What happened to my salary? (Taxes)

I have been neglecting this post for months now. I know, I know, how can you keep a blog and not update it. It's been really hectic for me lately. RRSP season (January 1 to March 1), tax season March 1 to April 30. And I just have been busy taking care of my clients, work and family and it's hard to balance sometimes and sit down and think of something to write.

Anyway, tax season is over and I'm sure a lot of people are not very happy about it. Wondering why they have to pay so much taxes and stuff. Well, in this section, my aim is to explain as simple as possible how taxes work in Canada.

They said that there are only two guarantees in life. Death and taxes. And if you plan to live in Canada, you better be prepared to pay a lot of tax.

Tax rates differ from Province to Province. but there are generally two types of taxes you have to pay, Federal and Provincial. The Canadian tax system is based on a progressive tax system. The higher your income, the higher the tax you pay.

Now you may be wondering why you have to pay two different taxes. The Federal tax is paid to the Federal government and the Provincial is for the Provincial government. You don't pay them separately, you file them together with your tax return.

The 2007 Federal and Provincial tax rates can be found on the CRA website.

Basically, everybody pays the same rate for their Federal tax. But each province sets a different tax rate. From the tax table of the CRA, Alberta has the lowest tax rate at 10% for any income level. Other provinces has a different tax rate depending on how much you make.

To simplify the understanding of how much taxes you will be assessed at. Let's use the marginal tax rate. Marginal tax means the combined rate of both the Federal and the Provincal rate. This makes it easier to understand than computing how much you have to pay in the Federal rate and how much on the Provincial rate. The marginal tax rate combines them and you only use one single rate. Note that you pay your taxes on Federal and Provincial, the marginal tax rate is only a guide to simplify things.

Now, since I'm from British Columbia, let's look at the marginal tax rate for someone named John Doe living in B.C. who made $75,000 in 2007. Looking at the table, you can see that John's tax rate falls in the 37.7% bracket for salary.

Does that mean John will pay tax on 37.7% of $75,000 or $27,750? No. Here is how taxes work. On the first $8,928 of John's income, he doesn't have to pay tax. That's called the basic personal amount. Any income up to that amount is not taxed. This changes every year and I believe it goes up to $9,000 in 2008.

Now, on the income from $8,929 to $34, 397. John pays 21.6% or $5,501.09.
From $34, 398 to $37, 178, he pays 24.7% or $686.66.
From $37,179 to $68, 794 he pays 31.1% or $9,832.27.
From $68,795 to $74,984 he pays 33.7% or $2,085.70.
From $74,358 to $75,000, he pays 37.7% or $642.

In total, the taxes John has to pay is $18,747.72. A lot less than $27,750 is it not? It's still a lot of money, but it's better than paying $27,750. The employer will usually take 10 to 12% in salaries as withholding tax. You can see this in your pay stub under Federal and Provincial.

There are also other deductions like Employment Insurance (EI) and Canada Pension Plan (CPP) which reduces your take home pay. Your employer may also provide group benefits which is deducted from your salary as well. If the company you're working for has a union, then there are unions dues to pay as well.

These are just some of the taxes you pay in Canada and taxes on income are treated differently compared to capital gains and dividends. I'll discuss them in more details in my next entry.