms, from the Schedule 4 to report investment income to the Schedule 1 to calculate federal tax owing, students gain an appreciation for how different types of income, such as Canadian dividends, capital gains and employment income, are taxed as well as an understanding of our graduated federal tax brackets and non-refundable tax credits.

For instance, have you ever tried working through the calculation of taxes owing on Canadian eligible dividends? Well, you first have to gross them up by 38% such that you report 138% of the dividends actually received on your Schedule 4. Then you calculate your federal tax on your taxable income, which includes those taxable dividends, before deducting the federal non-refundable dividend tax credit, which is equal to 15.0198% of your taxable dividends.

By going through this exercise, it then becomes obvious why, to cite an example, your federal marginal tax rate on dividends can be zero for lower income earners with no other source of income. For example, if your only income in 2012 was $30,000 of Canadian eligible dividends, when you gross them up by 38% to $41,400 and calculate federal tax of $6,210 (at 15% for income in the lowest federal bracket), once you subtract your non-refundable federal dividend tax credit of $6,218 (15.0198% X $41,400), your federal tax owing is zero.

Confusing? Perhaps, but that’s where the software or professional tax preparer comes in to make sure your calculations are up to snuff.