The concept of taxes was perhaps best encapsulated by Benjamin Franklin, who said that “in this world, nothing can be said for certain, except death and taxes.” But, understanding general tax laws, and income tax plus adjustments or deductions, doesn’t need to be stressful.
Taxes are often seen as an arduous process. However, they are the most important source of revenue for governments who use the funds to pay for services such as the free healthcare and education we enjoy in Canada. This money also pays for other essential services like policing, firefighting, and infrastructures such as libraries, roads, and bridges.
Your income tax paid should actually feel like a value-add every year. So take the time to learn more about what you’re paying, why you’re paying it, and how it improves your daily life.
Most Common Forms of Taxes
Examples are GST, PST, HST, and QST. This applies to most goods and services produced in Canada. Depending on the province you live in, one or a combination of the above may be applied to the base price of goods.
Note that Ontario, New Brunswick, Newfoundland & Labrador, Nova Scotia, and PEI harmonized the Provincial Sales Tax (PST) with the GST to create the HST. This might sound confusing, so here is a table explaining the sales tax that consumers pay by province.
Municipal governments usually charge property taxes based on the tax assessed value of land and buildings.
Employment Income Taxes
Effectively, you pay a portion to the government for each dollar you earn beyond a certain threshold.
Contributions made by employers and employees to social security plans such as the Employment Insurance (EI) system, the Canada Pension Plan (CPP), and the Quebec Pension Plan (QPP).
While there are other forms of taxes that consumers are liable to pay depending on their particular circumstances, most Canadian consumers will end up paying most of the above at some point in their lives.
Importance of Tax Filing
Tax season is a time that stresses out even the most relaxed Canadians. In fact, 22 percent of people state that they find tax season too stressful.
The truth is that most people feel so stressed during tax season because they don’t properly understand how to file their taxes. However, you can avoid tax season issues with a bit of education and understanding.
This guide is for you if you’re getting ready to file your federal or provincial taxes. Keep reading to learn how to file your income tax, plus get some great tips on doing so correctly.
What To Know About Income Taxes In Canada
Before we dive into the ins and outs of income tax returns in Canada, let’s take a minute to talk about what income taxes are and why we file them. Although aggravating to file, tax returns are actually significant for our country to function correctly.
Tax returns are important because they allow us to calculate our tax liability, request refunds for overpayment, and schedule tax payments. They’re essentially a way for us to comply with government tax policies.
Filing income taxes in Canada is important for two key reasons. For one, doing so enables us to make sure that we’re giving our portion of income to the government to fund public services such as education and public healthcare.
It’s also important to ensure that we’re not over or underpaying. When we file tax returns, we let the government know how much tax we should have paid versus what we actually paid.
This helps keep the system fair and ensures that all citizens pay their portion of taxes without being overcharged.
The Income Tax Act
So, how exactly did the idea of income tax come about? Income tax in Canada originated in the Income Tax Act and the Excise Tax Act. These documents explain what Canadian taxes are used for and how the government breaks them down.
If you need additional information about income tax, reading the ITA and ETA is the best place to look. These documents explain why paying income tax is such an important financial responsibility. They also explain in detail individual tax brackets and break down all laws surrounding Canadian taxes.
Who Needs To File An Income Tax Return In Canada
Now that you have a better idea of what income taxes are and why they matter let’s look at who needs to file an income tax return in Canada. Here are a few situations where you’ll need to file income taxes.
You Live Permanently In Canada
If you live permanently in Canada, you’ll need to pay taxes. This includes Canadian residents, immigrants to Canada, deceased Canadian residents, and Indigenous peoples.
You Leave Canada Permanently Or Temporarily
Individuals who live in Canada but have temporarily left the country are still responsible for paying taxes. This includes residents who leave the country temporarily for school, work, vacation, or medical treatments.
This tax situation also affects individuals who live part-time in the US, emigrate to another country, or live abroad part-time as part of a government job.
You Live Temporarily In Canada
Those who temporarily live in Canada are also responsible for filing taxes. For example, non-residents who live in Canada for 183 days or less in a year, non-residents with rental income, deemed residents, seasonal workers, and international students must all pay income taxes.
The Lowdown On Federal Income Tax Brackets
To calculate your taxes, the CRA creates tax brackets. Tax brackets apply to any personal income that falls between a certain minimum and maximum dollar amount.
Tax brackets only apply to taxable income. So, that means that they are calculated based on your total income minus any deductions or credits that you’re able to claim.
The amount of income tax you’re responsible for depends on how much money you earn. The more money you make, the more taxes you’ll have to pay to the government.
It’s important to understand where your income falls within tax brackets to know what changes to make to your income taxes. For example, if you’re pushed into a new tax bracket, it will change how much money you’ll receive as a refund.
How Personal Income Tax Brackets Work
Now that you understand what personal income tax brackets are, it’s time to look at how they work. Knowing how they work will help you calculate how much federal tax you must pay based on your current income.
