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What Is the Difference Between Marginal Income and Marginal Income Tax?

Marginal income and marginal income taxes sound similar, but they refer to vastly different concepts. If you run a business, you should understand the basic differences between these two terms. Manufacturing and production businesses, in particular, need to understand what marginal income means.

Marginal Income

Marginal income refers to the difference between sales revenue and variable costs. For example, if your company sells $100,000 worth of products and has $40,000 in variable costs, it has $60,000 in marginal income. Variable costs represent production costs that change. This can include manufacturing supplies and energy costs that differ from month to month but not fixed costs, such as rent, business insurance, and administrative payroll, that typically stay the same.

Businesses have the option of tracking their total marginal income, or they can break down these amounts to focus on the marginal income associated with specific products. This individual focus often proves a useful way to track and compare the profitability of different items your company makes or sells.

Marginal Income Tax

In contrast, marginal income tax basically refers to tax brackets. To clarify, the Canada Revenue Agency (CRA) applies income tax at different rates depending on the amount of income.

For the 2022 tax year, tax margins are:

  • 15% on the first $50,197 of taxable income, plus
  • 20.5% on the next $50,195 of taxable income (on the portion of taxable income over 50,197 up to $100,392),plus
  • 26% on the next $55,233 of taxable income (on the portion of taxable income over $100,392 up to $155,625),plus 
  • 29% on the next $66,083 of taxable income (on the portion of taxable income over 155,625 up to $221,708), plus
  • 33% of taxable income over $221,708

For example, imagine you earn $60,000 in 2022. Using the rates in the bulleted list, your taxes will amount to:

  • 15% or $7529.55 for the lowest tier, plus
  • 20.5% or $2009.62 on the amount between $50,197 to $100,392

In total, you would pay $9,539.17 on taxable income. You pay a higher tax rate, 20.5%, just on the second $50,197 you make, but you only pay 15% on the first $50,197. You gradually pay more as your income goes up.

The rate continues to increase progressively with higher amounts of income. Marginal income tax doesn’t refer to the final or effective tax rate of individuals or businesses. It only refers to the rate assessed on income in each bracket.

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 had $100,000 in income already before you landed this job. You choose to take an up-front deposit of $1,000 at the start of the project before receiving the $4,000 a month later on Jan. 15. The income you receive gives you $101,000 in income for the tax year, which is within the third tier of the marginal tax rates.

Here’s the difference. Rather than pay 26% on $4,608, or $1198.08, of income above the $100,392 threshold from the previous tax year, you would pay just 15% or $600 on the revenue for the next tax year. That’s a difference of $598.09 that you didn’t pay on your previous year’s tax bill. Rather than owe that money to the CRA, you can invest the dollars in new computer software, expand your marketing tools or save it as a profit.

What is an 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 $101,000 earned in 2021 is around 18%. That percentage is in between the first and second tiers of the marginal tax rate structure.

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.

Running a small business requires you to navigate all kinds of financial concepts. When you understand the differences between marginal income and marginal income tax rates, you can better communicate with accountants, lenders, and financial professionals concerning your business needs.

QuickBooks Online offers a variety of tutorials that help you learn as you record and track your company’s revenue and expenses, and it can also help you maximize your tax deductions. Keep more of what you earn today.

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