Unwanted surprises

While tax season is well behind us, some people are still paying the consequences of not having enough tax deducted at source.

Often, college-aged kids who worked a number of casual or part-time jobs are surprised to find they have to pay income taxes in April. They may have had some income taxes deducted on their paycheques, but realized far too late it wasn’t enough. They made the assumption payroll was “taking care of things,” which included taking off the correct amounts of required deductions.

So, how does a casual or part-time employee get a large tax bill? And how can HR professionals ensure this does not happen to their employees? 

Further, what can part-time employees, or employees working at more than one job during a year, do to ensure come tax time they are not blindsided by a tax bill?

The whys and hows

The issue arises from the employee’s work situation. Some people work multiple part-time or casual jobs in a year and while there is nothing wrong with this, each employer is unaware or has not adjusted the taxes withheld for the fact that other income is being made by the employee.

Every employee is able to make about $12,000 per year tax-free in Canada. This is called the basic federal exemption. The provincial exemption varies; however, for this purpose, keep $12,000 in mind. If an employee works part time at multiple employers within the year, he should be reminded of the basic exemption amount and asked to consider if his income from all sources might exceed that.

From a payroll department perspective, most payroll software will adjust the calculated amount of withholding tax in consideration of this exemption due to annual tax updates. Often, these programs will not withhold taxes on yearly wages estimated at less than the federal exemption ($12,000) or will withhold amounts based upon the projected income at that particular job.

But what happens when one person works three part-time jobs and, combined, makes more than the federal exemption, such as $18,000 per year? To avoid a big tax bill, one employer should be informed to withhold taxes based on an $18,000 yearly income, rather than the smaller income made there during the year. 

If each employer thinks the employee has made less than the exemption, and this will be the only income for that person in the year, then it is correct to assume no taxes should be withheld. Often, tax is automatically computed using a payroll computer platform — an employer may not even be aware no taxes are being withheld.

Understanding the TD1

Sadly, statistics show most employees don’t even read their pay stubs, so an employee may also not realize tax is not being deducted. 

One way to easily identify this potential pitfall is to issue the mandatory TD1 form to new employees.  This form asks employees for information related to income tax credits, but can also be used to request additional tax withdrawn at source.

The TD1 form helps payroll departments determine the amount of taxes they must deduct from employees’ paycheques. Since many people have different personal circumstances (such as dependants, spousal support or kids in college), and since the money they make is taxed at different rates, this form allows employees to essentially “customize” their tax deductions to meet their specific situation.  

The default amount on the TD1 form is merely the basic exemption or tax credits. All employees working in Canada are allowed to claim the basic exemption.

In fact, without filling out a TD1 form, the employer would have probably used the basic amount as the default option. This is the option that would calculate the lowest amount of the credits (and thus most tax) needed to be deducted from a paycheque each pay period. 

Employees with multiple sources of income need to be reminded to consider voluntarily increasing their tax withholding or taking no basic exemption at that employer. In fact, page two of this form actually asks the employee if he has more than one employer and, if so, he is instructed not to take any deduction if he has filled out this form elsewhere. 

By following these guidelines, the person may avoid a large tax payment come spring when he is required to claim income from all sources on his tax return.

Payroll professionals may want to consider explaining this form to employees — most people have no idea what it is or what it attempts to accomplish. By spending just a few minutes going over this form and asking employees how much they anticipate making in a year (from all employment and other income), they might be saved a lot of strife come tax time. 

And while the employee has the option on the TD1 form to contribute in excess of the amount automatically calculated by the payroll department, this optional payment can be adjusted or cancelled at any time by the employee.   

And don’t forget about tips. Often, these are reported on the tax return but, again, this is taxable income and if no taxes have been deducted, then reporting them will now add to the tax payable to the employee.

While some employees often find out the hard way about the importance of the TD1, HR professionals can come to the rescue by pointing out some not-so-obvious pitfalls in having numerous employers throughout the course of a year. 

Spending just a few minutes explaining the TD1 form to a new employee might save that person a lot of shock, grief and stress come tax time.

Wendie Karlowsky is the general manager at Blue Canvas Work Management & Payroll in Winnipeg. For more information, visit www.bluecanvasgroup.com.