Canadian Income Tax Explained

Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.

Benjamin Franklin’s infamous quote certainly holds true in Canada.

“In this world nothing can be said to be certain, except death and taxes,”

Canada’s taxes are as abundant as our lakes. First there are a multitude of taxes on consumption, such as sales tax, land transfer tax, liquor tax, gas tax and custom tariffs on imported goods. Then there are taxes on assets, such as property taxes and car stickers. And finally, there’s a tax on income.

What is income tax?

For almost every dollar you earn you must deposit portion in the government coffers.

It wasn’t always this way. Before World War I Canada was a tax-free haven. Unlike England or the United States Canada prided itself on its no-federal-tax regime and viewed it to attract desperately needed skilled immigrants, investors and capitalists. Instead, the government made money mostly by selling off natural resources and charging high custom fees on imported goods.

But in 1917, the then-Finance Minister Sir Tomas White implemented the income tax act to pay for World War I and asked that it should be reviewed after the war.

But once implemented the government was unable to let go of this new and profitable stream of revenue and we’ve had it ever since.

While income tax may seem natural and inevitable to us today, it was met with resistance at the time and considered a significant burden.

When income taxes were first introduced, single people had a personal exemption of $24,500 in today’s dollars, while married people had an exemption of $50,000. Over those amounts they were taxed just 4%.

Now married and single people have identical federal personal exemptions, at around $13,230. The top federal tax rate is 33% and when we add in provincial tax rates, the total marginal tax rate now reaches 53.53%.

Surprisingly, 33% or 9 million Canadians pay no income tax at all. The millstone falls upon the necks on the 67%, or 18.4 million Canadians who do. For them, income tax is likely one of the most expensive line items on their budget.

Collectively, taxes now contribute about $265 billion annually to our government, which makes up about 50% of its total revenue.

But they pay it without (much) complaint because it’s the price of living in one of the most developed, prosperous nations of all time. As Oliver Wendell Holmes, the 19th century US Supreme Court Justice said, “I hate paying taxes. But I love the civilization they give me.”

The Canadian Revenue Agency (CRA) collects this money to pay for the government’s operating expenses and delivery of services. Taxes are the reason we have the military, the police force, libraries, high schools, hospitals, roads, prisons, and the CBC. The government also choose to redistributes much of these taxes to lower income and vulnerable Canadians in the form of child benefits, employment insurance, old age security, and social assistance.

How income tax works in Canada

You’re required to report your income to the CRA annually by filing paperwork known as a tax return. In this return you must list all your income sources and note your eligibility for any deductions or credits.

The tax system is based off of trust. Although the CRA does know about some of your income, they mostly rely on citizens to self-report their total income accurately.

Fudging or cheating on your taxes is serious—our system would collapse if we didn’t all pay our fair share. Plus, the CRA is now cracking down on fraudsters. It set aside $444.4 million over five years to help track down $2.6 billion in additional taxes it thinks hasn’t been paid.

The CRA recommends you file a return even if you do not earn any money.

Remember how we said our government redistributes taxes to some Canadians? Well they determine your eligibility for these redistribution schemes based on your tax return. So if you don’t file your taxes you may miss out on free money. Some payouts you may be eligible for include:

  • Child tax benefit

  • GST/HST credit

  • Guaranteed income supplement

The deadline to pay your income taxes

The deadline to pay taxes, for those who earn enough to do so, can be confusing because the date you must pay does not always line up with the date that you must file.

Employed individuals have the same payment and file date: April 30th. That’s because their taxes usually get taken off at the source, on each paycheque, and so their tax calculation is simpler.

Self-employed individuals must pay any taxes owed by April 30th, but they have until June 15th to file their return. That’s likely because their taxes are more complicated—they are responsible for setting aside money throughout the year, keeping organized books and for storing proof of expenses.

Large corporations must pay any taxes owed two months after their year end, while small Canadian businesses have until three months after their year end. However, they have until six months after their year end to actually file their taxes. Sometimes a corporation’s fiscal year end lines up with the calendar year.

The CRA charges a fee for late filers—5% of your balance owed plus an additional 1% for each month late.

Income tax rates in Canada

Canada has a graduated tax system, which means the more you earn the more you pay.

Under this system, money is divided into income brackets which determines the applicable tax rate. A common mistake is to assume that all income is charged at the rate of its highest tax bracket. In fact, we are charged progressively, which means that first you pay the rate in the lowest bracket and only pay the higher rate on each additional dollar. This is also called your marginal tax rate.

