Let’s Learn-What is Tax Efficiency?

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Similar to the American system, Canada has it’s own progressive tax rate where you are taxed the same rate as everyone up to a certain point, then the percentage progressively increases as you hit a higher gross income (def: the sum all taxable income sources minuses their corresponding expenses minus any non-eligible sources). The provinces/states would set up their own tax rate system in tandem with the federal rate with each bracket (def: a range in which tax is applied at a specified rate).
Both federal and provincial tax have a tax credit that applies to your taxes payable known as the basic personal amount. Of course, if you have no taxes payable then the basic personal amount would either to transferred assuming you have a dependent (def: someone who relies on you for money and care) or it would be wasted. There are many other tax credits that will not be covered here, but it knowing about the more common ones should help you determine how to be the most tax efficient. Common ones include: dividend tax credit, donations tax credit, public transit, caregiver, and child’s art and fitness credits.
Marginal tax rate (def: the rate at which your next dollar would be taxed at) and average tax rate (def: the total amount of tax payable for the year over the the total amount of taxable income earned in the year) are metrics used to analyze where and how you can save money
The 2017 Ontario and Canadian federal rates are as follows:
Canadian Federal Income Bracket Canadian Federal Rate Ontario Income Bracket Ontario Rate
First $45,916 15% First $42,201 5.05%
Over $45,916 up to $91,831 20.5% Over $42,201 up to $84,404 9.15%
Over $91,831 up to $142,353 26% Over $84,404 up to $150,000 11.16%
Over $142,353 up to $202,800 29% Over $150,000 up to $220,000 12.16%
Over $202,800 33% Over $220,000 13.16%

Example:

A person with total taxable income of $92,000 would pay 6,887.40 (45,916*15%) + 9,412.58 (91,831-45,916=45,915*20.5%) + 43.94 (92,000-91,831=169*26%) = $16,343.92 in Canadian federal taxes.

That same person with total taxable income of $92,000 would pay 2,131.15 (42,201*5.05%) + 3,861.57 (84,404-42,201=42,203*9.15%)+ 847.71 (92,000-84,404=7,596*11.16%) = $6,840.43 in Ontario provincial taxes.

The gross taxes payable is $23,184.35 (16,343.92 + 6,840.43). The marginal tax rate is at 37.16% (26% for federal and 11.16% for Ontario). Basic personal amount tax credits will then be deducted for the federal and provincial of $1745.25 and $514 respectively. Total net taxes payable is now $20,925.10 (23184.35-1745.25-514). The average tax rate is 22.74% ($20,925.10/92,000). This calculation does not take into effect other tax credits or the Ontario surtax.

There are several tools that you can use to adjust and reduce your taxable income. The reason for doing so is to minimize the taxes payable especially if you are young and anticipate that your salary will increase significantly in the next 20 years or if you are elderly and retired and anticipate your income falling. In our example, if total taxable income was $84,400, then the marginal tax rate would have been 29.65% effectively taxing you less. Should that have been the taxable income, the gross tax payable would be $20,768.98 compared to $23,184.35 – a difference of $2415.52.

Tools that you can use to lower taxes payable and will be discussed further in detail include:

  • Expenses and costs that correspond to the income earned (reduces taxable income)
  • Registered Retirement Savings Plan or RRSP (reduces taxable income)
  • Income Splitting (attempt to even out the income between spouses
  • Non-refundable tax credits (reduces tax payable)
  • Tax-Free Savings Account or TFSA (cannot be taxed)
  • Registered Education Savings Plan (cannot be taxed)

Sources:

https://www.efgi.com/personal/tax/art.html

Taxtips.ca

 

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