How Personal Taxes Work in Canada
In this article, you鈥檒l learn how your money is taxed, and the types of income and deductions that allow you to reduce that tax.
We鈥檒l look at the most common types of income and which ones are taxed at lower rates.
We鈥檒l also dive into tax deductions and tax credits before showing how to estimate your tax refund or amount owing in less than 5 minutes.
馃帴 If you'd rather see Joe explain personal taxes in a video, hit the play button below! 馃憞
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.听聽
That includes both federal and provincial income taxes.
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If that same Canadian lived in Nova Scotia she would pay around $64,000 in income tax.听聽
The difference comes from the different provincial tax rates between Alberta and Nova Scotia.
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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鈥檒l use fictional marginal tax rates to illustrate the point.听
The tax rates increase as income increases.
Each higher tax rate is only applied to the taxable income within its own tax bracket.听
- The first $20k is taxed at 0%
- Income between $20k and $40k is taxed at 10%
- Income between $40k and $60k is taxed at 20%
- Income between $60k and $80k is taxed at 30%
- 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鈥檛 want to earn more income because it will put them in a higher tax bracket.听聽
That鈥檚 the wrong idea.听
The higher rate is only applied to the income within that tax bracket.
It鈥檚 an important concept to understand - all else being equal, it鈥檚 always better to earn more income.
Don鈥檛 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鈥檒l use some of the most common income types to illustrate this concept.
We鈥檒l discuss:
- Employment income
- Investment income, and
- Business income
Employment Income
I鈥檒l start with the most common type of income which is income from employment.
If you鈥檝e ever been employed in Canada, you鈥檝e 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.听聽
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.听 You鈥檒l likely have seen these abbreviated as CPP and EI
This example shows a pretty typical T4.
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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鈥檚 T4.
You can also see in box 18 there were $915 worth of employment insurance premiums deducted and remitted to the government on Pam鈥檚 behalf.听聽
Then the biggest deduction we see is $9,000 worth of income tax that was withheld.听 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.听 Later on we鈥檒l 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鈥檚 employment income on her tax return.
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Her Employment income of $58,000 shows up at the top of her Total Income section.
We鈥檒l come back to this example as Pam earns different income types and claims tax deductions and credits.
I鈥檒l 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鈥檒l look at investment income and how it鈥檚 taxed.
There are a few different types of investment income but I鈥檒l focus on dividend income, interest income and capital gains.
Interest Income
Interest income that you earn is fairly straightforward.听 It is included in your taxable income and taxed at your marginal tax rates.
There isn鈥檛 any preferential tax treatment for interest income, but that certainly doesn鈥檛 mean that you should avoid it!聽聽
One way to improve how your interest income is taxed is to hold those investments inside of a TFSA or an RRSP.听聽
Earning interest within a TFSA or RRSP means that you don鈥檛 actually pay any tax in the years you earn the income.
To learn more about how TFSAs and RRSPs work, check out 鉁嶏笍this blog post or 馃帴.
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鈥檚 a bit convoluted sounding, but what happens is:
- First, the dividend income is grossed up (aka increased by a percentage)
- This 鈥済rossed up鈥 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鈥檚 important.听
You can read more info specifically about how dividends are taxed in this article here馃憟
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.听
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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鈥檝e got capital gains.
Capital gains arise when you sell property for more than you paid for it.
When we鈥檙e talking about 鈥減roperty鈥 in this context we鈥檙e not necessarily talking about real estate.听聽
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.听聽
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鈥檙e then taxed on half of the capital gain that you earn.听聽
For Example聽
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If you sell your Shopify shares for $10k and your adjusted cost base was $2k, you鈥檒l only pay tax on one-half of your gain.听
So $4,000 gets included in your total income as a 鈥淭axable Capital Gain鈥.
Income Example So Far
Ok let鈥檚 have a look at what investment income looks like on Pam鈥檚 tax return.
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We can see that Pam has earned dividend income of $100 which has been grossed up to $115.听 We鈥檒l 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鈥檚 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.听聽
So far, Pam has earned employment income from her work at Dunder Mifflin鈥檚 Vancouver office and some investment income.
Her total income is $64,115 and she鈥檚 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鈥檒l look at income from self employment.
Business Income
Self-employment income is commonly also referred to as 鈥渂usiness income鈥.
