How Taxes Work in Canada 🍁 - Learn to Lower Your Tax Bill

hey everybody Joe here from Avalon in this video I'll explain in plain English how your personal taxes work in Canada if you've ever wondered why they didn't teach you useful stuff in high school like how taxes actually work then this is the video for you luckily you won't have to sit in a dank portable for an hour a day for six months to learn this in under 30 minutes you can go from tax beginner to knowing more than 90 of Canadians about personal taxes don't worry though the video is much more interesting than it might sound oh really you're going to learn how your money is taxed and the types of income and deductions that allow you to reduce that tax stick around to the end and I'll show you how to easily estimate your tax refund in less than two minutes all that and nothing else coming right up [Music] foreign [Music] we're breaking the topic of taxes in Canada into two different videos the first video that's the one you're watching right now is all about personal income taxes the second video Linked In the description below dives into corporate taxes in Canada corporations allow business owners to access lower tax rates as well as some truly excellent government programs that help you build wealth excellent for now though we're talking about personal taxes in the Canadian tax system there are two types of income tax for individuals federal income tax and provincial income tax these separate taxes have their own tax rates and they stack on top of one another for example a Canadian Living in Alberta earning 180 000 a year of taxable income will pay about fifty three thousand dollars in income tax that includes both Federal and provincial income taxes if that same Canadian lived in Nova Scotia she would owe around sixty four thousand dollars in income tax the difference comes from the different provincial tax tax rates between Alberta and Nova Scotia the person would owe eleven thousand dollars more in taxes just from living in Nova Scotia compared to living in Alberta wow Nova Scotia must be really nice with both from federal and provincial taxes the percentage of tax you pay increases as you earn more income this is called a progressive tax system and is our next Topic in Canada we use a progressive tax system this basically means that your tax rates increase as your income increases you may have also heard it described as tax brackets or marginal tax rates but it all means the same thing the best way to explain the concept is to just demonstrate it with an example we'll use fictional marginal tax rates to illustrate the point you can see an example here the tax rates increase as your income increases each higher tax rate is only applied to the taxable income within its own own bracket so running down the list here the first twenty thousand dollars is taxed at zero percent no tax on that between 20 and 40 is is at 10 percent between 40 and 60 is at 20 between 60 and 80 is at 30 percent and the income between 80 and 100 000 is taxed at forty percent so in this fictional example I want to stress that the total tax payable on a hundred thousand dollars of income is only twenty thousand dollars there is a common misconception that the new higher tax rate will be applied to all of your income you hear people saying they don't want to earn more income because it will put them in a higher tax bracket that is the wrong idea this is all wrong the higher tax rate is only applied to the income within that tax bracket it's an important concept to understand all else things being equal it's always better to earn more income don't turn away extra income because it puts you in a higher tax bracket it's the wrong idea there are also different tax treatments for different types of income in Canada I'll use some of the most common income types to illustrate this concept I'll talk about employment income investment income and we'll talk about business income as well so start with the most common type of income which is income from employment it would be nice to have that kind of job security but if you've ever been employed in Canada you likely received a T4 slip that shows how much employment income you earned in the year employment income can include wages salaries bonuses and commissions among other forms of compensation when you receive employment income you are required to pay federal and provincial income tax on those earnings your employer will typically withhold this tax from your pay and remit it to the government on your behalf really nice of them you will also see Canada pension plan contributions and employment insurance premiums deducted from your paycheck you'll likely have seen these abbreviated as CPP and EI this example here shows a pretty typical T4 Pam here has earned fifty eight thousand dollars of employment income which you can see in box 14. pam pam her employer deducted three thousand one hundred dollars of CPP and remitted to remitted it to the government that shows up in box 16 on Pam's T4 you can also see in box 18 there were 915 dollars worth of employment insurance premiums deducted and remitted to the government on Pam's behalf as well then the biggest deduction we see is nine thousand dollars worth of income tax that was withheld this amount shows up in box 22. the T4 is how employers report your employment income and taxes paid to the government each year your employment income and the income tax withheld is taken into consideration when you file your tax return each year keep that in mind for now later on we're going to be looking at how your overall taxes are actually calculated and how you can estimate