Every year, like clockwork, accounting firm ads on billboards and bus stops give you the kind (and unwanted) reminder when tax season is just around the corner. A pain at the best of times, filing your tax returns can get incredibly stressful if you’re in debt or preparing to file for a consumer proposal.
Many misconceptions surround filing a consumer proposal and income tax, most of which exist because your taxes are treated differently in a consumer proposal than in a bankruptcy.
Many of our clients at David Sklar & Associates come in with questions about their consumer proposal and income tax returns and debts. Our Licensed Insolvency Trustees can give you detailed answers about your financial situation and what you can expect from your consumer proposal and tax return in Canada.
Our trustees are here to help you through the consumer proposal and income tax process. Our team is prepared to answer any debt related question you have, whether it’s about taxes, your assets, or your credit rating.
There are a few basics you might want to know about how your taxes work when you file for bankruptcy or a consumer proposal in Canada.
Income Tax Before a Consumer Proposal
To start a consumer proposal, you need to file the request and get it approved by your creditors. If they don’t provide approval, you will need to amend your proposal.
It’s essential to file all of your income tax returns in Canada before proceeding with a consumer proposal, as the CRA will not approve a proposal by an individual with unfiled income tax returns.
Specifically, to have your proposal accepted by the CRA, you will need to do the following:
- File all tax returns to date
- File all tax returns due during the proposal period at the scheduled date
- Pay all taxes owing during the proposal period
Income Tax & Consumer Proposals
When you file a consumer proposal in Canada, taxes get treated as unsecured debt — that is, as long as you don’t have a lien issued against your property by the CRA.
The way consumer proposals and tax debt works is that a proposal can help reduce your tax debt alongside any other debt owed to other creditors. Consider how filing your income tax while in a consumer proposal works in Canada:
Do you have to file your taxes in a consumer proposal?
By law, you must continue to file your income taxes in a consumer proposal. Failing to do so could even interrupt your agreement. In the case of bankruptcy, the licensed insolvency trustee will have to file both a pre-bankruptcy tax return and a post-bankruptcy tax return.
Does a consumer proposal affect my tax return?
Getting to keep your tax refund is a significant pro to consider when weighing a consumer proposal’s pros and cons.
A significant advantage of a consumer proposal is that, unlike a bankruptcy, because it does not require you to give up your assets, it will not affect your consumer proposal tax return. As a result, you will still need to file your yearly income tax returns.
The CRA will continue to send you any tax refunds you were eligible for before your proposal unless you have outstanding tax debts. Any previous tax debt will get treated as a creditor in the consumer proposal process and any tax refund related to the period prior to your consumer proposal will be offset against any tax debt you owe in your consumer proposal.
Consumer Proposal Tax Returns VS. Bankruptcy
It is essential to consider the future of your tax returns when you are weighing your options and considering a consumer proposal vs a bankruptcy.
One of the reasons David Sklar & Associates encourages clients to consider a consumer proposal over bankruptcy is that it allows you to keep your tax refunds and protects you in the case of any future increases in income (i.e. surplus income.)
In the case of a consumer proposal, you will agree to pay your creditors a fixed monthly amount for a period of up to five years. That agreement doesn’t change unless you file for a new one with a faster payback rate.
The average tax refund in Canada is $1,700, which is money that can help a lot when you’re climbing your way out of debt. In bankruptcy, these returns are forgone. Consider how consumer proposal tax returns get treated differently than bankruptcy tax returns.
Tax Returns in Bankruptcy
In most cases, it is possible to include income tax debt in the bankruptcy and get released from it after completing the bankruptcy.
If you file bankruptcy, you will indeed have to give up your tax refund for the year of filing, just as you would have to give up part (or all) of an inheritance or any increase in your income.
Before Filing for Bankruptcy
Before filing for bankruptcy, you must bring all of your income tax filings up to date. The good news is that, even if you have lost documentation or it has been years since you last filed, it is possible to bring these filings up to date.
In the fiscal year you file for bankruptcy, your tax return gets divided into a pre-bankruptcy income tax return and a post-bankruptcy income tax return. This is meant to divide any balances you owe to the CRA as well as other creditors.
Pre-bankruptcy Income Tax Return: This tax return will cover January 1st, the first day of the new year, up until the date you file for bankruptcy. If you owe any additional tax debt, it will get added to your bankruptcy. If you get a tax refund, it will get submitted to your trustee or be offset against your income tax debt.
Post-bankruptcy Income Tax Return: This tax return will extend from the day you file for bankruptcy up until December 31st. If there is an amount owing, this is a post-bankruptcy debt and must be paid. If there is a refund, it forms part of your bankruptcy estate. These returns must be filed by your Licensed Insolvency Trustee.
Other essential factors to consider include:
Canadian Child Tax Benefits: If you are entitled to Canadian child tax benefits, you will still be permitted to receive these funds in a bankruptcy. This is because, while tax returns are considered an asset, Canadian child tax benefits are considered a part of your income. As a result, you will still be able to receive these tax benefits as usual.
Liens & Garnishees: As long as there has not been a fraud, a bankruptcy discharge will usually result in the lifting of any liens or wage garnishees filed by the CRA.
Tax Refunds: If the person filing bankruptcy is eligible for a refund on their income taxes, that refund will become part of the bankruptcy estate and be distributed by the trustee to the unsecured creditors. The payment redistribution priority of these unsecured creditors is outlined in Section 136 of the Bankruptcy and Insolvency Act.
After your bankruptcy, you are entitled to any tax refunds in the tax years that follow the bankruptcy’s completion. This entitlement means that you will also be obligated to pay any taxes you owe.
Income Tax After a Consumer Proposal
The good news is that a consumer proposal will cover any taxes you owe up to the date you file the proposal. The CRA, specifically, will allow you to include a provision for any unpaid income tax up until the date of your proposal.
That said, this provision does not include the taxes you may need to pay after you start your proposal. When filing your consumer proposal, your Licensed Insolvency Trustee will include a specific clause that will outline that you must file all future tax returns and pay your taxes on time.
You must ensure your income tax is accurately reported, as your income tax will impact the amount owed. If, for whatever reason, your yearly earnings decrease, you will need to coordinate with your LIT to ensure reasonable payment expectations.
Debt Relief with David Sklar & Associates
At David Sklar & Associates, we are happy to help you weigh your options for debt relief. Our compassionate trustees walk you through the process of both consumer proposals and bankruptcies in Canada and explain in detail the nuances and legalities involved in both debt management programs.
When you get a consumer proposal or file for bankruptcy, you will also be required to take credit counselling to assess your financial situation and create goals and habits for a healthier financial future. David Sklar & Associates offers credit counselling help in Mississauga, Brampton, Pickering, Scarborough, North York, and midtown Toronto.
There are six David Sklar & Associates locations throughout the Greater Toronto Area. Get in touch with the location closest to you. Get debt help as soon as possible.