If you have a taxable income that’s lower than the $49,020 threshold, then you’ll only be responsible for paying federal tax of 15% of the total. For example, if your total taxable income after deductions and credits is $20,000, you’ll be responsible for $3,000 in taxes.
Marginal Tax Rates
Part of understanding personal income tax brackets involves understanding marginal tax rates. Your marginal tax rate equals the amount of tax you have to pay for every additional dollar of income.
Many people think that if your taxable income falls in a higher tax bracket, you’ll have to pay more taxes on your entire earnings. In reality, however, your earnings are divided into portions that are taxed at the rate of the bracket they fall into.
That means that even as you earn more money, only part of your income will be taxed at a higher rate. This concept is known as the marginal tax rate.
To make things easier to understand, let’s take a look at an example. Let’s say that you earned $200,000 this year. That $200,000 will be taxed at a few different tax brackets.
The first $49,020 will be taxed at 15 percent in the first tax bracket. So the total tax you’ll pay on those first $49,000 will be $7,353.
The second tax bracket is $40,020-$98,040 and has a tax rate of 20.5 percent. For this next bracket, you’ll pay $10,048.90.
The third tax bracket is $98,041-$151,978 and is taxed at 26 percent. In this bracket, you’ll pay $14,023.62.
The fourth and final tax bracket calculates your remaining income of $64,533 at a tax rate of 29 percent for a total tax of $18,714.57. To get your total tax, add all the numbers together for a total tax of $50,140.09.
Keep in mind that if you fall into the top tax bracket of earnings greater than $216,511, you’ll be taxed at 33 percent. That’s the highest tax bracket possible.
Federal Income Tax Plus Provincial Income Tax Brackets
You need to worry about not just federal personal income tax brackets. As part of your income tax return, you’ll also need to submit your provincial taxes.
Luckily, provincial income tax rates are calculated in much the same way as federal income tax brackets. Just make sure to calculate your tax brackets based on the province that you live in.
To determine which province you live in, you’ll want to use the provincial rate of the province where you resided on December 31 of the year for which you’re filing taxes.
For example, if you moved from Quebec to Ontario in June, you’ll live in Ontario on December 31. Even though you spent part of the year in Quebec, you’ll be responsible for paying Ontario provincial taxes.
How to Get Into A Lower Tax Bracket
One way to be smart with your money is to get into a lower tax bracket. Doing so can help reduce the amount of taxes you owe and get you a bigger and better refund.
There are a couple of different ways to maximize your personal taxes in Canada using this method. Let’s take a look at two ways to get the best tax rates in Canada by moving into a lower tax bracket.
One way to minimize your taxable income is through tax credits. Tax credits are amounts that let you reduce how much tax you pay on your income.
Some tax credits are refundable while other tax credits are not. However, regardless of whether they’re refundable or not, they still lower how much tax you pay overall, which can push you into a lower bracket.
Deductions are expenses and amounts of money that you can subtract from your total income. This makes the number of taxable earnings you have much lower.
In turn, that reduces how much income is subjected to taxes. When that happens, you can jump down into lower tax brackets that make it much easier for you to maximize your return.
How to File Your Income Taxes
Once you’ve identified your income tax bracket, you’ll be ready to fill out your tax return. Luckily, filing an income tax return in Canada is pretty straightforward. Here are the different ways that you can file your taxes.
The easiest and fastest way to file your income tax is to use certified tax software to do so. You’ll need to make sure that you find CRA-approved software so that you’re staying compliant with tax laws.
With the software, you can either file your taxes online or download it for use on your tablet, phone, or computer. The application guides you through filling out your details for your income tax plus some information to file your return.
At the end of the questionnaire, the program will electronically submit the form for you. It typically takes about two weeks for the government to process the return and get you any refunds!
Paper Tax Return
If you want to keep things old school, you can also file your taxes using a paper return. You’ll need to download and print out your tax forms and fill out your personal information.
After completing your paper tax return, you’ll need to mail these to the government. Mailing a tax return takes longer than if you choose to file online, so expect your return to process for between 10 and 12 weeks.
Sometimes, you’d rather leave your tax return up to a friend, family member, or accountant that you trust. In these cases, you can authorize an individual to access and complete your tax return on your behalf.
Working with an authorized representative is a much faster option than filing your return yourself. The processing time is usually about two weeks, but you don’t have to worry about sorting through the paperwork on your own.
Community Volunteer Tax Clinic
Every tax season, community volunteer tax clinics pop up around Canada. These tax clinics offer free tax preparation services that make it easy to file your taxes the right way.
Tax clinics are only available to people who have simple tax situations. Some clinics also limit how much money you can make to use their services.
Anyone who wants to get their tax refund quickly can use a tax preparer. Tax preparers calculate your tax refund and pay you a discounted return right away. The remaining percentage of the return goes towards the preparer’s fee.
