Canada is Progressive!
Canada has a progressive tax system which means as you earn more, you’re taxed at higher rates. These progressive rates are termed brackets. The federal government has 5 brackets of taxation on your income, while individual provinces have their own brackets that layer on top of federal taxes (see how this works in the illustration below). Federal and provincial taxation occurs separately, but both are calculated on the same tax return so you’ll never notice (except for Quebec).
A key misconception associated with the Canadian tax system is the concept of shifting to new brackets of taxation. Any thinking aligned with “I don’t want to make this sale or accept this bonus this year because it’ll push me into the next tax bracket” is based on an incorrect understanding! The correct idea is that additional income is taxed at the applicable rate of the bracket it’s inside. It’s never the case that your entire income is taxed at the new brackets rate.
Let’s check out an example:
If a taxpayer earns $53,359 per year gets a raise to $60,000 per year. As you can see from the illustration below, they’ve been bumped from a combined tax rate of 22.70% to 28.70%. however, their entire salary of $60,000 won’t be taxed at the higher tax rate, only the incremental income from $53,360 to $60,000. Therefore, they pay the same amount of tax on the first $53,359 of their income, and for the remaining $6,640, they pay 28.20%. This same concept works throughout all levels of income, so the same taxpayer pays 3 different combined tax rates to arrive at their final calculation with their first tax bracket $0 – 45,654 at 20.06% and their final one at $53,359 – $91,310 at 28.20%.
You can find the tax bracket for your province by clicking it on this webpage.
What Are Canadian Tax Deadlines?
Personal taxation occurs on all earnings within the calendar year from January 1 – December 31. Most tax returns are due 4 months after the calendar year, meaning your tax return and payment is due April 30th of the year following the year of taxation. The exception is for those individuals who earn self-employment or rental income. Their due date isn’t until June 15th, but comically, taxes are still due on April 30th, along with everybody else. If this is your situation, contact us and we can give you an estimate to avoid penalties and interest!
How Are Taxes Calculated in Canada?
Everyone’s tax return is unique based on their type of work, lifestyle, and living arrangements but learning the general framework used to process taxes will help you understand how final balances are calculated. Come tax time; you’ll have the advantage of reviewing your return and taxes owing with a knowledgeable base. The framework can be broken into 4 primary sections: income, deductions, tax credits, and net taxes.
Section 1: Income
Another important feature of Canada’s tax system is that different types of income have different tax rates. The 3 types of income are:
- Dividends: Income received from owning shares of a corporation (public or private).
- Capital Gains: Income received from selling an investment. This includes real estate except for a primary home.
- Other Income: All other forms of income (These rates are reflected in the first illustration). This includes the most common types like salary, bonuses, commission, or self-employed net income.
When you file your taxes, all income is added to generate total income. If you operate a personal business, the net income (revenue – expenses) is added to total income, not revenue. Then there are deductions that you claim against your total income to reduce it.
Section 2: Deductions
If you were taxed on total income, it would be missing some key elements—what if you had a big loss from selling a stock in a prior year? Or if you added $5,000 to your RRSP during the year? This section is where these deductions enter the tax process. They include but aren’t limited to:
- Investment fees
- Childcare expenses
- Spousal support payments
- Professional and union dues
- Moving expenses (when moving for a specific job)
All these deductions (and many more) combine to reduce your total income. Some deductions can only be applied to the same type of income. Losing money on the sale of a stock falls under ‘Capital Gains’ and can only apply to that income type. However, most deductions, like RRSP contributions, can be applied to all forms of income. Once deductions reduce total income, you are left with taxable income—the dollar amount that will be taxed in Canada’s progressive bracket system.
Deductions are not the only thing that reduces your taxes. The next section will introduce Tax Credits, which reduce taxes differently. People often get deductions and credits confused, so hopefully, we can demystify the differences.
Section 3: Non-Refundable & Refundable Tax Credits
Once taxable income is sifted through Canada’s tax brackets, and a tax owing is determined, the tax system has various tax credits that can be applied to reduce taxes owing further. The major difference between tax credits and deductions is that deductions reduce your income (pre-tax), but credits reduce your taxes owing (post-taxation). Subtle but important. For example, when you make a RRSP Deduction of $5,000, the entire amount reduces your income but when you donate $1,000, you’ll receive a Donation Credit of $262* against your taxes owing (not income).
*The formula: 15% of 1st $200 + 29% of remaining $800 = $262
Credits can be complicated. Different credits have different formulas; the Donation Credit has a different formula than the Medical Expense Credit. The most common tax credit is the Basic Personal Amount (BPA) which ensures that everybody’s first $12,719 (as of 2022) of income is tax-free.
Non-Refundable Tax Credits
Credits can be separated further between non-refundable and refundable credits. What separates them is, as the names suggest, non-refundable credits reduce your tax amount owing to $0 but no further. Refundable credits can reduce your taxes beyond $0 and trigger a refundable balance.
Here are a few other examples of non-refundable tax credits:
- Age Amount: For individuals aged 65 and older
- Child Amount: For individuals with children under 18 years of age
- Canada Employment Amount: For those who are employed in Canada
- Disability Amount: For infirm individuals
- Tuition, Education, and Textbook Credits: For students
There are many more, and each has its own formula to produce a usable credit.
Refundable Tax Credits
These are credits that can result in a refund if they reduce your taxes owing below $0. They are rare and the most common one is the Canada Workers Benefit which provides a credit to low-income employees in Canada that earn at least $3,000 and is eliminated at $22,944 for individuals ($26,177 for family households).
Deductions, credits, and expenses are areas where a professional accountant can add significant advantages above simple tax software because you cannot tell the software to claim a credit you aren’t aware exists. A good accountant knows all the credits and can optimize your tax return accordingly.
Section 4: Net Taxes
We’ve reached the conclusion of your tax return. Your total income has been calculated, and then deductions were compiled to reduce income into taxable income. Then, taxes owing was calculated based on the progressive tax brackets, and all relevant tax credits were applied to reduce taxes a little further. Now we’ve arrived at your net taxes for the year. If you work as an employee, most standard employers pre-pay their employees’ net taxes, so you’re not left with a huge annual tax bill. When you file your tax return in April, you pay (or receive) the difference between what your employer remitted and your net taxes owing.
The illustration to the right outlines the entire process we just went over in a simple image. Our hope is as you review your next tax return, you will be educated enough to make sure it was done correctly. A good income tax preparer can save you lots of money and hours of stress, but taxes are complicated and no one knows your situation better than you. A tax preparer can make mistakes based on a lack of information or miscommunications, so it’s important to have knowledge of the process so you can ask the right questions.
May your tax strategy be high and your tax owing be low!
Bring Your Taxes To Us!
Doing your taxes is complicated and stressful, so we’re here to help! Set up a meeting by calling our office (604-946-4441) or booking directly with one of our consultants!
