Why You Owe Taxes This Year and How to Avoid It Next Year

Finding out you owe taxes can be frustrating and confusing, especially when it catches you off guard. You’re probably wondering how you could possibly owe more taxes when taxes were coming off your paycheque all year.

While everyone’s situation is unique, being hit with an unexpected tax bill can happen for many reasons. However, understanding why you owe taxes and planning ahead can help you avoid surprises in the future. Read on to learn why you might owe money this year and how to prevent future tax liabilities.

Common Reasons for Owing Taxes

• Insufficient Tax Withholding

One of the main culprits behind owing taxes is insufficient tax withholding. This happens when your employer doesn’t take enough taxes out of your paycheque throughout the year. It’s more likely to happen if you have multiple jobs, switch jobs, or your income changes unexpectedly. For example, if you switch jobs mid-year, your new employer might not withhold enough taxes based on your previous salary, leading to a bigger tax bill.

• Additional Income Sources

Another reason why you might owe taxes is from additional income you didn’t realize would impact your filing. This includes things like freelance work, investments, or side jobs. If you’ve started a side hustle or picked up freelance gigs, that income isn’t automatically taxed—it’s up to you to set aside some of that money for taxes. The general rule is to set aside between 25% and 30% of self-employment income earned for taxes. If you don’t, you could end up owing more than you expected when tax season rolls around.

• Changes in Tax Credits and Deductions

Life changes can also have a big impact on how much you owe in taxes. For example, if your children have aged out of certain credits, or if your marital status has changed, you might no longer qualify for some of the deductions that helped lower your taxes in the past.

How to Prevent Owing Taxes in the Future

• Adjusting Your Tax Withholding

One of the easiest ways to avoid owing taxes in the future is by adjusting your tax withholding. This starts with reviewing your TD1 forms—these are the forms you fill out when you start a new job to help your employer figure out how much tax comes off your paycheque. If you’ve had any life changes, like a new job, a raise, or changes in your dependents, it’s important to update your TD1. This ensures the right amount of tax is being deducted throughout the year.

• Making Quarterly Installment Payments

If you’re self-employed or earn income that isn’t automatically taxed, like freelance work or investment earnings, you may need to make quarterly installment payments to the Canada Revenue Agency (CRA). You can easily make payments online, and the CRA will notify you if installments are required based on the net tax owing threshold on your previous tax returns. These installments can help you spread out what you owe throughout the year, so you won’t face a large bill when it’s time to file.

• Contributing to Registered Accounts

Contributing to registered savings accounts like Registered Retirement Savings Plans (RRSPs), Tax-free Savings Accounts (TFSAs) or First Home Savings Accounts (FHSAs) can help lower how much tax you owe. An RRSP is a tax-advantaged account. This simply means the Canadian government provides tax breaks to those who invest in RRSPs. TFSAs don’t directly reduce your taxable income, but the income earned inside them is tax-free. Similarly, a FHSA allows prospective first-time home buyers the ability to save $40,000 on a tax-free basis. Contributing to these accounts each year allows you to save for the future while also reducing your tax bill. 

What to Do If You Owe Taxes

• Payment Options

The CRA offers multiple ways to pay your taxes, including online banking, debit or credit card payment, cheque, e-transfer, wire transfer, cash, or using the CRA's My Payment service.

If you’re unable to pay your taxes by the deadline for any reason, your first step should be to contact the CRA to discuss a payment plan. In many cases, the CRA may allow you to make payments on your tax debt over time through a tax payment arrangement rather than forking over a lump-sum payment. To qualify for a payment arrangement, you’ll need to prove your current inability to pay. So, be prepared to share details regarding your income, expenses, assets, and liabilities. 

If you can’t devise a payment plan that works for you or are struggling financially, check your eligibility for Taxpayer Relief Provisions. Provisions include cancelling or waiving interest or penalties. The CRA provides these options to Canadians who are in an emergency situation, due to a job loss or other circumstance beyond their control, such as a natural disaster, an illness, or a death in the family. 

To be eligible, you’ll need to show financial hardship in addition to these circumstances and prove that paying the interest or penalties would make it difficult for you to afford the basic necessities of life. But keep in mind that even if you do qualify for Taxpayer Relief Provisions, you’ll still owe your tax debt; the CRA will just waive the interest and penalties.

• Consequences of Not Paying on Time

While filing a tax return may bring up feelings of dread—especially if you owe a balance—it’s crucial to pay on time. Not doing so can have serious financial implications, including penalties, interest charges and the temporary loss of some government benefits until the balance is paid.

Once the tax deadline passes, the CRA starts charging interest on any unpaid taxes, beginning May 1st. If you're late filing, you'll face a late-filing penalty too. This penalty starts at 5% of the balance you owe, plus an additional 1% for every month it’s late, up to a maximum of 12 months. Even if you can’t pay the full amount, filing on time will help you avoid these charges.

Programs like the Canada Child Benefit and the Guaranteed Income Supplement part of Old Age Security rely on the information from your tax return to determine how much you’re entitled to. If you don’t pay your taxes on time, your benefits might be delayed or even temporarily stopped. Your tax return is also used to determine eligibility for loans, student grants, provincial benefits, and even low-income assistance like home repair or heating rebates, so it’s important to pay on time to take advantage of these credits.

How Credit Canada Can Assist

• Personalized Financial Counselling

Finding out you unexpectedly owe taxes can be a shock, and while your tax debts can’t be erased, Credit Canada can help you manage your finances so it’s easier to pay what you owe. 

If you’re experiencing unmanageable debt and cannot afford to pay your tax bill, our certified Credit Counsellors can help you explore debt relief solutions, including debt consolidation and negotiating with your creditors. By enrolling in a Debt Consolidation Program, we can help you reduce or pause interest on credit cards and payday loans, and lower your monthly payments, freeing up more money to take care of your tax bill. Plus, debt consolidation could work in your favour if you're trying to set up a payment plan with the CRA—it shows you’re still making an effort to pay off your debts, despite financial trouble.

• Budgeting Assistance

Maintaining a budget may sound like a hassle, but doing so can help you manage your tax liabilities. Credit Canada makes it easy with our free budgeting tools and resources. It’s important to track your income and expenses to make sure your tax debt payment plan aligns with your budget. Otherwise, you might pay off last year’s taxes but fail to save for your next income tax return. Using these tools, you’ll be able to plan ahead and achieve debt relief.