Tax preparers are a perfect option for anyone who needs fast access to cash. You don’t have to wait for your refund to be processed to get your money, but you won’t get the full amount.
Tax-Saving Tips for Individuals
Let’s face it; no one enjoys paying taxes. However, as we have discussed previously, not paying your taxes on time can incur significant penalties, and not paying taxes at all is a criminal offence. Therefore, the only way to legally reduce your tax bill is by reducing your taxable income (i.e., the amount of money that you report to the CRA that is then used to determine how much you owe or are owed in taxes). The taxable income is essentially all of your gross income, less income adjustments that you make.
So what are some of these adjustments you can make to reduce taxes paid?
The Canadian government has various incentives for people looking to save up for retirement. One of the most significant incentives is the Registered Retirement Savings Plan (RRSP). The RRSP is a “tax-advantaged” account, which means that any withdrawals made into the RRSP are exempt from taxable income calculations in the year that the contribution is made. It is only taxed years later when the amount is withdrawn. Additionally, any gains earned inside the RRSP are non-taxable.
Note, however, that citizens cannot continue socking money away into RRSPs without limits. The government only allows a maximum contribution each year. This maximum amount is located on your previous year’s Notice of Assessment. It is important to not over-contribute beyond this maximum amount as that accrues a 1% penalty for each month that the RRSP is over the limit.
RRSP Home Buyers’ Plan
The RRSP Home Buyers’ Plan enables first-time homebuyers to access up to $35,000 from their RRSP accounts tax-free to make a down payment on their home. Both spouses can tap into this $35,000 limit for a total of $70,000. However, both spouses have to be first-time home buyers. Another caveat is that the funds must be in the account for a minimum of 90 days before withdrawal. Lastly, it is essential to remember that this Home Buyers Plan is technically considered a loan. Hence, after purchasing the home for two years, the loan must be repaid to the RRSP through annual payments made over 15 years.
Borrow to Invest
A further option to boost returns while reducing taxes paid is the concept of borrowing capital to invest in securities such as equities or bonds. Over time, the value of these securities is likely to grow, meaning that you have made more returns with the added capital than you could have on just your equity. Additionally, from a tax savings standpoint, interest paid on borrowed money is tax-deductible.
Canadian taxpayers can claim amounts paid for public transit passes such as buses, trains, ferries, and streetcars.
Tax-Saving Tips for Small Business Owners
Many individuals may also be self-employed and run small businesses (1-50 employees). There are strategic ways these individuals can reduce their taxable income as well.
Account for All Receipts
As a small business owner, you often have so much going on that filing away your receipts accurately may seem like a low-priority item. However, this is a low-effort solution that can drastically help to reduce taxes at the end of the year. For example, that lunch you had to wine and dine a client or that parking fee you paid to meet a client at their office are all deductible. Ensure you keep track of these receipts, as the CRA does not generally accept the credit card statement as proof of payment.
Know Your Deductions
Small businesses are entitled to several deductions, such as insurance costs, interest paid on business loans, office supplies, and even the gas and maintenance costs paid on company vehicles. In addition, the marketing costs paid to agencies or freelancers to promote your business are legitimate deductible expenses for your taxes. Understanding these deductible expenses can be crucial to maximizing tax returns at the end of the year.
Use an RRSP
Like individuals, business owners also stand to gain from using an RRSP as a ‘shelter’ that helps to reduce taxable income.
The Capital Cost Allowance (CCA) stipulates capital expenditures (i.e., purchases of assets that provide benefits for more than a year) that allow businesses to record depreciation amounts on these assets. For example, if you purchase a capital item for $10,000 in the current year, a portion of that $10,000 can be claimed, with the rest claimed in future years. The amount claimed is called the Capital Cost Allowance. Before you claim the CCA amount, though, make sure you read the CRA’s guidelines. Assets are classified into different categories with varying levels of maximum CCA allowances.
Canadian Income Tax Explained
Whether you’re trying to navigate the complications of tax on split income or you’re just filing your return for the first time, knowing these key pieces of information will help you have a successful tax season.
By being aware of federal income tax plus provincial income tax acts, you can make sure you’re complying with Canadian law.
We know how complicated income taxes are in Canada, so why not contact a team who can offer you more tax assistance? Reach out to us today for even more tips and tricks on tackling your taxes in Canada.
When in doubt, use an accountant. A qualified accountant offers the dual benefits of identifying additional deductions that you may have missed and ensuring that you are not committing any infractions of the tax law. Tax-related penalties can be severe, so paying an accountant can often be the cheaper option in the long term.
Depending on your circumstances, you may want to consider incorporating your business as a small business owner, as incorporated companies pay a lower tax rate. However, there are other expenses and risks to bear in mind as an incorporated business, so only do so once you have done a cost-benefit analysis with a trusted financial advisor.