Inflation and interest rates have surprising effects on taxes

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The Bank of Canada’s decision this week to keep the benchmark interest rate unchanged at 5% to combat inflation was welcome news to many. But the tax implications of both rising interest rates and inflation will be felt in at least some ways in the new year, based on the latest economic data available over the past week or so.

First, let’s look at the interest rate environment. Even if central bank interest rates aren’t going up, it looks like the Canada Revenue Agency’s stated interest rate will actually go up (and again) starting January 1, 2024. The stated interest rate is set quarterly and is directly tied to the yield on government bonds. The Government of Canada’s three-month Treasury bill is delayed.

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This calculation is based on an income tax regulation formula that takes the simple average of three-month Treasury bills for the first month of the previous quarter and rounds up to the next highest whole percentage point (if not a whole number).

To calculate the interest rate for the next quarter (January 1, 2024 to March 31, 2024), look at the first month of the current quarter (October 2023) and calculate the three-month T-bill yield. Calculate the average of It was 5.16. % (October 10) and 5.16% (October 24). The stated interest rate will be rounded up to the nearest whole percentage, resulting in a new stated interest rate of 6 percent for the first quarter of 2024. Compare this to the historically low interest rate of 1 percent since July 1, 2020. The last time the stated interest rate was 6% was over 20 years ago, in the second quarter of 2001.

Raising the stated interest rate has many implications. To understand these, we need to point out that there are actually three prescribed tax rates: the basic tax rate, the tax rate paid for tax refunds, and the tax rate charged on unpaid taxes. The basic tax rate, which will rise to 6% (from 5%) from January 1, will apply to taxable benefits to employees and shareholders, low-interest loans and other related party transactions.

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The tax refund rate is 2 percentage points higher than the basic tax rate. So if the CRA owes you money, the interest rate as of January 1st would be 8%. However, keep in mind that you need to rush to file your 2023 taxes. Filing as early as possible during the next tax filing season doesn’t necessarily mean you’ll get a refund at that tax rate. Because if filed by the deadline, the CRA will only pay refund interest on amounts owed after May 30th.

Finally, if you owe money to the CRA or are delinquent or missing any of your quarterly tax installments, the tax rate charged by the CRA is a full 4 percentage points higher than the basic tax rate. This means interest on tax debts, penalties, insufficient installments, unpaid income taxes, Canada Pension Plan contributions and employment insurance contributions will be a whopping 10 per cent from January 1.

Please note that this interest is compounded daily and is not tax deductible. For example, if you’re a resident of Newfoundland and Labrador and fall into the top tax bracket of 55 percent in 2023, that means you need to find investments that earn you a guaranteed rate of return of 22 percent before taxes. . It’s about becoming richer than paying off your tax debt.

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Another recent economic news that will impact taxpayers in 2024 is the latest inflation rates. Tax brackets and most other amounts in the tax system are adjusted for inflation. The 2024 inflation index factors, which apply to tax brackets and various other amounts, will not be officially released by the CRA until November, but are roughly based on Consumer Price Index (CPI) data published by the Bureau of Statistics. You can do calculations. Canada last week.

The 2024 Federal Price Index is calculated by dividing the average monthly CPI factor for the 12 months ending September 30, 2023 by the average monthly CPI factor for the 12 months ending September 30, 2022. will be done. September CPI data released last week showed an increase of 3.8% over the past 12 months. This data can then be used to finalize the index coefficients for 2024. This factor should be 4.7 percent. By comparison, the indexation factor in 2023 was 6.3%.

The silver lining in the latest inflation numbers is that the 2024 tax-free savings account (TFSA) limit will increase to $7,000 from the current 2023 limit of $6,500. Note that the 2022 TFSA limit was $6,000, so this is the first time it has been increased for two consecutive years.

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The TFSA was first introduced in the 2008 federal budget and has been available to Canadians since the 2009 calendar year. The original limit was $5,000, which then rose to $5,500 and remained that way for years, but in 2015 it was briefly reduced to $10,000. Under the tax code, starting in 2016 and each year thereafter, the annual limit for a TFSA was fixed at $5,000. $5,000. The annual limit is easy to remember because it’s indexed to inflation for each year since 2009 and rounded to the nearest $500.

Therefore, the TFSA limit will only increase if the cumulative effect of the annual inflation adjustment is sufficient to increase the limit to the next higher $500 increment. The 2024 indexed TFSA dollar amount is currently $6,859. This means that the official limit increases to the nearest $500 increment of $7,000.

For people who have never contributed to a TFSA and have lived in Canada since 2009 and are 18 years of age or older, the total available contribution limit increases from $88,000 in 2023 to $95,000 in 2024. do.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is Managing Director of Tax and Estate Planning at CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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