When I arrived home from the office this week, I found a brown envelope from Canada Revenue Agency (CRA) waiting for me in my mailbox. It’s the middle of the summer, so I had a pretty good idea what it was: an instalment reminder.

Although I’m a salaried employee with a full-time job, I earn a significant amount of money on the side. Not only do I work part-time, I earn rental and freelance income. At the end of the day, it adds up to a hefty tax bill. Despite contributing the maximum to my RRSP, I still ended up owing over $6,000 to CRA when I filed my 2013 income tax return. This marked the second straight year I owed the taxman over $3,000, so I knew the request to pay my income tax by instalments was coming.

Why Do I Have to Pay Tax Instalments?

While most Canadians don’t have to worry about instalment payments, those who earn substantial income without taxes being withheld at source will more than likely have to pay instalments. If your net tax is greater than $3,000 in the current year or any of the last two years, you’ll have to make tax instalment payments towards next year’s tax bill. Freelancers and landlords aren’t the only ones who need to worry about tax instalments – retirees with RRIF withdrawals can end up paying tax instalments.

While paying your taxes by instalment may seem like punishment, there are benefits. Instead of owing the taxman a hefty amount come April 30th, your tax liability is spread over the year. This helps you manage your cash flow better, so you won’t have such a large balance owing all at once. If you pay your tax by instalments, you still have an advantage over salaried employments – at least income tax isn’t withheld at source. This  at least frees up your cash flow for a few months. Your instalments are based on last year’s balance owing, so if you earn even more this year, it’s like receiving an interest-free loan on the difference (although you’ll have to pay the difference come April 30th).

Calculating Your Tax Instalments

Even if you receive an instalment reminder, you may not have to pay your tax by instalments. If your net tax owing in the current year will be $3,000 or less, you can simply ignore the reminder. However, if you’re unsure you should make the instalment payments, as you’ll be charged interest if you end up with $3,000 or more in net tax owing.

In your first year paying tax by instalments, you’ll only have to make two payments: by September 15 and December 15. In subsequent years, you’ll have to pay your instalments quarterly by the following deadlines:  March 15, June 15, September 15, and December 15.

There are three options if you have to pay your tax by instalment:

1.) No-calculation option

If you’re unsure which option to choose, you can’t go wrong with the first option. This option is ideal if your income, deductions, and credits remain relatively  the same from year to year. You won’t need to do any math to figure out the amount owing – CRA will send you instalment reminders in February and August with the amounts owing.. Simply pay the instalment by the due date and you’re good to go.

2.) Prior-Year Option

This option is ideal if your current year (i.e. 2014) income and deductions are similar to the previous year (i.e. 2013), but significantly different from two years ago (i.e. 2012). Take your balance owning from the previous tax year and divide it by four to calculate your current year’s quarterly instalments.

3.) Current-Year Option

This option is ideal if your current year income and deductions will be significantly different from the previous two years. This option is a little more complicated to calculate. You’ll need to use the calculation chart from CRA to figure out how much your instalment will be.

How Can I Avoid Paying Tax by Instalment?

The easiest way to avoid paying tax by instalment is to reduce your net tax. How can you do this? Contributing to your RRSP is a good way.

Do you pay your tax by instalments? Which instalment option do you use to pay your tax?

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians, available now on Amazon and at Chapters, Indigo and major bookstores, and as an Audiobook on Amazon, Audible and iTunes.