The Basics of the Canadian Tax System

Welcome to tax season! Like the old saying goes: nothing is certain in life but death and taxes.

We all pay taxes in some way or another, and of course, taxes help pay for valuable services and infrastructure. However, at the end of the day, you don’t want to pay more tax than you need to.

In today’s post, I’m going to give you some exciting (sarcasm!) insights into the world of taxes so that you can make the type of personal financial decisions that help you pay just what you need to and not more.

In Canada, we have what is called a progressive tax system.

This means that there are multiple tax brackets, and as you move up the brackets, you pay higher taxes on the additional income. This doesn’t mean that you will earn less total income as you move into a higher bracket, it just means that for every extra dollar you earn, you won’t keep as much as the first dollar you made.

Suppose you make $90,000 per year. On the first $45,282, 15% federal tax is paid, equal to $6,792. On the next $45,192 to reach $90,000 a rate of 20.5% is applied, equal to $9,264.36, for a total tax of $16,056.36 in Federal tax, or a 17.8% average tax rate.

If you earned $95,000 in income, you’d still pay $6,792 on the first $45,282, you’d pay $9,283 on the next $45,281 (20.5% on income between $45,282 and $90,563), and on the remaining $4,437 to reach $95,000 in income, you’d pay 26% federal tax, equal to $1,153.62. This gives total tax of $17,228.62, or an average of 18.1% tax.

	Federal Rate	$90,000 Income	$95,000 Income
Taxable Income up to $45,282	15.0%	$45,282 – $0 = $45,282$45,282 @ 15% = $6,792	$45,282 – $0 = $45,282$45,282 @ 15% = $6,792
Income between $45,282 and $90,563	20.5%	$90,000 – $45,282 = $45,192$4,718 @ 20.5% = $9,264.36	$90,563 – $45,282 = $45,281$45,281 @ 20.5% = $9,283
Income between $90,563 and $140,388	26.0%		$95,000-$90,563 = $4,437$9,437 @ 26% = $1,153.62
Total Tax Paid		$16,056.36	$17,228.62
Average Tax		17.8%	18.1%
Leftover after Taxes		$73,943.64	$77,771.38

So even though you were bumped into a higher tax bracket, you still earned more total income, you just didn’t keep as high a proportion of your income in your own pocket at the end of the day. You’re always better off earning more income, but only marginally. Provincial tax works in a similar manner.

For the majority of employed people, income tax is automatically deducted from your paycheque by your employer. When you complete your tax return in April, you are simply calculating whether or not enough tax was already paid.

If you didn’t pay enough tax throughout the year, you’ll owe the government come tax time. If you paid too much tax throughout the year, you get a tax refund.

Now, I know that people love to celebrate a tax refund, HOWEVER, tax refunds aren’t really a good thing.

Getting a tax refund simply means that you loaned the government money throughout the year, and are now getting it back, interest free. If you’re consistently in this situation, you might want to reduce the tax withheld by your employer and invest that money instead. As I’m sure you know, there are ways to reduce your taxes while working. This can be done through various deductions and credits.

Let’s start with deductions.

Some popular deductions include RRSP and employer pension contributions, child care expenses, some legal fees, and deductions related to business and moving expenses.

The higher the tax bracket you’re in, the more valuable deductions are. Deductions reduce your taxable income directly, and therefore the value depends on your tax rate. Ignoring provincial taxes, for the $95,000 earner, a $1000 deduction is worth $260, whereas the $90,000 earner only gets a $205 benefit from the same $1000 deduction.

A credit, on the other hand, reduces taxes directly and in many cases the value of the benefit does not fluctuate with your taxable income. Some common credits include: spousal and child tax credits, children’s fitness and art credits, tuition credit, tax credit for interest on student loans, caregiver credits, medical expenses, transit passes, donations, and first time home buyers credits. The eligibility of some credits depend on the income the taxpayer earns, while others don’t.

Credits are typically offered at the lowest tax rate. Refundable credits are always worth what they say they are, while non-refundable credit disappear if you don’t owe any taxes. Some common non-refundable tax credits include the personal tax credit, tuition tax credit, medical expenses, donations, interest on student loans, and more. Refundable tax credits include the GST/HST tax credit and the working income tax credit. If you submit a tax credit worth $100 and it’s a refundable credit, you get $100 from the government whether you owe taxes or not. If it’s non-refundable, but you don’t owe any taxes, you don’t receive the $100.

It’s useful to understand if any of your current expenses are eligible for a tax credit or deduction and to keep those receipts if they are! Also, if you can, try to time expenses you’d normally incur so that you can maximize your tax refund, like medical expenses for example.

Due to Canada’s progressive tax system, it’s always financially better to earn more income, even though it doesn’t always appear that way. It’s important to understand what tax credits and deductions you are eligible for, so you can make sure you are applying for them come tax time to reduce your taxes thereby allowing you to save or spend more.

Say you have no tax owing (which is rare unless you have very low taxable income – don’t get this confused with not having to pay any tax at the end of the year – that simply means that through source deductions, you don’t owe any more tax than you’ve already paid throughout the year).