For example, if you earn $1, you’ll pay 10%. But on the second dollar you’ll have to pay 20%. And on the third dollar, you’ll be on the hook for 30%. But you never have to pay 30% of $3. Instead, you paid a total of just $0.60 which works out to an average tax rate of just 20%.

Some find this graduated system fair, while others feel it burdens hard workers, penalizes success, and discourages prosperity.

Corporations are the exception to this system, however. They get to pay a flat tax instead of a graduated tax. The flat tax for small, private Canadian corporations, for example, maxes out at 15% (9% federal rate plus up to an additional 6% provincially, no matter how much they earn).

Graduated tax rates can be extremely confusing because the tax brackets don’t depend just on the amount earned—they also depend on where the money comes from. Plus, Ottawa and each province has a completely different tax bracket. You must add the two together to come up with the total rate.

Some Canadians are surprised to learn that not all income is treated equally. To encourage economic growth, the government typically gives a tax break to money earned from selling an investment—capital gains are charged at half the typical rate. And to encourage jobs and development, small Canadian corporations, as we said, have extremely low tax rates. The highest tax rates are applied to wages and salaries.

The CRA differentiates between these six types of income sources:

  1. Other income (including employment and interest)

  2. Capital gains

  3. Eligible dividends (from large, public Canadian corporations)

  4. Ineligible dividends (from small Canadian corporations)

  5. General corporate income

  6. Small business corporate income

So, for example, let’s say you made $50,000 in employment income, and you live in Ontario. That’s in the second tax bracket both federally and provincially.

The federal government charges you 15% on the first $48,535 you made, minus the federal exemption of $13,229, and then 20.5% on the remaining amount. Ontario charges you 5.05% on the first $44,740, minus the provincial exemption of $10,783, and 9.15% on the remaining amount. That’s what we mean when we say that the more you make the more you pay.

Or, let’s say you sold a lucky stock and made $50,000. That would be considered a capital gain, which is taxed at half the typical rate. So Ottawa would charge just 7.05% on the first $48,535 and 10.25% on the remaining amount Ontario would charge you 10.03% on the first $44,740 and 12.08% on what remains.

The tax system is set up so that if you earned $50,000 of eligible dividends and no other income and live in Ontario you would pay almost no tax. Dividend money is considered to have already done its duty, since it comes from after-tax corporate profit.

Income that’s not taxable

Luckily, not all income is taxable. Here are some examples of income that is taxed in Canada:

Income that we’re required to pay a duty on includes:

  • Employment income

  • Self-employment income minus expenses

  • Dividends

  • Interest

  • Income from selling stocks, bonds or an investment property

  • Pension income

  • Withdrawals from RRSPs

  • Foreign income

  • Corporate income minus expenses

Income exempt from taxes includes:

  • Most lottery winnings

  • Most inheritances and gifts

  • Child benefit payments

  • GST/HST credit

  • Payouts form a life insurance policy

  • School scholarships

  • Withdrawals from TFSA

  • Strike pay from a union

ProvinceTax Rate
British Columbia5.06% on the first $41,725 of taxable income
7.7% on the next $41,726-$83,451
10.5% on the next $83,452-$95,812
12.29% on the next $95,813-$116,344
14.7% on the next $116,345-$157,748
16.8% on the amount over $157,748
Alberta10% on the first $131,220
12% on the next $131,221-$157,464
13% on the next $157,465-$209,952
14% on the next $209,953-$314,928
15% on the amount over $314,928
Saskatchewan10.5% on the first $45,225 of taxable income,
12.5% on $45,226-$129,214
14.5% on the amount over $129,214
Manitoba10.8% on the first $33,389 of taxable income
12.75% on the next $33,390-$72,164
17.4% on the amount over $72,164
Ontario5.05% on the first $44,740 of taxable income
9.15% on the next $44,741-$89,482
11.16% on the next $89,483-$150,000
12.16% on the next $150,001-$220,000
13.16 % on the amount over $220,000
Quebec15% on the first $44,545 of taxable income
20% on the next $44,546 - $89,080
24% on the next $89,081 - $108,390
25.75% on the amount over $108,390
New Brunswick9.68% on the first $43,401 of taxable income
14.82% on the next $43,402 - $86,803
16.52% on the next $86,804 - $141,122
17.84% on the next $141,123 - $160,776
20.3% on the amount over $160,776
Nova Scotia8.79% on the first $29,590 of taxable income
14.95% on the next $29,591-$59,180
16.67% on the next $59,181-$93,000
17.5% on the next $93,001-$150,000
21% on the amount over $150,000
Prince Edward Island9.8% on the first $31,984 of taxable income
13.8% on the next 31,985 - $63,969
16.7% on the amount over $63,969
Newfoundland and Labrador8.7% on the first $37,929 of taxable income
14.5% on the next $37,930 - $75,858
15.8% on the next $75,859 - $135,432
17.3% on the next $135,433 - $189,604
18.3% on the amount over $189,604
Nunavut4% on the first $46,277 of taxable income
7% on the next $46,278 - $92,555
9% on the next $92,556 - $150,573
11.5% on the amount over $150,573
Yukon6.4% on the first $48,535 of taxable income
9% on the next $48,536 - $97,069
10.9% on the next $97,070 - $150,473
12.8% on the next $150,474 - $500,000
15% on the amount over $500,000
Northwest Territories5.9% on the first $43,957 of taxable income
8.6% on the next $43,958 - $87,916
12.2% on the next $87,917 - $142,932
14.05% on the amount over $142,932

