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Personal Tax Guide in Canada

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In this article, you’ll learn how your money is taxed, and the types of income and deductions that allow you to reduce that tax. Personal Taxes guide in Canada

How Personal Taxes Work in Canada

In this article, you’ll learn how your money is taxed, and the types of income and deductions that allow you to reduce that tax.

We’ll look at the most common types of income and which ones are taxed at lower rates.

We’ll also dive into tax deductions and tax credits before showing how to estimate your tax refund or amount owing in less than 5 minutes.

Types of Personal Income Tax

In the Canadian tax system there are two types of income tax for individuals – Federal income tax and Provincial income tax.

These separate taxes have their own tax rates and they stack on top of each other.

Example – Difference Between Provincial Tax Rates

For example, a Canadian living in Alberta earning $180,000 of taxable income will pay about $53,000 of income tax.  

That includes both federal and provincial income taxes.

Canada EY Personal Tax Calculator

If that same Canadian lived in Nova Scotia she would pay around $64,000 in income tax.  

The difference comes from the different provincial tax rates between Alberta and Nova Scotia.

This person would owe $11,000 more in taxes just from living in Nova Scotia compared to living in Alberta.

With both Federal and Provincial taxes, the percentage of tax you pay increases as you earn more income.

This is called a progressive tax system and it is our next topic!

Progressive Tax System

In Canada, we use a progressive tax system. This basically means that your tax rates increase as your income increases.

You may have also heard it described as tax brackets or marginal tax rates, but it all means the same thing.

The best way to explain the concept is to demonstrate with an example.

Tax Bracket Example

We’ll use fictional marginal tax rates to illustrate the point. 

Tax bracket example

The tax rates increase as income increases.

Each higher tax rate is only applied to the taxable income within its own tax bracket. 

  1. The first $20k is taxed at 0%
  2. Income between $20k and $40k is taxed at 10%
  3. Income between $40k and $60k is taxed at 20%
  4. Income between $60k and $80k is taxed at 30%
  5. And the income between $80k and $100k is taxed at 40%

So in this fictional example, the total tax payable on $100k of income is only $20k.

Common Misconception

There is a common misconception that the new higher tax rate will be applied to ALL of your income.

You hear people saying that they don’t want to earn more income because it will put them in a higher tax bracket.  

That’s the wrong idea. 

The higher rate is only applied to the income within that tax bracket.

It’s an important concept to understand – all else being equal, it’s always better to earn more income.

Don’t turn away extra income because it puts you in a higher tax bracket.

Types of Income

There are also different tax treatments for different types of income in Canada.

We’ll use some of the most common income types to illustrate this concept.

We’ll discuss:

  • Employment income
  • Investment income, and
  • Business income

Employment Income

I’ll start with the most common type of income which is income from employment.

If you’ve ever been employed in Canada, you’ve likely received a T4 slip that shows you how much employment income you earned in the year.

Employment income can include wages, salaries, bonuses and commissions, among other forms of compensation.

When you receive employment income, you are required to pay federal and provincial income tax on those earnings.  

Your employer will typically withhold this tax from your pay and remit it to the government on your behalf.

You will also see Canada Pension Plan contributions and Employment Insurance premiums deducted from your paycheque.  You’ll likely have seen these abbreviated as CPP and EI

This example shows a pretty typical T4.

T4 Example

Pam here has earned $58,000 of employment income which you can see in box 14.

Her employer deducted $3,100 of CPP and remitted it to the government. That shows up in box 16 on Pam’s T4.

You can also see in box 18 there were $915 worth of employment insurance premiums deducted and remitted to the government on Pam’s behalf.  

Then the biggest deduction we see is $9,000 worth of income tax that was withheld.  This amount shows up in box 22.

The T4 is how employers report your employment income and taxes paid to the government each year.

Your employment income and the income tax withheld is taken into consideration when you file your tax return each year.

Keep that in mind for now.  Later on we’ll be looking at how your overall taxes are actually calculated and how you can estimate your tax refund or amount owing each year.

Income On Your Tax Return – Example

Here we can see Pam’s employment income on her tax return.

Income on a tax return

Her Employment income of $58,000 shows up at the top of her Total Income section.

We’ll come back to this example as Pam earns different income types and claims tax deductions and credits.

