When it comes to financial planning, it's not enough to know how much money you earn. To better know how much of your money is truly yours to save, spend and invest, you first need to get a good approximation about how much you could have to pay in income tax each year.
If you live and work in Canada, you need to file a personal income tax return every year. Understanding how your income is taxed is an important part of financial planning. In Canada, the federal government calculates how much tax you should be paying based on the amount of income you earn.
To calculate a rough estimate of how much you might have to pay in income tax (without reference to any credits or deductions that would be unique to you), start by taking your average tax rate – which is the amount calculated by taking the total of the provincial and federal tax you paid for the year to the government – divided by your annual income for that year.
Where things can get confusing is the fact that your entire income isn't taxed at a single tax rate.
Canada has what's known as a marginal tax rate system, which means your income is divided into different sections (called tax brackets). Each tax bracket or section of your income is taxed at its own unique tax rate, and the tax bracket for each section of income increases for each additional amount of income you earn over the previous bracket
There's a lot of jargon and numbers when talking about taxes. To help better understand how it all works, see below for a visual guide to Canadian tax brackets and their corresponding marginal tax rates for 2022.
Federal tax brackets
Canadians pay both federal and provincial taxes, each of which have their own tax brackets and corresponding marginal tax rates.
Let's start with the federal tax brackets…
Tax brackets are based on your taxable income, which is roughly all the money you earned in a calendar year, minus any tax deductions, tax credits, and other exemptions for which you may qualify.
To help you understand marginal tax rates, think of a cake as representative of your total taxable income. Now imagine cutting that cake into multiple slices with the first slice representing all the money you earned up to and including $50,197 – the first tax bracket. The second slice of cake you cut represents every dollar you earned above $50,197 up to and including $100,392 – the second tax bracket.
Now imagine that you have to take a piece of each slice of cake you cut (i.e. segment of income earned) and pay it to the federal government as income tax. For the first slice of cake, which represents the first tax bracket, you would need to give 15% of that slice to the federal government in taxes.
But for the second slice of cake, you would need to give 20.5% of that slice to the federal government in taxes.
As your income increases and enters into a new tax bracket, the marginal tax rate applicable to that new tax bracket gets higher. Your marginal tax rate is the amount of tax you pay on each additional dollar of income earned over the previous tax bracket.
An increase in income that attracts a new marginal tax rate doesn't mean that your entire income will be taxed at this new marginal rate. It's a common misconception that if your taxable income increases you are then pushed into a higher marginal tax bracket that applies to all the income you earned.
That's not true.
Think back to the cake example. Many people believe that because you need to give the government 20.5% of that second slice of cake for the $50,197 - $100,392 tax bracket, it means you also need to apply the 20.5% marginal tax rate to the first slice of cake as well. This is not the case.
For the amount you earned up to and including $50,197, you still only need to give 15% of that amount to the federal government in taxes.
To recap: Your income is divided into tax brackets according to amounts specified by the government, and each bracket is taxed at its own marginal tax rate. If your income increases and you fall into a higher marginal tax bracket, only the amount of income that falls within that new tax bracket will be taxed at the new higher marginal rate.
Here are Canada's federal income tax brackets and corresponding marginal tax rates for the 2022 tax year, according to the Canada Revenue Agency. Tax brackets and marginal tax rates are adjusted every year by the government based on inflation and other factors.
To help understand how marginal tax rates are applied, imagine you make $110,000 in taxable income in 2022. This example is focused solely on the tax brackets involved and does not take into account any other possible credits or deductions that could apply, such as RRSP contributions or medical payments.
For the first $50,197 you earned, the 15% marginal tax rate on that income would mean a tax payment of approximately $7,530.
For the next $50,195 you earned – that is the amount you earned within the next tax bracket from $50,198 to $100,392 – the 20.5% marginal tax rate applicable to that income would mean a tax payment of approximately $10,290.
For that final $9,607 you earned (which is the amount from $100,393 to $110,000), the 26% marginal tax rate applicable to that income would mean a tax payment of approximately $2,498.
That means that if you earn $110,000, you are actually paying taxes on three different tax brackets at three different marginal tax rates.
Therefore, based on this example of $110,000 in earned income, the total amount of tax payable (without reference to any possible credits and/or deductions that might apply), would be $20,318 ($7,530 + $10,290 + $2,498).
The misconception many people have is that if an increase in their income puts them into a new tax bracket (e.g. they received a raise at work from $95,000 to, say, $110,000) that their entire income will be taxed at the highest marginal tax rate – which in this example would be 26%. However, in reality, only the amount of money earned above $100,393 would be taxed at the higher marginal rate of 26%.
Going back to the $110,000 example, to calculate the average federal tax rate applicable – again, not taking into account any other possible credits or deductions that could apply, such as RRSP contributions or medical payments – would be roughly 18.5% ($20,318 divided by $110,000).
Provincial and Territorial tax brackets
In addition to federal income tax, Canadians also pay provincial/territorial income taxes based on where they lived as of Dec. 31 of the calendar year for which income tax is to be paid. All provinces and territories have their own tax brackets and corresponding marginal tax rates (see the Canada Revenue Agency website).
For example, here are Ontario's income tax brackets and marginal tax rates for the 2022 year, according to the Canada Revenue Agency. (Note: While Ontario has an extra surtax that applies – which as of the date of this article, other provinces do not – this surtax is not factored into the examples used in this article which is solely focused on marginal tax rates.)
How to calculate the marginal tax rate and average tax rate for Ontario
Let's say your taxable income for 2021 is $75,000 and you live in Ontario. Using the 2022 federal and provincial tax brackets, here's a very rough estimate of how much you might pay in federal taxes and provincial taxes alone, based on the applicable marginal tax rates.
Remember that this tax calculation is solely concerned with the marginal tax rate payable on the amount in question and makes no allowances for any surtaxes, or for any tax deductions or credits such as RRSP contributions, or other credits or deductions such as claims for medical expenses or dependents.
Average tax rate for $75,000 Annual Income Example for Ontario
Total taxable income: $75,000
Total federal taxes paid: $12,615
Total provincial taxes paid: $4,967
Total federal + provincial taxes paid: $17,582
Average tax rate: 23.4% [Total federal and provincial taxes paid ($17,690) divided by total taxable income ($75,000)]
This article is for informational purposes only, and its information should not be construed as legal, tax, investment, financial, or other professional advice. The information provided is general and does not address the circumstances of any particular individual or entity for which you must obtain your own legal, tax or other professional advice