Chapter 17: Taxes
You may have noticed by this point that the topic of taxes is mentioned a lot in this blog. In fact, we’ve used the word tax over 150 times. This is because taxes are complicated in Canada, as in most of the world. After all, they’ve been built over decades to meet different goals along the way.
Most of the discussion has been about how to pay less tax. You can open a TFSA and avoid paying taxes on the growth of your investments. You can deposit money in an RRSP and avoid paying income tax until you withdraw. Or you can apply for tax credits when you buy your first home. Before we move on and learn more about how to pay less tax, let’s first discuss why taxes are important.
Rationale for Taxes
Paying for goods and services individually, like we do for a car or movie, doesn’t always make sense. For instance, splitting up the cost of a road or park between the people who use it is cumbersome and costly. It’s also challenging to charge directly for services that police officers and firefighters provide. In addition, there are those who can’t afford certain goods and services in their current situation and require support.
For these reasons and more, we’ve decided governments in Canada should provide certain services for us. From roads to education to health care, the government funds critical spending to help improve the standard of living of Canadians. To raise money for this spending, the various levels of government collect taxes. Paying these taxes can sometimes feel onerous and unwarranted because we don’t see the benefit as we’re paying. If you consider your childhood education, the local park you walk through on the weekend or visits to your doctor, paying tax is more bearable.
Why Taxes Are Complicated
Governments in Canada raise money through a range of taxes. You likely pay sales tax, income tax, payroll tax and property tax. These are collected by your municipal government, a provincial or territorial government or the federal government.
Three layers of government using different taxes to raise money provides enough complexity as it is. However, taxes are also used to incentivize desired behaviour. As we mentioned in Chapter 9, the government recognizes the value of your saving for retirement. If you save for later, you’ll be less dependent on government services in retirement. As a result, to incentivize you to save, they created accounts like the TFSA and RRSP. They also see the value of saving for your child’s education, so the next generation is well-trained and able to pay future taxes. Therefore, they created the RESP to help you save the money needed for post-secondary school.
In addition to saving for the future, governments provide tax breaks for a list of other activities, including:
Donating to charity
Purchasing your first home
Furthering your education
Having a child
Paying taxes is a matter of balancing the need for government spending with the value of the money if you get to keep it. We’ll now cover the different types of taxes and ways to minimize what you pay using the incentives available to you.
Sales Tax
The most common tax you likely encounter is sales tax charged on individual purchases. While this is the most common tax, it’s also one of the simplest and offers few ways to pay less of it. Therefore, you’ll need to factor it into your savings plans when making large purchases. From cars to new construction homes, paying sales tax on a major expense can add thousands in unforeseen costs. While rare, there are some cases where you can receive rebates for sales tax paid. Examples include:
GST/HST credit for low- to modest-income families
GST/HST new housing rebate if you buy a new property
Income Tax
While you may only deal with income tax on an annual basis, it’s a much larger tax than the others. For the year ended March 31, 2018, personal income tax accounted for 49% of the Government of Canada’s revenues compared to 11.7% for GST. As a result, much of the opportunity to lower your taxes focuses on personal income tax.
You pay income tax to the federal government and your provincial or territorial government throughout the year. This is often done through direct payroll deductions that are sent to the CRA by your employer on your behalf. You then file your taxes annually to see whether the amount paid was the right amount. The deadline to file your income tax return is typically April 30. There are several key rules to paying income tax that are important to understand before we move on to ways to lower your taxes.
Tax Brackets
In Canada, as you earn more money in a year, you pay a higher percentage of your income to the government. This is the result of tax brackets that apply higher tax rates to higher levels of income. For instance, in British Columbia, income under $40,000 is charged a 20% tax, while income over $200,000 is charged roughly 50%. The exact amount you pay depends on your province or territory. However, the rates and process are similar across the country.
Exhibit 42 – The following tables show the federal tax rates and provincial tax rates for British Columbia as of 2019.
Exhibit 43 – By combining the federal and provincial rates, you get the total tax rate at each income bracket.
This demonstrates that as your income increases, you pay a higher percent in taxes. If you earned $70,000 in British Columbia in 2019, you’d pay 20.06% on the first $40,707. You’d then pay 22.7% on the next $6,923 in earnings and 28.2% on the remaining $22,370. In total, you’d owe $16,045 in taxes.
There are two important income tax rates to consider:
Average income tax rate: the total tax you pay divided by your income. In the example above, the average tax rate is 23%, which is $16,045 divided by $70,000.
Marginal income tax rate: the rate you paid on the last dollar you earned. In the example above, the marginal tax rate is 28.2%, which was charged on the last $22,370 of income.
Exhibit 44 – With an income of $70,000 in British Columbia, the average income tax rate is 23% and the marginal rate is 28.2%.
Non-Refundable Tax Credits
Non-refundable tax credits can help you lower your taxes owed each year. The most common credit is the basic personal amount, which lowers your federal income tax owed by $1,810 as of 2019. You can also lower your provincial or territorial income tax through this credit. There are additional non-refundable tax credits available in various situations. This may apply to you if you have dependents, are over the age of sixty-five, receive a pension, have a disability or meet other criteria.
