Canada’s tax laws have a tax rate structure that increases based on the amount of money you make in one tax year. Rates may change as you earn more income throughout a tax year since you pay a lower rate for lower income tiers, but you can graduate to a higher rate once you go above a certain amount. The amounts that fall under specific tax rates and the tax rates themselves can change from year to year. Another thing to consider when it comes to figuring out your tax rate is that a different tax rate applies to personal income compared to business taxes.
Learning the difference between marginal vs. effective tax rates can help you develop a strategy for a tax year as you seek to maximize your income and profits. Take a look at marginal, or graduated, tax rates and effective tax rates in terms of how you approach paying taxes.
What is the Marginal Tax Rate?
The Canada Revenue Agency divides taxes into income tiers called tax brackets (or segments) at the federal level. It’s important to note that these numbers fluctuate every year based on inflation and other factors.
For the 2018 tax year, tax margins are:
- $46,605 or less pay 15%
- $46,605 to $93,208 pay 20.5%
- $93,208 to $144,489 pay 26%
- $144,489 to $205,842 pay 29%
- More than $205,842 pay 33%
For example, imagine you earn $50,000 in 2018. Using the rates in the bulleted list, your taxes amount to:
- 15% or $6,990.75 for the lowest tier, plus
- 20.5% or $695.98 on the amount between $46,605 to 93,208
In total, you would pay $7,686.98 on taxable income. You pay a higher tax rate, 20.5%, just on the second $45,916 you make, but you only pay 15% on the first $45,916. You gradually pay more as your income goes up.
Calculating Your Effective Tax Rate
Your total tax liability as a percentage of your income is your effective tax rate. Determining your total tax liability involves calculating the tax owed at each margin up to your total income. Simply take the sums of each tier of marginal tax rates and divide by your total income to arrive at your effective overall tax rate for your income. For the above example, your effective tax rate on $100,000 earned in 2018 is around 18%. That percentage is in between the first and second tiers of the marginal tax rate structure.
Why Knowing Your Marginal Tax Rate Matters
Knowing your marginal tax rate can help with business planning and tax savings at the end of the year. For instance, imagine you run a graphic design business as a self-employed person, and a client hires you for a project on Dec. 15. The job nets you $5,000 in income, and you have $90,000 in income already before you landed this job. You choose to take an up-front deposit of $1,000 at the start the project before receiving the $4,000 a month later on Jan. 15 the following year. The income you receive gives you $91,000 in income for the tax year, which is below the third tier of the marginal tax rates.
Here’s the difference. Rather than pay 26% on $3,169, or $823.94, of income above the $93,208 threshold from the previous tax year, you would pay just 15% or $475.35 on the revenue for the next tax year. That’s a difference of $348.59 that you don’t pay on your previous year’s tax bill. Rather than owe that money to the CRA, you can invest the dollars into new computer software, expand your marketing tools or save it as a profit.
By knowing how tax rates affect your business, you can better plan for the future and keep more cash in your account when you owe taxes. QuickBooks’ income tracking software helps you accomplish this kind of planning when it comes to tax time. This kind of software makes record keeping for tax purposes more efficient.
You have more options when it comes to saving at tax time. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.