your tax refund or amount owing each year here we can see Pam's employment income on her tax return her employment income of fifty eight thousand dollars shows up at the top of her total income section we'll come back to this example as Pam earns different types of income and claims tax deductions and credits I'll also note that so far Pam is expecting a tax refund of 305 dollars because her employer withheld more income tax than is currently calculated on her return this will change as Pam earns other types of income or taxes are not withheld and paid automatically like they are with employment income so next we'll look at investment income and how it's taxed there are a few different types of investment income but I'll focused on dividend income interest income and I'll also talk about capital gains interest income that you earn is fairly straightforward it is included in your taxable income and taxed at your marginal tax rates there isn't any preferential tax treatment for interest income but that certainly doesn't mean that you should avoid it one way to improve how your interest income is taxed is to hold these Investments inside a tfsa or an rrsp earning interest within a tfsa or RSP means that you don't actually pay any tax in the years that you earn that income that's interesting to learn more about how tfsas and rs work check out our video Linked In the description below we explain how they work and when you should use them so that's interest income that's interesting dividend income on the other hand is tax at a lower rate than interest income or employment income you earn dividend income as a shareholder of a private or publicly traded company because Dividends are paid from after tax dollars of Corporations they have preferential tax treatment on your personal taxes it's a bit convoluted sounding but here's how it happens first the dividend income is grossed up AKA increased by a percentage this grossed up amount is included in your total income then a dividend tax credit is applied to reduce taxes paid on that income excuse me baking powder there's a lot more we could talk about with how Dividends are taxed but the basic premise is truly what's important here the main thing to understand is that dividend income typically creates less personal tax than the equivalent amount of interest income or employment income this table is a great illustration of that point and so check that out you can see that the tax rates on dividends are much lower than tax rates on employment or self-employment income if you're curious to learn more about how Dividends are taxed check out the link in the description below next up we've got capital gains so capital gains a rise when you sell property for more than you paid for it and now when we're talking about property in this context we're not necessarily talking about real estate property can mean real property but it can also mean Investments like shares in a publicly traded company when you sell your investment at a gain your capital gain will be equal to the selling price minus the adjusted cost base of the property now adjusted cost base just means the amount that you paid for the purchase of the property plus any expenses paid to acquire it like commissions or legal fees you're only taxed on half of the capital gain that you earn for example if you sell your Shopify shares for ten thousand dollars and your adjusted cost base was 2 000 then you'll only pay tax on one half of the gain so the eight thousand dollars of gain means a four thousand dollar taxable capital gain okay let's have a look at what investment income looks like on Pam's tax return we can see that Pam has earned dividend income of a hundred dollars which has been grossed up to 115 dollars we'll see how the dividend tax credit reduces her taxes on this income later in the video we'll also see on the investment income lien that she's earned a thousand dollars of interest income and she also earned a capital gain of ten thousand dollars but only half of that is her taxable capital gain of five thousand dollars so far Pam has earned employment income from her work at Dunder mifflin's Vancouver office and some investment income her total income is sixty four thousand one hundred fifteen dollars and she's now expecting that she will owe fourteen hundred dollars in taxes the change from an expected refund to owing tax happened because she earned investment income without remitting tax like she did on her employment income this is normal and why people with significant investment income can often have a balance owing when filing their taxes [Music] all right moving on lastly we'll look at income from self-employment self-employment income is commonly referred to as business income this is an interesting one because you're allowed to deduct many types of expenses that you've incurred to earn that business income you're then taxed on what's left over after you've deducted all of your business expenses as usual an example is the best way to explain this here we see that Pam has a side hustle as an artist she has sold twenty six thousand dollars worth of her art this year and she's also incurred some expenses for advertising office supplies and travel costs her net income after deducting those expenses was twenty one thousand three hundred dollars this is also the amount that we see here on the line for her total self-employment income business income is great because there are more available deductions that allow you to reduce taxes that you pay check out the link in the description below to learn more about what types of expenses you can deduct when earning business income all right