Most tax software will help you determine the amount of taxes you owe and help you see which credits apply. If your situation is more complex, it may be worth speaking with a tax professional to ensure you’re receiving the benefits intended.
Taxes on Your Investments
In addition to paying income tax on your salary, you also pay taxes on income from your investments. Growth on your investments may come from:
Interest paid by a financial institution or bond issuer
Dividends paid by a company
Capital gains from selling an investment for more than you paid
Each type of income is taxed differently, as we’ll see shortly. The opportunities to lower your taxes discussed in this blog mostly apply to taxes on investment income.
Exhibit 45 – The following tax rules apply to the different types of investment income.
An important note is that investments held in a TFSA, RRSP or other registered account aren’t charged these taxes. This is the main advantage of these accounts, since it simplifies your tax reporting and lowers what you owe. However, if you receive this income in a non-registered account, it’s taxed at the appropriate rate. If you earned $70,000 in salary and received $5,000 of interest in a year, you’d pay tax as if you had income of $75,000. However, if you had a capital gain of $5,000, only half is added to your income, resulting in a total of $72,500. The number of accounts available and different rates charged on investment income results in a complex situation. As a result, you can benefit significantly by spending time to learn or work with a professional on where to put your money.
Payroll Tax
In addition to paying income tax on your salary, you’re also charged other payroll taxes. These taxes fund the Canada Pension Plan (CPP) and Employment Insurance (EI). Each year, you’re required to pay a portion of your earnings to the government up to a maximum amount. As of 2019, you’re required to pay 5.1% of your earnings up to a maximum tax of $2,748.90 for CPP. In addition, you’re charged 1.62% up to a maximum of $860.22 for EI. This additional $3,600 provides you with pension income in retirement, employment insurance and other benefits.
The CPP helps the government ensure Canadians have a base level of income in retirement. For those currently retired who qualify, the CPP provides income each year. The maximum annual payment is roughly $14,000, and the average amount paid is roughly $8,000 as of 2019. The amount you receive depends on the number of years you contribute to the CPP, the amount you contribute and when you choose to start receiving payments.
Property Tax
In Chapter 15, we watched a couple decide whether to continue renting or buy a new home. One cost involved in the decision was the property tax charged each year on the home. Property taxes are paid to your municipal government to provide many services. These vary by region and include items like parks, libraries, policing and snow removal. Property tax is charged based on your municipality and the value of your house. In the case of the couple in Chapter 15, the residential property tax in Toronto was roughly 0.6% a year. This resulted in an annual tax of $4,200 on a $700,000 property. Depending on your province and situation, you may receive tax credits for property taxes paid in certain cases.
Filing Your Taxes
As we mentioned above, you pay income taxes throughout the year and then file your taxes by April 30. Filing your taxes requires that you provide relevant data to the CRA, so they can determine if you owe additional taxes. You can obtain the information you need from various forms received around tax time. These can include information about:
Income received from your employer
Donation receipts
RRSP contribution receipts
Tuition payments
Income received from investments
By combining all your income and any adjustments required, you’ll know whether you owe the CRA or if you’re owed a rebate.
If you’re owed a rebate, it means that you’ve paid more in taxes throughout the year than you needed to. Rebates are often celebrated, as the money can be used for savings or other expenses. However, it also means you may be able to pay less in taxes throughout the year and can start using that extra money earlier.
There are several low-cost or free filing options available if your tax situation is simple. If your situation is more complex, you can meet with a tax expert to review your circumstances and help you file.
Other Ways to Lower Your Taxes
When you’re filing your taxes, there are several other ways to lower your taxes. You can receive tax credits for a range of activities, some of which include:
Interest paid on qualifying student loans
Donations made to qualifying organizations
Tuition paid to a qualifying institution
Qualifying medical expenses
Childcare expenses
There are many other potential ways to lower the amount of taxes you’re required to pay. Some may not justify the additional work to document and track, while others can offer major savings. As we’ll cover in Chapter 19, there are many resources available for you to learn more about taxes. It’s something you’ll likely need to do each year for the foreseeable future and is worth taking the time to understand.
Final Thoughts
The goal of this chapter is to cover the importance of taxes while explaining steps you can take to lower them. It’s in your best interest, as well as Canada’s best interest, for you to take advantage of the incentives available to you today. This helps the policies that are in place have the intended outcome. Therefore, it’s worth taking the time to learn more about taxes or to work with a professional as needed. By using accounts like the RRSP and TFSA and claiming credits you’re eligible for, you’ll have more money available for your goals.
Key Takeaways
Sales tax, income tax, payroll tax and property tax are paid to different levels of government in Canada.
Reduce the amount of tax you pay by using registered accounts and claiming eligible credits.
Continue to learn about taxes to take advantage of all the incentives, or work with a professional as required.
This blog is a duplicate of the recently self-published book The Snowman’s Guide to Personal Finance available for purchase here.