The Hidden Costs of Using Income Tax Software Instead of a Professional
One size does not fit all. It’s like the should-be-one-size hat that never fits “just right” because, in reality… one size fits one.
It’s no different when it comes to income tax software. Income tax software usually fits an individual with a straightforward income tax return and becomes tricky when a return becomes more complex. Income tax software asks taxpayers questions and plugs in information accordingly, with limited support or assistance.
Success is not impossible when choosing to use an economical solution such as income tax software, but there's no doubt that individuals can be at an advantage when working directly with a tax professional.
Working one-on-one with a tax professional allows the taxpayer to identify potential risks, opportunities, and strategies, and will enable them to fully understand their personalized tax obligations, which otherwise may not be apparent when using an income tax software.
With tax season well underway, the purpose of this post is to assist those toying with the idea of using income tax software for their upcoming income tax return. We will explore some common examples of potential errors or oversights that can occur when using income tax software, as well as the risks associated with same.
Our goal is to reveal the potential hidden costs that may result from choosing to use income tax software over a tax professional, with the hopes of raising awareness to minimize risk to those who choose to prepare their return on their own.
Income Tax Software – Potential Errors/Oversights
Income Tax software often asks a series of questions and plugs in answers, often missing the human component to following tax guidelines, rules, and advantages. There are several costly types of oversights and/or errors, such as:
RRSP Tax Deduction Carry Forward
An income tax software may not explain specific tax advantages available to you for things such as RRSP tax deduction carryforwards and other tax strategies.
For example, suppose you've contributed a considerable amount to your RRSP, but you believe you may be in a higher tax bracket next year. In that case, you can carry over a portion of your RRSP contributions to next year to reduce your tax bill. This strategy may not be included in an income tax software, but it could reduce your next tax bill substantially if it fits your situation.
Child Care Expenses
The ability to claim child care expenses such as child care provider fees, day camp fees, boarding school fees, etc., are all eligible expenses. Some expenses are also ineligible, such as clothing, transportation, etc.
Confusion often arises when deciding which parent or support person should claim the childcare expense. The Canada Revenue Agency states that the taxpayer with the lower income shall claim the child expense (please note there are exceptions to this rule).
Childcare expenses are further complicated when there has been a breakdown in a marriage or a common-law relationship (living separate and apart at the end of the year for at least 90 days). In that instance, the above rule would not apply, and the taxpayer who paid the childcare expense would claim the expense.
Knowing which types of medical expenses are eligible and ineligible to be claimed is also crucial when completing your tax return. Income tax software may give hints of the types of eligible expenses but likely will not provide you with the rules and strategy surrounding your eligible medical expenses.
Some items you may not know are considered eligible expenses are air filters or purification devices (by prescription only) and gluten-free food for individuals with celiac disease (you must retain letters from medical professionals for your records), etc.
Further, many individuals do not know that medical expense receipts do not have to fall within a calendar year to be claimed. They can still be claimed if the end date falls within the tax year. For example, you may have a substantial medical receipt that was not used in 2021 for an expense from November 2021. You may think that you can’t claim the expense, but you can claim this expense and deem your medical year as occurring from November 2021 to November 2022 (as long as the next year does not overlap from the prior year).
Further, the calculations required to determine your total medical expense deductions are not straightforward. For instance, medical expenses are calculated based on the lesser of 3% of your net income or $2,479. You might therefore think your medical expenses are giving you a huge deduction when, in reality, they’re not. It’s imperative to look at medical expense strategies such as these in view of considering whether your lower net income spouse or common-law partner could benefit from claiming the eligible medical expenses instead.
Eligibility for Canadian Worker’s Benefit
Understanding whether you are eligible for the Canadian Worker’s Benefit can also be confusing if you have reason to believe you’ve met the threshold.
For example, you can claim the Benefit if you are a Canadian Resident throughout the year, earned a working income, and are at least 19 years of age or older on December 31st, or you live with your spouse or common-law partner or your child.
You are not eligible for the Benefit if you are a student (among other exceptions). Therefore, if you are a student and have also earned income, you are not entitled to the Canadian Worker’s Benefit, and you shouldn't claim it on your return.
Reporting the Sale of the Principal Residence
Many individuals are not aware that as of October 3, 2016, it is mandatory that you report the sale of your principal residence on your income tax return. As this is a relatively new rule designed to improve compliance and administration of the tax system, many individuals believe they don’t need to report the sale because they’re not paying tax on the capital gain due to the principal residence exemption.
Not reporting the sale of your principal residence on your income tax return can result in penalties, even if it was an inadvertent error. This is not something that individuals would likely know on their own (without referencing CRA resources) and is another reason why a tax professional can be advantageous in personalized circumstances.
Optimizing Other Carry Forwards – Charity Donations & Student Loan Interest
Optimizing your tax strategy is critical to navigating your return efficiently, thus saving you money. Another strategy to note is the ability to carry over student loan interest from one year to the next. For example, if you pay interest and don't have tax payable that year, it would be better to carry the interest deduction forward into another year, as you can apply it to any of the next five years.
Similarly, you can carry over tax deductions for charitable donations for the next five years (or ten years in exceptional circumstances related to ecologically sensitive land donations). Also, it's important to note that you must use amounts from carried-forward gifts before using deductions for gifts in the current year.
Income Tax Software Risks
Knowing the risks of filing your taxes incorrectly using income tax software is essential. If the Canada Revenue Agency suspects a discrepancy in your return, you may be at risk for an audit resulting in paying back funds. In contrast, it’s possible that you may have missed out on strategies that would have saved you money. At the end of the day, you must keep a detailed record of all supporting documents, whether you use income tax software or a bookkeeper and/or accountant.
No matter which method you choose, you are responsible for your tax return; however, working with a professional and having the ability to ask questions and receive guidance will give you the peace of mind and support you require to complete an accurate income tax return.
Get Peace of Mind with a Tax Professional
It's important to recognize that although using income tax software may appear to be the most economical route in your circumstances, it can cost you money and cause you to stress
in the form of lost savings or audits.
It's possible that you may lose money as a result of not strategizing your return, if for example, you use a credit this year that may be better for use next year or if you’ve claimed a medical expense or benefit to which you are not entitled.
By working with a professional, you can ensure that your tax return is accurate, compliant, and optimized to save you money on your taxes. Contact us today if you're looking for help with your tax return this year!