Many individuals are not required to make tax instalments. For example, if employment income is your main source of income, income taxes are withheld from your salary or wages by your employer and remitted to the government on their behalf. If you have little or no other sources of income, you likely will not have to pay instalments.
On the other hand, if you have significant income from sources where there is no withheld tax, such as dividends, interest, capital gains, business income, or rental income, you may have to make quarterly instalments of tax.
Generally speaking, you are required to make quarterly instalments in a taxation year (current year), if, in the current year and one of the two preceding years, you have federal and provincial net tax owing of more than $3,000 (not including tax withheld at source such as from your pay cheque). For Quebec residents, the same rules apply but the threshold is $1,800 of federal tax owing.
The instalments are due quarterly, on the 15th day of March, June, September and December of the year. Late or insufficient instalments are subject to interest charges. However, if you “prepay” or overpay instalments, the amount you have overpaid earns “contra interest” or “offset interest” at the same rate as interest on late instalments, so you can avoid interest charges on late instalments by making other instalments early. If instalment interest charges exceed $1,000 for the year, you may be subject to a monetary penalty.
Remember that the tax instalments are essentially a “down payment” of your actual taxes owing for the year, which are due in full on April 30 of the following year. If your actual tax liability exceeds your instalments (and any tax withheld) for the year, you will be required to pay the excess by April 30. On other hand, if your instalments (and any tax withheld) exceed your tax liability for the year, you will get a refund.
Assuming you are required to pay quarterly instalments, they can be calculated in one of three ways, and you are entitled to choose the method that leads to the lowest instalments.
Method 1:
Each quarterly instalment equals ¼ of your estimated tax owing for the current year.
Method 2:
Each quarterly instalment equals ¼ of your net tax owing for the preceding year.
Method 3:
The first two instalments equal ¼ of your net tax owing for the second preceding year. The last two instalments each equal ½ of (preceding year net tax owing minus the first two instalments that were based on the second preceding year). Put more simply, the last two instalments are what is needed to make your total instalments equal your tax owing from the preceding year.
The third method is sometimes called the CRA instalment method because it is the method the CRA uses when they send instalment reminders to taxpayers. However, you are not obligated to follow this method and may choose whichever method you wish.
If you have late or insufficient instalments, interest will be charged relative to the method that provides the least amount of instalments (and therefore the least amount of interest charged).
Example of 3 methods
Mary had the following amounts of net tax owing (net of tax withheld):
2013: $12,000
2014: $24,000
2015: Expected to be $30,000
Under method 1, in 2015 she would remit $7,500 each quarter ($30,000/4).
Under method 2, she would remit $6,000 each quarter ($24,000/4).
Under method 3, she would remit $3,000 for each of the first two quarters ($12,000/4). For each of the last two quarters, she would remit $9,000, being one-half of ($24,000 minus $6,000), and totalling $18,000, which added to the $6,000 paid for the first two quarters equals her 2014 tax of $24,000.
Methods 2 and 3 end up with the same total amount of instalments (in this example, $24,000). However, Mary might prefer method 3 because the first two instalments are lower and the last two instalments “catch” up to make the difference. That is, because of the time value of money, you would usually want to delay paying your tax.