Each additional dollar you earn is taxed at the marginal tax rate. However, the tax credits to which everyone is entitled significantly reduces the amount of taxes you actually pay compared to the tax bracket values and the marginal tax rates. For example, for income close to the top of the first tax bracket and the basic personal tax credit, the actual average rate is just 72% of the marginal tax rate.
Because of the progressive nature of Canada’s income taxes, the tax rate increases as income increases. This leads to tax brackets where a fixed percent is applied to all income within a specific range. These ranges and the tax percentages are given in Marginal Tax Rates – 2014. However, your average tax is much less than the marginal rate because of the effect of any taxes paid on lower rates. The accompanying chart shows the rates for Manitoba with the blue stair-step line being the marginal rates and the dotted red line being the average rate. You actually pay taxes on all your income using the average tax rate.
But this does not take into account any non-refundable tax credits you can claim. And there are a lot of them. The federal credits are itemized in Schedule 1 while the Provincial credits are given in each province’s 428 form (except Quebec). For the 2014 taxes, there were some 25 federal credits that you can claim. A few of them are given below.
- – Everyone is entitled to the Basic personal amount (line 300 for federal at $11,038 and line 5804 for provincial which varies for each province but for Ontario it is $9,574).
- – Everyone can claim Medical expenses above 3% of your income or a fixed amount.
- – Everyone can claim a portion of Donations and gifts.
- – If you are working, you can claim the CPP contributions and Employment insurance premiums. There is also a federal credit for public transit and an employment amount.
- – If you are retired, there is an age amount (maximum $6,854 for federal and variable for provinces) which is income adjusted. There is also a Pension income amount of $2,000 for federal and a lesser amount for provincial.
- – If you have dependents, there are spousal and eligible dependent and well as children and infirm dependents, plus Children fitness and arts amount.
- – You can even transfer a credit from a child or spouse that they do not use.
All of the tax credits can add up to a significant amount and can reduce the taxes you have to pay. For example, if your taxable income is less than the federal Basic personal amount $11,038, you pay no federal tax at all. You will have to pay some provincial tax unless you are below the similar provincial credit. Claiming even a few of the tax credits can increase this amount.
For example, if you are retired, and have an income of less than $35,000 you can claim the full Age amount. If you can also claim the full pension amount, this will result in federal tax credit of 19,892 (= 11,038 + 6,854 + 2,000) and an Ontario tax credit of 15,472 (= 9,574 + 4,674 + 1,324). The chart below is from the spreadsheet and shows these values with the following tax rates against income: marginal (the blue To and From symbols), average (dotted red line) and actual average (solid green line) tax rates. For this income, the actual average tax rate is 9.2% and not the 20.5% of the average and marginal rates.
By examining your past year’s tax return, you can see what credits you used. You can determine your actual average tax rate by using the spreadsheet that goes with this post. Click on Download Spreadsheet. It contains the above data for Ontario. Refer to the instructions below for how to change your provincial tax rates. Then enter your own federal and provincial non-refundable tax credits in the variables provided. It should be easy to pick out your actual average tax rate for your income from the chart.
As an example, if you are in Ontario, the combined federal and provincial tax rate for income up to $40,000 is 20.5%. However, at this amount with the minimum non-deductible tax credits of $11,038 and $9,574, the actual average tax rate is just 14.7%. This is where the 72% given above comes from (14.7/20.5). Try this out on the spreadsheet yourself and see the impact of the credits for even higher incomes as the actual average tax rate is always less than the average tax rate, no matter the tax bracket because of the credits.
Estimating Taxes for Additional Income
You must still use the marginal tax rate value to estimate the additional taxes you will have to pay for any additional income. If you try to apply the actual average rate you must also apply it to all of your income. The resulting taxes are the same as if you just add the marginal taxes to your base amount. There will be cases when the additional income spans 2 tax brackets and when additional tax implications (such as surtaxes, hospital taxes, clawbacks) will change this simple calculation.
If you are concerned about the impact of any income that is additional to your normal income (such as capital gains or dividends), and do not want to use the marginal rate, there are two options:
1) If you used a software application for your taxes last year, open it and record the taxes you paid. Then include the additional income and record the taxes. Compare the taxes and determine the change. As explained above, the increase will be the added income times the marginal tax rate for the tax bracket, unless some of the tax implications happen.
2) If you cannot do the above (you may no longer have the application or data, you may have done it online and have no access to the data or you may have manually completed the tax form), you can estimate your taxes by using the spreadsheet provided in the Estimating Canadian Income Taxes post.
Customizing the Spreadsheet
The spreadsheet is loaded with Ontario tax rates. If you live in another province, you can change the values show in the table on the following three columns: Fed+Prov To, Federal and Prov. Either use the marginal post or your last year’s tax form to obtain the values for each of the tax brackets. Note that only 4 brackets are available so that the chart is manageable.
You can experiment with any Federal and Provincial Tax Credits by entering values into the two fields at the top of the spreadsheet. Examine your past year’s tax return to see what you claimed and use them.
Charting Marginal Tax Rates
The chart shows the marginal tax rates differently than in the marginal post. The stair-step chart is replaced by the “Fed+Prov From” and “Fed+Prov To” lines that only show the symbols at each break-point. These are used so that the table can be used without any modifications as in the marginal post. It makes it a little hard to see the marginal rates, so use the table instead where the marginal rates are shown in the “Fed+Prov” column at each break-point.