I’ll also note that, so far, Pam is expecting a tax refund of $305 because her employer withheld more income tax than is currently calculated on her return.

This will change as Pam earns other types of income where taxes are not withheld and paid automatically, like they are with her employment income.

Investment Income

Next we’ll look at investment income and how it’s taxed.

There are a few different types of investment income but I’ll focus on dividend income, interest income and capital gains.

Interest Income

Interest income that you earn is fairly straightforward.  It is included in your taxable income and taxed at your marginal tax rates.

There isn’t any preferential tax treatment for interest income, but that certainly doesn’t mean that you should avoid it!  

One way to improve how your interest income is taxed is to hold those investments inside of a TFSA or an RRSP.  

Earning interest within a TFSA or RRSP means that you don’t actually pay any tax in the years you earn the income.

We explain how they work and when you should use them.

Dividend Income

Dividend income, on the other hand, is taxed at a lower rate than interest income or employment income.

You earn dividend income as a shareholder of a private or publicly traded company.

Because dividends are paid from after-tax dollars of corporations, they have preferential tax treatment on your personal taxes.

It’s a bit convoluted sounding, but what happens is:

  • First, the dividend income is grossed up (aka increased by a percentage)
  • This “grossed up” amount is included in your total income
  • Then, a dividend tax credit is applied to reduce taxes paid on that income

There is a lot more we could talk about with how dividends are taxed, but the basic premise is truly what’s important. 

The main thing to understand is that the dividend income typically creates less personal tax than the equivalent amount of interest income or employment income.

This table is a great illustration of that point. 

Canada federal tax brackets

You can see that tax rates on dividends are much lower than tax rates on employment or self-employment income.

Capital Gains

Next up we’ve got capital gains.

Capital gains arise when you sell property for more than you paid for it.

When we’re talking about “property” in this context we’re not necessarily talking about real estate.  

Property can mean real property, but it can also mean investments like shares in a publicly traded company.

When you sell your investment at a gain, your capital gain will be equal to the selling price minus the adjusted cost base of the property.  

Adjusted cost base just means the amount you paid to purchase the property plus any expenses paid to acquire it like commissions or legal fees.

You’re then taxed on half of the capital gain that you earn.  

For Example 

Capital gains calculation example

If you sell your Shopify shares for $10k and your adjusted cost base was $2k, you’ll only pay tax on one-half of your gain. 

So $4,000 gets included in your total income as a “Taxable Capital Gain”.

Income Example So Far

Ok let’s have a look at what investment income looks like on Pam’s tax return.

Line 15000 total income

We can see that Pam has earned dividend income of $100 which has been grossed up to $115.  We’ll see how the dividend tax credit reduces her taxes on this income later on in the video.

We also see on the investment income line that she’s earned $1,000 of interest income.

And she also earned a capital gain of $10,000, but only half of that is her taxable capital gain.  

So far, Pam has earned employment income from her work at Dunder Mifflin’s Vancouver office and some investment income.

Her total income is $64,115 and she’s now expecting that she will owe $1,400 in taxes.

The change from an expected refund to owing tax happened because she earned investment income without remitting tax like she did on her employment income.

This is normal and why people with significant investment income can often have a balance owing when filing their taxes.

Lastly we’ll look at income from self employment.

Business Income

Self-employment income is commonly also referred to as “business income”.

This is an interesting one because you’re allowed to deduct many types of expenses that you’ve incurred to earn the business income.

You’re then taxed on what’s left over after you’ve deducted your business expenses.

As usual, an example is the best way to explain this.

Self-Employment Income Example

T2125 Self-employment income

Here we see that Pam has a side hustle as an artist. She has sold $26,000 worth of her art this year.
She also incurred some expenses for advertising, office supplies and travel costs.

Her net income after deducting those expenses was $21,300.

This is also the amount that we see here on the line for her total self-employment income.

Line 15000 Total Income

Business income is great because there are more available deductions that allow you to reduce the taxes that you pay.

Also check out our article to learn more about what you can deduct from your business income. 

Now we’ve got a good picture of Pam’s income.

Total Income (Line 15000)

She’s earned $85,415 in total income, which you can see on line 15000.

This includes her income from employment, her investment income and her self-employment income.

If that was the end of Pam’s story here, we would calculate Pam’s taxes based on her total income of $85,415.

She would be expecting to pay $8,000 in taxes.

