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.
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):
|Income Bracket||Marginal Tax Rate|
|$0 – $10,320||0.00%|
|$10,321 – $12,269||15.50%|
|$12,270 – $15,658||27.60%|
|$15,659 – $36,848||21.55%|
|$36,849 – $40,726||24.65%|
|$40,727 – $64,881||31.15%|
|$64,882 – $73,698||32.98%|
|$73,699 – $76,442||35.39%|
|$76,443 – $81,452||39.41%|
|$81,453 – $126,264||43.41%|
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! :)