How to reduce your income tax

Paying what you owe in income taxes is a civic duty. But there’s no reason to pay a penny more than is required. Finding ways to reduce your taxable income is not only legal, but financially responsible. Strategies to do so range from the simple and the common—maximize deductions—to the elaborate and the esoteric—like buying flow-through shares. Ultimately, a good accountant will be the best person to help find you tax efficiencies in your particular situation.

But here’s a few ideas:

1. Change up your income sources

As we discussed previously, our government gives some types of income preferential treatment. Employment income and interest bear the heaviest burden, while capital gains and dividends are barely touched. Instead of relying on a job and stashing funds in a savings account, many people try investing. If you can manage, over the long-term, to transfer surplus income from your salary into an investment portfolio you will be able to shelter much of your funds from taxes.

2. Move from sole-proprietorship to incorporation

If you’re a freelancer or have a small business, consider switching from a sole-proprietorship to a corporation. While incorporating comes with heavier compliance requirements and a trickier tax return, it could drop your tax rate significantly. In Ontario, for example, high earners would go from a marginal tax rate of 53.5% to just 13.5%. That’s only inside the corporation of course—once you transfer the funds and pay yourself a salary or dividend you’ll have to pay income taxes at your regular marginal rate. This strategy will only save you on taxes if you make enough to be able to retain income inside the corporation. Speak with a professional accountant to see if your small business can benefit from this tactic.

3. Defer taxes

There’s a concept in financial planning that states that money today is always better than money tomorrow. So if there’s a way to put off paying taxes until tomorrow you should always take advantage of that opportunity. That’s because money can grow over time, and the more money you have the faster it can grow. Paying taxes impedes this process.

The most obvious way to defer taxes is to stash funds and invest inside your RRSP. The money can grow sheltered from taxes until you withdraw funds in retirement. While eventually you’ll have to pay the piper, your marginal tax rate will hopefully be lower than it is in your prime working years. You can do the same in your TFSA. Although you’re contributing with after-tax funds, the money once inside will also be able to grow free, away from the long-reach of the CRA.

For investors and small business owners, a common way to defer taxes is to leave money inside a corporation for as long as possible. If you own an investment property you can write off the depreciation every year, which delays paying taxes until you actually sell the property.

As you can see, there’s still quite a bit of wiggle room in the tax code to postpone your tax obligations and put your money to better use.

4.Maximize all deductions

Deductions work by lowering your income, hopefully by enough to kick you down a tax bracket.

Typical deductions include charitable donations, medical expenses, union dues, RRSP contributions, childcare expenses, and capital losses.

How to calculate income tax

Calculating your exact income tax is no easy task. Canada’s tax system is a warren of baffling codes, 1.1 million words long, that sometimes even confuses call centre agents at the CRA. (An audit found that nearly 30% of the answers given to taxpayers by these agents was wrong.)

A rough tax estimate can be done by first figuring out your total income minus any applicable deductions. Then simply multiply your income, per source, by its suitable marginal tax rate.

To get an estimate, use an online tax calculator.

How to pay income tax online

You can file longhand, the old-fashioned paper way, or though a free or paid service online. Many Canadians choose to outsource the work to an accountant, although learning to do your own taxes can feel like quite an achievement, as if you’ve just cracked some sort of cryptogram, 1,412 pages long.

You can pay your taxes by mailing a cheque, or by walking into any major bank with a cheque.

  1. If you prefer to pay online you have three options:

  2. Pay through online banking. Simply set-up up the CRA as a bill payee through your bank

  3. Pay direct at the CRA with a debit card through “My Payment”

  4. Use a third-party service to pay with a credit card or PayPal.

Last Updated May 14, 2020

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