now we have a good picture of Pam's income she's earned 85 415 in total income which you can see online fifteen thousand this also includes her income from employment her investment income and her self-employment income if that was the end of Pam's story here we would calculate Pam's taxes based on our total income of eighty five thousand four hundred and fifteen dollars she'd be expecting to pay around eight thousand dollars in taxes this might sound like a lot of tax but it would have been even more if Pam wasn't able to deduct business expenses to reduce her income from self-employment again the reason her taxes have jumped up is because she's earned more income without paying taxes throughout the year however it's not the whole story Pam still has some tax deductions and tax credits that are going to help this situation next we'll look at some common tax deductions available to Pam these will reduce her taxable income which reduces her taxes owing don't confuse tax deductions with tax credits because they behave differently even though they sound like they do the same thing tax deductions reduce your taxable income whereas tax credits reduce your income tax what are you doing talking about hey okay I know it sounds confusing so let me break it down a bit further so Pam had just over 85 000 of total income let's say that she had ten thousand dollars of tax deductions this would reduce her taxable income to seventy five thousand and then that number would be used to calculate her taxes owing her total tax would only drop by four thousand dollars in this example because ten thousand dollar deduction only reduces the income used to calculate those taxes tax credits on the other hand directly reduce taxes payable but there's an extra step needed to calculate them tax credits create tax savings based on the lowest tax bracket which is fifteen percent on the federal side so a ten thousand dollar federal tax credit will reduce federal tax by fifteen hundred dollars applying that back to our example if Pam had ten thousand dollars of tax credits her taxes owing would only Reduce by fifteen hundred dollars all right now that we maybe know the difference between tax credits and tax deductions let's look at if few common tax deductions in this example Pam has tax deductions from her RSP contributions child care expenses and moving expenses you'll see on her tax return there are a number of other deductions available to her but we've chosen three of the most common ones to cover in this video RSP contributions are probably the most common type of tax deduction that we see contributing to your rrsp allows you to deduct that amount from your income which means that you're taxed on a smaller amount of money there's a maximum amount that you can contribute and deduct each year but rrsps are still great because they reduce your tax and help you save for retirement check out our video Linked In the description below for our full guide on rrsps Pam has five thousand dollars of rrsp contributions which will reduce their taxable income and save her about fourteen hundred dollars in taxes pretty nice next up Pam had some child care expenses there are quite a few specific rules around who can claim child care expenses and how much can be claimed in general though child care expenses can be deducted acted by the lower income earning spouse up to a maximum amount now the maximum amount is list coming eight thousand dollars for each child under seven five thousand dollars for each child between seven and sixteen and eleven thousand dollars for each child who qualifies for the disability tax credit there is also an overall maximum equal to two-thirds of the earned income of the lower income spouse Pam's husband Jim has had a really good year with his Sports marketing company so Pam is the lower income spouse and will have to claim the child care expenses on her return Pam and Jim paid ten thousand dollars in child care expenses for cc but the maximum Pam can claim is eight thousand dollars this is because cc is under seven and doesn't qualify for the disability tax credit the eight thousand dollar Child Care expense deduction reduces Pam taxes owing by about twenty two hundred dollars so that's pretty good the last tax deduction that Pam had was moving expenses moving expenses are deductible if you've moved and established a new home to be employed or run a business at a new location you also need to have moved at least 40 kilometers closer to your new place of work or business if you've met those requirements you can deduct things like transportation and storage costs travel expenses temporary living expenses incidental costs are related to your move and various rehoming costs for a full list of eligible expenses check out the link in the description below in Pam's case she was transferred to the Dunder Mifflin Vancouver office and incurred ten thousand dollars in eligible moving expenses this deduction reduced Pam's taxes by about twenty eight hundred dollars here we can see that Pam had eighty five thousand four hundred fifteen dollars in total income before any deductions then we deduct five thousand dollars of rrsp 8 000 of child care expenses and ten thousand of moving expenses we arrive at Pam's net income of sixty two thousand four hundred fifteen dollars on line two three six zero zero next we can see that there are a few other deductions that could be deducted from Pam's net income before we arrive at our taxable income these didn't apply to pams or taxable income is also 62 415 Pam's Federal and provincial income tax is calculated based on this number her marginal tax rates are applied to her