This might sound like a lot of tax, but it would have been even more if Pam wasn’t able to deduct business expenses to reduce her income from self employment.

Again the reason her taxes have jumped up is because she’s earned more income without paying tax throughout the year.

However, that’s not the whole story.  Pam still has some tax deductions and tax credits that will help the situation.

Tax Deductions vs Tax Credits

Next, we’ll look at some common tax deductions available to Pam. These will reduce her taxable income which reduces her taxes owing.

Don’t confuse tax deductions with tax credits, because they behave differently, even though they sound like they do the same thing.

Tax deductions reduce your taxable income.

While tax credits reduce your income tax.

Ok, that still sounds confusing, so let me break it down a bit further.

Tax Deductions

Pam had just over $85,000 of total income

Let’s say she had $10k of tax deductions, this would reduce her taxable income to $75,000

And then that number would be used to calculate her taxes owing.

Her total tax would only drop by $4k in this example because the $10k deduction only reduces the income used to calculate taxes.

Tax Credits

Tax credits, on the other hand, directly reduce taxes payable, but there’s an extra step needed to calculate them.

Tax credits create tax savings based on the lowest tax bracket, which is 15% on the Federal side. 

So a $10,000 Federal tax credit amount will reduce Federal tax by $1,500 ($10,000 x 15%).

Applying that to our example, if Pam had $10k of tax credits, her taxes owing would only reduce by $1,500.

Tax Deductions 

Now that we know the difference between tax credits and tax deductions, let’s look at a few common tax deductions.

In this example, Pam has tax deductions from her:

  • RRSP contributions, 
  • Child care expenses, and
  • Moving expenses.

You’ll see on her tax return that there are a number of other deductions available to her, but we’ve chosen three of the most common ones to cover in this video.

RRSP Contributions

RRSP contributions are probably the most common type of tax deduction that we see.

Contributing to your RRSP allows you to deduct that amount from your income, which means you’re taxed on a smaller amount of money.

There’s a maximum amount you can contribute and deduct each year, but RRSPs are still great because they reduce your tax and help you save for retirement.

Pam has $5,000 of RRSP contributions which will reduce her taxable income and save her about $1,400 in taxes.

Child Care Expenses

Next up, Pam had some child care expenses.

There are quite a few specific rules around who can claim child care expenses and how much can be claimed.

In general, though, child care expenses can be deducted by the lower income earning spouse up to a maximum amount.

The maximum amount is:

  • $8,000 for each child under the age of 7
  • $5,000 for each child between 7 and 16 years of age, and
  • $11,000 for each child who qualifies for the disability tax credit

There is also an overall maximum equal to two-thirds of the “earned income” of the lower income spouse.

Pam’s husband, Jim, had a really good year with his sports marketing company, so Pam is the lower income spouse and will have to claim child care expenses on her return.

Pam and Jim paid $10,000 in child care expenses for Cece but the maximum Pam can claim is $8,000. This is because Cece is under 7 years old and also doesn’t qualify for the disability tax credit.

The $8,000 child care expense deduction reduces Pam’s taxes owing by about $2,200.

Moving Expenses

The last tax deduction that Pam had was moving expenses.

Moving expenses are deductible if you moved and established a new home to be employed or run a business at a new location.

You also need to have moved at least 40 kilometers closer to your new place of work or business.

If you’ve met those requirements, you can deduct things like:

  • Transportation and storage costs
  • Travel expenses
  • Temporary living expenses
  • Incidental costs related to your move, and
  • Various rehoming costs

For a full list of eligible expenses, check out this CRA link.

In Pam’s case, she was transferred to the Dunder Mifflin Vancouver office and incurred $10,000 in eligible moving expenses.

This deduction reduced Pam’s taxes by about $2,800.

Net Income (Line 23600)

Here we can see that Pam had $85,415 in total income before any deductions.

Line 23600 Net Income

Then we deduct $5,000 of RRSP contributions, $8,000 of child care expenses and $10,000 of moving expenses.

We arrive at Pam’s net income of $62,415 on line 23600.

Taxable Income (Line 26000)

Next we can see that there are a few other deductions that could be deducted from Pam’s net income before we arrive at her taxable income on line 26000.

These didn’t apply to Pam, so her taxable income is also $62,415.

