Thursday, April 16, 2015

Canadian Taxes A to Z (2015): M is for Marginal Tax Rate

Okay, so maybe I was the marathon runner who shot out the gate a little too fast. Managing to knock off post after post, day after day, in the Canadian Taxes A to Z (2015) odyssey, only to start to slow down as the mid-alphabet range of the race was entered.

Today, 14 letters down, 12 to go! I'm past the half-way point. And promise to finish prior to tax deadline time.

To know your marginal tax rate is to know how many cents of every dollar you make will stay in your pocket if you continue to earn more income throughout the year. The reason we don't just use the term "tax rate" without the word "marginal" is because we don't use a flat tax system in Canada (nor does any country with a "progressive" tax system).

Marginal tax rate is the percentage rate that will be applied to the next dollar you earn. To take Ontario as an example, your combined federal and provincial tax rate on the first $40,922 you earn is 20.05%. That doesn't mean you'll necessarily lose that much of your income, since you'll be entitled to various deductions, but the "margin" bump up to the next tax bracket (24.15%) happens when you earn more than $40,922.

The top bracket in Ontario of 49.53% kicks in at over $220,000 in net income (there are several in between brackets). Meaning you get to keep just slightly over 50 cents of every dollar you earn. A lot of countries now try to keep their top marginal rates under 50%, since they saw that income tax rates which used to range about 80% at the top end simply encouraged a flight of the wealthy (and their capital) to lower tax jurisdictions.

Other provinces have different rates at different marginal brackets. The finishing top marginal tax rates tend to be somewhat similar among the provinces, but may kick in much sooner than in Ontario. In Quebec, for example, on the first $41,935 of income you pay at a rate of 28.53% (almost 50% higher than in Ontario). The top marginal rate of 49.97% is very similar to Ontario's top rate, but kicks in at $138,587 income, much sooner than Ontario's top marginal rate.

The other thing to know about marginal tax rates in Canada is that you only pay tax on capital gains at 50% of the normal rate. So even if you're in the top tax bracket, your marginal tax rate for capital gains would only be 24.76%. You'll also get a bit of a tax break on marginal rates for Canadian dividend income.

Some think it unfair that those with active income (from employment or self-employment) pay taxes at a higher rate than those with passive investment gains. But like a lot of things tax, that's just the way it is. Not unlike it being potentially unfair that those whose primary owned residence goes up massively in value pay no tax at all on those capital gains, whereas those who rent get no similar tax break.


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