taxable income and we can see that Pam would owe ten thousand dollars in Federal Income Tax Plus twenty eight hundred dollars in provincial income tax however that's not the end of the story there's so much more to it than that we still have tax credits to account for before we find out how much Pam owes or if she gets a refund like I mentioned earlier tax credits reduce the actual tax amount that you owe there are different provincial tax credits available depending on which province you live in and there are federal tax credits that are available to all Canadians we'll look at a couple of the more common federal tax credits to illustrate how they work the most common tax credit is the basic personal amount the basic personal amount is just one of the non-refundable tax credits every Canadian resident can claim the amount of the credit changes from year to year generally to keep up with inflation in 2022 the federal basic personal amount was equal to 14 398 dollars there is also a corresponding provincial basic personal amount which varies depending on which province or territory that you live in pemp certainly qualifies for the basic personal amount as she's a resident of Canada in our fictional example the other tax credit that we'll discuss here is the home buyers amount in 2022 you can claim up to ten thousand dollars for the purchase of a qualifying home if you meet a couple of criteria you or your spouse acquired a qualifying home and in the last four years you didn't live in another home that you or your spouse owned now for it to be a qualifying home it must be either a single family house a semi-detached house a townhouse a mobile home a condo an apartment in duplexes triplexes fourplexes or apartment buildings okay thanks I get it okay so the criteria for a qualifying home does cover most scenarios the tax credit can be split between spouses or claimed fully by one spouse in our example Jim and Pam bought a house in Vancouver and Pam is going to claim the full amount on her return greedy this we can see here on Pam's return again that she has the basic personal amount of 14 398 dollars at the top then she has a few other tax credits that are important but that we didn't have enough time to cover in this video and lastly we see the home buyers amount of ten thousand dollars at the bottom we'll total up the tax credits and multiply that by 15 which is the lowest federal tax rate that gives us Federal non-refundable tax credits of four thousand five hundred dollars ish this amount is subtracted from Pam's federal taxes owing okay so now we're almost ready to find out how much tax Pam will owe at the top we can see federal tax of ten thousand thirty four dollars was calculated based on Pam's taxable income then we're reducing that balance by her non-refundable tax credits of forty four hundred forty five dollars and ninety cents and we get to deduct that 10 Federal dividend tax credit that arose from Pam's dividend income next we add in CPP that Pam will owe on her self-employment income of 799.60 CPP is a bit beyond the scope of this video but check out the link in the description below for more info on that and finally we add in Pam's provincial taxes owing of just under 2 900 so our total taxes payable is nine thousand two hundred seventy two dollars and twenty five cents thankfully Pam has already paid the nine thousand dollars in tax that was withheld from our employment income this amount gets deducted from her total tax payable which means that she will only have to pay a small balance owing of 272 dollars which when she files her tax return my God so we've looked at a simplified calculation for for taxes for Pam but it's still not that simple however there is an easier way for you to get a reasonable estimate of your tax balance and that's using the wealth simple tax calculator no they're not a sponsor it's just a free online tool that is straightforward to use that we use all the time click the link in the description below of this video and then just fill in a few fields on the calculator choose your Province income amounts RSP contributions and income taxes already paid it will then give you a pretty good idea of whether you'll have a refund or a balance owing when you go to file your tax return for example if you've earned sixty five thousand dollars of employment income and your employer withheld twelve thousand dollars of income tax you could estimate receiving a refund of around fourteen hundred dollars all right that's it for part one of how taxes work in Canada hopefully this video has helped you give you a good idea of how your taxes work and how they're calculated if you want to dive into more topics like this one please check out our links in the description below we've got articles guy guides online courses and lots of other resources for you we do love helping small business owners and creating this these videos is just one way that we do that but if you're not subscribed yet to our Channel please consider hitting that subscribe button and if this video has been helpful please hit the like button too that's super helpful for us it really motivates us to get uh get out there put more useful content out to you guys and thanks for watching and we'll see you in the next video cheers

Channel: Avalon Accounting

Views: 3,559

Keywords: Small Business Accounting, Small Business Bookkeeping, Small Business, Canadian Small Businesses, Online Accountant, Online Bookkeeper, Business Advice, Accounting Advice, Corporate Tax, Business Taxation, Tax Tips, Canadian Tax Tips, Build a Business

Id: SM2gD_K9JBA

Length: 21min 10sec (1270 seconds)

Published: Fri Mar 24 2023