Income Tax – The Canadian Tax Bracket System

Posted by Preet on Oct 15, 2007 | 64 comments

Updated to 2009 Tax Year

Personal Income Tax

You may or may not be aware that Canada’s personal income tax system is set up in a “progressive” manner. Basically the more you earn, the more you are taxed. In fact you may have heard people referring to high-income earners losing half of what they make to income tax. While it is true that a high income earner will pay a lot of money in tax, they don’t normally pay HALF of their income to the income tax collectors.

Tax Rates

Allow me to explain… There is no 50% tax bracket in Canada. In Ontario, the highest tax bracket, or marginal tax rate,  that exists is 46.41% for income over $126,265 (for the 2009 tax year). So right off the bat you can see that someone would not lose HALF their earnings to income tax. But there is more to this story than just the top tax rates. Let’s start with an example and then work backwards… If Bob earned $130,000 for 2009, he would have a combined total federal and provincial income tax of $41,171. That would leave him with a “take-home pay” of approximately $88,829. As you can see this is clearly not half of his income. So what gives?

The Candian tax system uses what are commonly called “tax brackets”. Each bracket has its own rate of tax, and as you move up through the brackets the marginal tax rate increases until you reach the top tax bracket which is 46.41% (Ontario). Here are the income tax brackets for Ontario (2009 Combined Federal and Ontario Provincial Personal Income Tax Rates as sourced from Ernst & Young):

If you earned $130,000 you would be in the highest of tax rates subject to the highest “Marginal Tax Rate” of 46.41%, but that rate of 46.41% ONLY applies to the income over $126,265. As you can see from the table above, the first $10,320 of your income (no matter how much your total income is) incurs no personal income tax. The concept of “Average Tax Rate” is just a way of figuring out roughly how much of your income is going to the government in the form of personal income tax. If we go back to our high income earner ($130,000) and do the math, we will find: $41,171 Total Tax Bill / $130,000 Total Income = 31.67% Average Tax Rate.

Average Tax Rates serve no purpose for tax filings – they are only calculated to see how much of what you earn is going to the government. MARGINAL TAX RATES come into play for many calcuations and are important in calculating the effects of certain financial strategies – so that number is ultimately more important. The Average Tax Rate is just nice to know… Or not! :)

Here is a link for quickly figuring out your Marginal Tax Rate, Average Tax Rate and Tax Rates on different types of income.

Myth: "I don't want a raise! It will move me into a higher tax bracket and my take home pay will be less!"

Posted by Preet on Jul 30, 2007 | 6 comments

I’ve heard this many times, even from my beautiful mother! This is not true! Let’s bring up my SAMPLE tax table as a refresher:

$0-$10,000       = 0% Tax Rate

$10,000-$20,000 = 10% Tax Rate

$20,000-$50,000 = 20% Tax Rate

$50,000-$75,000 = 30% Tax Rate

$75,000+            = 50% Tax Rate

You will hear some people complain that they don’t want their next raise because it will move them into a higher tax bracket and reduce their takehome pay and they will have less money to spend. Okay, the Government does some interesting things but they’ve figured this one out a long time ago. Here’s how it works:  Let’s take someone earning $49,000. Their marginal tax rate is 20% in our example tax system. That DOES NOT MEAN they pay 20% x $49,000 in tax. They pay 0% on their first $10,000, 10% tax on the next $10,000, and 20% on the next $29,000. Let’s work that out:

(0% x $10,000) + (10% x $10,000) + (20% x $29,000) = $6,800 in tax

$49,000 Income – $6,800 tax = $42,200 TAKE HOME

So let’s say they get their raise to $50,001. The myth is that now instead of paying 20% on all their income, they pay 30% – which would reduce their take home pay by roughly $5,000! This could not be further from the truth! Let’s do the real math:

(0% x $10,000) + (10% x $10,000) + (20% x $30,000) + (30% x $1) = $7,000.30 in Tax

$50,0001 Income - $7,000.30 Tax = $43,000.70 TAKE HOME

Last time I checked, $43,000.70 is greater than $42,200! So feel free to ask for that next raise… :)

Thanks to everyone who has been submitting (and re-submitting) this post to your favourite social media websites like Reddit and Stumbleupon – much appreciated!

What is a "Marginal Tax Rate?"

Posted by Preet on Jul 30, 2007 | 0 comments

This is a basic concept that should be understood as it is referred to on a regular basis. When you look it up, the definition almost always seems to include this: “The percentage of tax you pay on the last dollar you earned.” I’ve always thought of this wording as a bit funny.  While it is precise, it’s a bit too lawyer-speak for my taste. So let’s take a closer/better look…

As a side note, unless a post is marked as an advanced level article, I’m going to use simple numbers and fictitious tax brackets for the purpose of educating without confusing. :)

Our personal income tax system is designed to tax higher-income earners more than lower income earners. It does this by using “tax brackets”.  Let’s look at an example:

$0-$10,000       = 0% tax

$10,000-$20,000 = 10% tax

$20,000-$50,000 = 20% tax

$50,000-$75,000 = 30% tax

$75,000+           = 50% tax

In this case you can see that some earning under $10,000 pays no tax at all. The Marginal Tax Rate is the rate of tax payable in the highest tax bracket you fall into. SO: if you earned $60,000 your marginal tax rate would be 30%.  If you earned $100,000 your marginal tax rate would be 50%.