This is an interesting one because you鈥檙e allowed to deduct many types of expenses that you鈥檝e incurred to earn the business income.
You鈥檙e then taxed on what鈥檚 left over after you鈥檝e deducted your business expenses.
As usual, an example is the best way to explain this.
Self-Employment Income Example
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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.
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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.听
Now we鈥檝e got a good picture of Pam鈥檚 income.
Total Income (Line 15000)
She鈥檚 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鈥檚 story here, we would calculate Pam鈥檚 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鈥檛 able to deduct business expenses to reduce her income from self employment.
Again the reason her taxes have jumped up is because she鈥檚 earned more income without paying tax throughout the year.
However, that鈥檚 not the whole story.听 Pam still has some tax deductions and tax credits that will help the situation.
Tax Deductions vs Tax Credits
Next, we鈥檒l look at some common tax deductions available to Pam. These will reduce her taxable income which reduces her taxes owing.
Don鈥檛 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鈥檚 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鈥檚 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.听
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聽
Now that we know the difference between tax credits and tax deductions, let鈥檚 look at a few common tax deductions.
In this example, Pam has tax deductions from her:
- RRSP contributions,聽
- Child care expenses, and
- Moving expenses.
You鈥檒l see on her tax return that there are a number of other deductions available to her, but we鈥檝e 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鈥檙e taxed on a smaller amount of money.
There鈥檚 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.
Check out 鉁嶏笍this blog post or 馃帴 for our full guide on RRSPs.
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 鈥渆arned income鈥 of the lower income spouse.
Pam鈥檚 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鈥檛 qualify for the disability tax credit.
The $8,000 child care expense deduction reduces Pam鈥檚 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鈥檝e 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 .
In Pam鈥檚 case, she was transferred to the Dunder Mifflin Vancouver office and incurred $10,000 in eligible moving expenses.
This deduction reduced Pam鈥檚 taxes by about $2,800.
Net Income (Line 23600)
Here we can see that Pam had $85,415 in total income before any deductions.
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Then we deduct $5,000 of RRSP contributions, $8,000 of child care expenses and $10,000 of moving expenses.
We arrive at Pam鈥檚 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鈥檚 net income before we arrive at her taxable income on line 26000.
These didn鈥檛 apply to Pam, so her taxable income is also $62,415.
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Pam鈥檚 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鈥檚 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 available depending on which province you live in.
And there are federal tax credits that are available to all Canadians.
We鈥檒l look at a couple of the more common federal tax credits to illustrate how they work.
Check for a complete list.
Basic Personal Amount
The most common tax credit is the 鈥淏asic Personal Amount鈥
The basic personal amount is just one of the non-refundable tax credits every Canadian resident can claim.听
The amount of the credit changes from year to year to keep up with inflation.听
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鈥檚 a resident of Canada in our fictional example.
Home Buyers鈥 Amount
The other tax credit that we鈥檒l discuss here is the Home Buyer鈥檚 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 鈥渜ualifying home鈥澛
AND
In the last four years you didn鈥檛 live in another home that you or your spouse owned.
For it to be a 鈥渜ualifying home鈥 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鈥檚 return again that she has the Basic personal amount of $14,398 at the top.
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Then she has a few other tax credits that are important, but that are more in-depth than we鈥檙e getting in this article.
And lastly we see the home buyers鈥 amount of $10,000.
At the bottom we鈥檒l 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鈥檚 federal taxes owing.
Tax Calculation
Ok so聽 we鈥檙e almost ready to find out how much tax Pam will owe.
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At the top we can see Federal tax of $10,034 was calculated based on Pam鈥檚 taxable income.
Then we鈥檙e 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鈥檚 dividend income.听
Next we add in CPP that Pam will owe on her self-employment income of $799.60.听 CPP is a bit beyond the scope of this article but you can find more info on 馃憟.
And finally we add in Pam鈥檚 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.
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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鈥檝e looked at a simplified calculation of taxes for Pam, but it鈥檚 still not that simple.
However, there is an easier way for you to get a reasonable estimate of your tax balance.
And that鈥檚 using the Wealthsimple Tax calculator.
It鈥檚 a free online tool and is straightforward to use.
Click the 馃憟, 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鈥檒l 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.
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Final Thoughts
Alright, that鈥檚 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鈥檙e calculated.
We do love helping small business owners, and creating these resources is聽 just one of the ways we do that.
Cheers and thanks for reading!
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