How income tax works

Filing your taxes might be one of the most important financial actions you’ll take each year. It can also feel confusing or stressful at times. Find out more about how income taxIncome tax A charge you pay based on your total income from all sources. The Canadian government and your province set the rate.+ read full definition works, including taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition deductions and tax credits, and try our interactive chart to see what tax bracketTax bracket The rate at which you pay tax, based on your income level.+ read full definition you are in.

Tax and income 

The amount of income tax you pay is based on how much taxable incomeTaxable income The amount of income you have to pay tax on, after tax credits and deductions.+ read full definition you have earned that year. Taxable income could include employment income, EI benefits, pensionPension A steady income you get after you retire. Some pensions pay you a fixed amount for life. Others save up money for you while you are working. You use that money to create income after you retire.+ read full definition income, and investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition income such as interest or capital gains.

If you have regular employment income, then your tax may be deducted directly from your paycheque. This will be shown on your pay stub.

SOME SOURCES OF INCOME THAT ARE NOT TAXED

For example, you don’t pay tax on life insuranceLife Insurance Insurance that pays cash to your family or other beneficiary after your death. This can give them income and help pay your funeral and other final costs.+ read full definition proceeds following someone’s death, most gifts and lottery winnings. Learn more about which sources of income that are not taxed.

Identifying your tax bracket

The amount of income tax you owe is calculated when you file your tax return each year. You are required to report your total income to the Canada Revenue Agency (CRA) when you file your tax return. The rate of tax increases as your taxable income increases and exceeds certain amounts, called tax brackets.

Watch our video Why open an RRSP  to see more on how tax brackets work.

Try the interactive chart below to see how your income level may affect your tax rateTax rate The rate at which you or a business pays tax on income. Often stated as a percentage, such as 25%.+ read full definition.

The government sets the tax rates and brackets. They may change from year to year. Find current tax rates.

Deductions and credits – what’s the difference?

You can reduce your taxable income and the taxes you pay by taking advantage of deductions and credits.

Tax deductions – reduce your taxable income. Common deductions include RRSPRRSP See Registered Retirement Savings Plan.+ read full definition contributions, childcare expenses, and union and professional dues.

Deductions won’t directly contribute to a refund at tax time. However, it is possible they could add up enough to put you into a lower tax bracket, which would mean you will be taxed at a lower rate.

Learn more about what you can deduct.

TipTip The sharing of important information about a company not known to the public.+ read full definition: If you’re in a higher tax bracket, a deduction will be worth more in terms of tax savings than if you are in a lower bracket. If you are already in a lower tax bracket, then deductions such as RRSP contributions will have less of an impact.

Non-refundable tax credits are amounts that reduce the amount of tax you owe – not from the amount of income you earn. They will not contribute to a refund. This means that if your non-refundable tax credits add up to more than the amount of tax you owe, the result will be that you owe no tax. Examples are: The disability amount, the charitable donation tax creditTax credit The amount you can deduct from your income when you file your taxes. This lowers the tax that you owe.+ read full definition, and the caregiver amount.

Refundable tax credits do contribute towards a refund, or they might be paid to you in amounts throughout the year. The government will pay you the refundable tax credits you qualify for, whether you owe tax or not. To claim them, you must file a tax return. Examples are GST/HST credits, and the Canada Workers BenefitBenefit Money, goods, or services that you get from your workplace or from a government program such as the Canada Pension Plan.+ read full definition (CWB).

TAKE ACTION

Tax credits and deductions can lower the amount of tax you have to pay. Remember to claim all the credits and deductions you’re entitled to.