Line 26000 Taxable Income

Pam’s federal and provincial income tax is calculated based on this number.

Her marginal tax rates are applied to her taxable income and we can see that Pam would owe $10,034 in federal income tax plus $2,895 in provincial income tax.

However, that’s not the end of the story.

Tax Credits

We still have tax credits to account for before we find out how much Pam owes or if she gets a refund.

Like I mentioned earlier, tax credits reduce the actual tax amount that you owe.

There are different provincial tax credits available depending on which province you live in.

And there are federal tax credits that are available to all Canadians.

We’ll look at a couple of the more common federal tax credits to illustrate how they work.

Check CRA’s database of tax deductions and credits for a complete list.

Basic Personal Amount

The most common tax credit is the “Basic Personal Amount”

The basic personal amount is just one of the non-refundable tax credits every Canadian resident can claim. 

The amount of the credit changes from year to year to keep up with inflation. 

In 2022, the federal basic personal amount was equal to $14,398.

There is also a corresponding provincial basic personal amount, which varies depending on which province or territory you live in.

Pam certainly qualifies for the basic personal amount as she’s a resident of Canada in our fictional example.

Home Buyers’ Amount

The other tax credit that we’ll discuss here is the Home Buyer’s Amount.

In 2022 you can claim up to $10,000 for the purchase of a qualifying home if you meet a couple of criteria.

You or your spouse acquired a “qualifying home” 

AND

In the last four years you didn’t live in another home that you or your spouse owned.

For it to be a “qualifying home” it must be either:

  • A single family house
  • A semi-detached house
  • A townhouse
  • A mobile home
  • A condo
  • Or an apartment in duplexes, triplexes, fourplexes or apartment buildings

The criteria for qualifying home cover most scenarios.

The tax credit can be split between spouses or claimed fully by one spouse.

In our example, Jim and Pam bought a house in Vancouver and Pam is going to claim the full amount on her return.

Tax Credits Example

We can see here on Pam’s return again that she has the Basic personal amount of $14,398 at the top.

Canadian Tax Credits

Then she has a few other tax credits that are important, but that are more in-depth than we’re getting in this article.

And lastly we see the home buyers’ amount of $10,000.

At the bottom we’ll total up the tax credits and multiply the total by 15%, which is the lowest Federal tax rate.

That gives us total federal non-refundable tax credits of $4,445.90.

This amount is subtracted from Pam’s federal taxes owing.

Tax Calculation

Ok so  we’re almost ready to find out how much tax Pam will owe.

Canadian Tax Calculation

At the top we can see Federal tax of $10,034 was calculated based on Pam’s taxable income.

Then we’re reducing the balance by her Non-refundable tax credits of $4,445.90.

And we get to deduct the $10 federal dividend tax credit that arose from Pam’s dividend income. 

Next we add in CPP that Pam will owe on her self-employment income of $799.60.  CPP is a bit beyond the scope of this article but you can find more info on CPP for self employed here 👈.

And finally we add in Pam’s provincial taxes owing of just under $2,900.

Her total tax payable is $9,272.25.

Thankfully, Pam has already paid the $9,000 in tax that was withheld from her employment income.

Canadian Tax Calculation

This amount gets deducted from her total tax payable.

Which means that she will only have a small balance owing of $272.25 when she files her tax return.

Estimate Your Taxes

So we’ve looked at a simplified calculation of taxes for Pam, but it’s still not that simple.

However, there is an easier way for you to get a reasonable estimate of your tax balance.

And that’s using the Wealthsimple Tax calculator.

It’s a free online tool and is straightforward to use.

Click the Wealthsimple Tax Calculator link here 👈, then just fill in a few fields on the calculator.

Choose your province, income amounts, RRSP contribution amounts and income taxes already paid.

It will then give you a pretty good idea of whether you’ll have a refund or a balance owing when you file your tax return.

For example

If you earned $65,000 of employment income and your employer withheld $12,000 of income tax, you could estimate receiving a refund of around $1,423.

Wealthsimple Tax Calculator example

Final Thoughts

Alright, that’s it for part one on how taxes work in Canada.

Hopefully this article has helped to give you a good idea of how your taxes work and how they’re calculated.

We do love helping small business owners, and creating these resources is  just one of the ways we do that.

Cheers and thanks for reading!

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

personal tax guide in Canada

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