How to Calculate Taxable Income in Canada
Canadians like to talk about their heavy tax burden. But do they realize that tax rates differ significantly between provinces and regions? Alberta has no sales tax and lower income tax rates. On the other side of the country, Quebec has the highest total tax and income tax rates in Canada.
As reported by the Montreal Gazette, the income tax paid in Quebec represented 13.4% of GDP in 2016. If you compare Quebec to the 35 wealthiest nations in the world, the province would have ranked third highest after Iceland and Denmark for 2016 data.
Canadians expect to pay tax on earned income. But some tax rules can be head-scratchers. For example, why do employees pay income tax at their marginal rate on the amount an employer paid for health plan premiums? And why is sales tax charged each time a used car is resold, although the first owner paid a hefty amount of tax on the new vehicle?
Understanding how taxes are calculated
Given all these complex rules that the Tax Act covers and condenses into the federal T1 tax return and associated forms, it’s good to understand which deductions and credits can help your family and allow your business to maximize the tax deductibility of eligible expenses.
Let’s say you run a small business in Quebec with customers across Canada. Your ongoing tax burden includes federal, provincial income and sales tax returns and instalments in multiple provinces, local taxes, licences and fees, etc. As a small business owner, you pay your share of taxes, so claiming any and all deductions entitled to you make perfect sense.
What is non-taxable income?
Most people think of income as money earned from business activity, employment or investments.
According to the Oxford dictionary, income is “money received, especially on a regular basis, for work or through investments.” For our tax authorities, most amounts seem to fall under “income”, whether they’re recurring or not, taxable or non-taxable.
With this in mind, taxpayers miss out on both personal and business tax deductions and credits every year. That’s why legions of tax experts give interviews every tax season and tips about overlooked deductions and credits.
Some amounts, such as disability tax credits and the working income tax benefit, are underclaimed. To illustrate, a diabetes patient may not realize she could be eligible for disability credits, going back as much as 10 years. If she meets the criteria, it could mean thousands of dollars in tax credit refunds and eligibility for other disability programs.
Enter taxable and non-taxable income amounts into the T1 general tax return (Ontario T1, for example) is divided into sections or steps:
- Calculate your income by adding up lines 101-150. Therefore, line 150 is your total income before deductions
- Net income, on line 236, is calculated by adding up lines 206-236. Reduce your total income by applying any deductions, tax-deductible expenses and other business and investment losses from line 150
- Taxable income, on line 260, is calculated by adding up lines 244-260. Apply other specific deductions and losses to reduce your net income from line 236
- Total tax payable, on line 435, is calculated by adding repayment and contributions to your taxable income, such as EI and CPP if you’re self-employed
- Finally, subtract taxes paid during the year and refundable credits from your total tax payable to the bottom line: your tax balance owing or tax refund.
They really do exist! The following amounts aren’t taxed. You still need to report them on your return for benefits calculations, but they won’t be included in your taxable income.
- GST/HST credits and Canada child benefit payments, including those from related provincial or territorial programs
- Child assistance payments (Quebec)
- Government compensation for victims of crime or vehicle accidents
- Most lottery winnings
- Most gifts and inheritances. When you give someone investments or property, CRA treats the gift like a sale, and capital gains tax apply to any increase in value while you owned the property. The person who receives the gift only pays tax on the income or capital gains that occur after the date of the gift.
- Amounts for disability or death due to war service
- Workers’ compensation benefits, including wage-loss replacement and other benefits
- Most amounts from a life insurance policy death benefit. Other living benefits, such as accidental dismemberment, disability and critical illness
- Strike pay
- Elementary and secondary school scholarships and bursaries, and some post-secondary school scholarships, fellowships, and bursaries
- Amounts from a tax-free savings account (TFSA).
Keep in mind that even if these amounts aren’t taxed, any interest or income they generate after you receive them is taxable in the year it’s earned.
How do you calculate taxable income?
Calculate taxable income by first adding up all types of income, to get the total income. Next, subtract personal deductions and tax-deductible expenses to get net income. Finally, apply other specific deductions to the net income, resulting in taxable income on line 260.
In a nutshell, after deductions from total and net income, you’re left with taxable income. To calculate net income, apply most of your larger deductions, such as RRSP contributions and child care expenses. If you use tax software, you’ll see your tax payable fall as you enter deductions. A word of caution: relief is a common symptom at the end of this step!
Report total income, which can include the following, on line 150:
- Employment income
- Business and professional income
- Wage loss replacement contributions
- Other employment income
- Old age security pension
- CPP or QPP benefits
- Disability benefits
- Other pensions and superannuation
- Elected split-pension amount
- UCCB amount designated to a dependent
- Employment insurance and other benefits.
Calculate the net income, on line 236, by applying the following deductions to total income:
- Pension adjustment (T4 and T4A slips)
- Registered pension plan (T4 and T4A slips)
- RRSP and PRPP deduction (Schedule 7; receipts required)
- PRPP employer contributions
- Deduction for the elected split-pension amount (form T1032)
- Annual union and professional dues (T4 slip)
- Universal child care benefit repayment (RC62 slip)
- Child care expenses (form T778)
- Disability supports deduction
- Business investment loss
- Moving expenses
- Support payments made
- Carrying charges and interest expenses (Schedule 4)
- Deduction for CPP or QPP contributions on self-employment and other earnings (either Schedule 8 or form RC381, as needed)
- Exploration and development expenses (form T1229)
- Other employment expenses
- Clergy residence deduction
- Other deductions
- Social benefits repayments.
Calculate the taxable income, on line 260, by applying the following deductions to net income:
- Canadian Forces personnel and police deduction (T4 slip)
- Employee home relocation loan (T4 slip)
- Security options deductions
- Other payments deduction
- Limited partnership losses of other years
- Non-capital losses of other years
- Net capital losses of other years
- Capital gains deduction
- Northern residents deductions (form T2222)
- Additional deductions like motor vehicle expenses.
Your federal and provincial tax amounts (except Quebec) are based on your taxable income. Schedule 1 uses your taxable income to calculate your net federal tax on line 62. It applies non-refundable tax credits and different tax rates to your taxable income in all applicable federal tax brackets. Enter the result from Schedule 1 on line 420 of your return.
Schedule 1 is a key step. Important deductions for disability, tuition, donations, eligible dependents, medical expenses and home buyers, just to name a few, are on Schedule 1.
TurboTax, like some other tax software, has a guided interview process that walks you through the full list of itemized deductions and credits. If you don’t use an accountant, it’s the next best thing to make sure you don’t miss any deductions.