Welcome back to the blog!
In addition to working with clients on investment and wealth management, I write a blog on tax tips and tidbits and share other articles that I think will be of interest.
In this edition, I’m going to write about tax rates as the season is now in full swing with the personal tax deadline approaching in less than two months.
How does Canada’s tax system work?
I have a lot of conversations with clients about taxes, and given that I actually chose to specialize in tax for the first 10 years of my career, unlike most folks, it is a topic that still gets me a little excited.
In these conversations, it has become apparent how much confusion there is around individual tax rates and the items that impact them, so my intent is to address this while providing a very basic overview of the Canadian tax system as it applies to individuals.
A Progressive Tax System
In Canada, there is a progressive tax structure where individuals pay taxes at graduated rates.
This means that our tax system is structured such that your tax rate gets progressively higher as your taxable income increases, which sounds simple enough, right?
However, it is important to note that not all taxable income is taxed at this same progressively higher rate. Instead, we have federal and provincial tax rates that result in tax brackets with each bracket having its own unique tax rate that applies to income in that bracket.
| Ordinary Taxable Income | Combined Tax Rate |
| Up to $47,937 | 20.06% |
| Above $47,937 and up to $55,867 | 22.70% |
| Above $55,867 to $95,875 | 28.20% |
| Above $95,875 to $110,076 | 31.00% |
| Above $110,076 to $111,733 | 32.79% |
| Above $111,733 to $133,664 | 38.29% |
| Above $133,664 to $173,205 | 40.70% |
| Above $173,205 to $181,232 | 44.02% |
| Above $181,232 to $246,752 | 46.12% |
| Above $246,752 to $252,752 | 49.80% |
| Above $252,752 | 53.50% |
If we reference the above table, we can see that an individual earning up to $47,937 per year is in the first tax bracket where the combined federal and provincial tax rate in BC is 20.06%.
Marginal Tax Rate
The marginal tax rate is the rate that applies on an extra dollar of income.
There is a common misconception that earning a little bit of extra income may result in all income being taxed at a higher rate, however, I have good news for you, this is not the case.
It might be helpful to illustrate this with an example here to clear up any confusion.
So let’s assume that we have a fellow named Miles living in BC that earns $100,000 of employment income each year. If we reference the above table, we know…
- his first $47,937 of income is taxed at 20.06%
- his income above $47,937 and up to $55,867 is taxed at 22.70%,
- his income above $55,867 and up to $95,875 is taxed at 28.20%, and
- his income over $95,875 and up to $100,000 is taxed at 31.00%.
If Miles earns an extra $15,000 in 2024 through a year-end bonus, he now finds himself in a new tax bracket with a tax rate of 38.29%!
In this example, it is only Miles’ incremental income over $111,733 that is taxed at this higher rate of 38.29% as all existing income will continue to get taxed at the rates applicable to the lower tax brackets as outlined above. Therefore, individuals like Miles don’t have to be concerned about a a bonus or promotion and the resulting small bump in income triggering significantly more overall tax as income in lower tax brackets is unaffected.
Average Tax Rate
The average tax rate is simply calculated as the total amount of tax that you pay divided by your total income, and for most individuals, this will be less than the marginal rate.
In the below table, average tax rates are illustrated at different income levels.
| Ordinary Taxable Income | Average Tax Rate |
| $50,000 | 14.19% |
| $100,000 | 20.99% |
| $250,000 | 33.80% |
In the example with Miles earning $100,00, an average tax rate of 20.99% means that his total taxes are approximately $20,990.
Knowing your average tax rate is useful for setting your withholding tax rate for government benefits like CPP and OAS or on RIF payments in retirement.
What impacts my tax rate?
There are a number of items that impact an individual's taxable income and therefore their marginal or average tax rate, including the following…
- Inclusions are amounts that are added to taxable income, such as interest earned on investments or employment income.
- Deductions are amounts that are subtracted from taxable income, such as RRSP contributions, investment management fees, or eligible home office expenses. A deduction is worth more to a higher income earner as they get to reduce taxable income that is subject to a higher marginal tax rate.
- Credits, in contrast to inclusions and deductions, have no impact on your taxable income. Instead, a fixed credit is applied to an eligible amount, such as a charitable donation, and the resultant credit amount offsets taxes payable.
A charitable donation of $1,000 in BC results in a tax credit or over $400, so there are tax savings equal to about 40 percent of the donation amount. This tax credit may be worth more than a deduction, especially for individuals with taxable income of $130,000 or less.
In other words, if we go back to our example with Miles earning $100,000, a $1,000 charitable donation will save him over $400 whereas a deduction of the same amount will only save him $282, so the charitable donation results in a greater reduction of tax payable. This occurs because the tax credit rate on the donation is greater than Miles' marginal tax rate, and therefore, the credit is more valuable.
How are different types of income taxed?
In addition to inclusions, deductions, and credits, the type of income you earn has a big impact on your tax rate. In the blog, I won’t go into all the details as it can get quite complex, however, I’ve noted a few general rules of thumb…
- Employment income is taxed at ordinary rates (refer to rates in first table)
- Capital gains are only one half taxable, so generating a capital gain results in significantly less tax than earning the same amount of employment income
- Dividends, which are distributions out of earnings by a company to its shareholders, are typically taxed somewhere just above or below the capital gains rate depending on income level and whether they are considered eligible or ineligible dividends.
Well there you have it, the basics of how personal tax rates work in Canada.
You can probably see that this is complex and I’m only just scratching the surface, so if you only take one thing away, remember that not all income is taxed at the same rate and that a little extra income will not result in all income being taxed at higher rates.
If you have questions I can be reached at craig.dale@rbc.com or 604.981.6680.
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