Marginal tax rate
A marginal tax rate is the rate of tax you pay on the last dollar of income.[1] For tax planning, it is also the rate you pay on the next dollar of income. The Canadian income tax system is a progressive tax system, based on tax brackets. The details of the brackets and their rates depend of your province, since there are federal tax brackets and provincial/territorial tax brackets.
Unless you understand your marginal tax rate, tax planning and investment planning cannot be properly done.
Your entire income is not taxed at your marginal tax rate. You should not confuse you marginal tax rate with your average tax rate (total tax paid divided by taxable income).[1]
What is your marginal tax rate
Combined marginal tax rate
To estimate your combined marginal tax rate, you must consider both federal tax brackets and provincial/territorial tax brackets.[2]
You must also consider the type of income, since not all types of income are taxed at the same rate, depending if it's a capital gain, eligible Canadian dividend, non-eligible Canadian dividend or other type of income.[1]
For current tax year, you must estimate your taxable income.
For past tax year, you can look at your notice of assessment to know your taxable income.
Example for Ontario: If you plan that your taxable income in Ontario in 2017 will be $90,000, an extra $100 in salary (Other Income in the table) would be taxed at 37.91% combined marginal tax rate, because it's over $87,559 up to $91,831, which should cost you an extra $37.91 in taxes.[3] However, if you plan that your taxable income will be $92,000, an extra $100 in salary would be taxed at 43.41% combined marginal tax rate, because it's over $91,831 up to $142,353, which should cost you an extra $43.41 in taxes.[3] A small difference in taxable income can cause a significant change in marginal tax rate.
Effective Marginal Tax Rate
The effective marginal tax rate (EMTR) is the combined effect on a person's earnings of income tax and the withdrawal of means testing of state welfare benefits.[4] Therefore, it's generally higher than your combined marginal tax rate based only on tax brackets.
In addition to federal tax brackets and provincial/territorial tax brackets, you should consider income-tested benefits that decrease when your income increases such as:
- Canada child benefit (when family net income is above $30,000)
- Old Age Security (when income is above the threshold: lower OAS by 15%)
- Guaranteed Income Supplement (each dollar in income can lower supplement by 50%).
The EMTR estimates are not published by the government, since it will depend on each individual's situation.
In Québec, a team of professors from UQAM university, M. Claude Laferrière with the help of Francis Montreuil, are doing annual estimates of EMTR, which can be helpful in your tax planning.[5]
How to use marginal tax rate
Knowledge of your marginal tax rate can be used when planning to make Registered Retirement Savings Plan (RRSP) contributions or Registered Retirement Income Fund withdrawals.
You might want to consider planning the amounts involved so that you reduce your marginal tax rate. In the case of RRSP contributions, one could choose to delay the tax deduction if you expect your marginal tax rate to increase in the future.
RRSP vs. Tax-Free Savings Account
Your choice between a RRSP or Tax-Free Savings Account (TFSA) contribution depends partially on the difference between your current marginal tax rate and the marginal tax rate that will apply when you withdraw the funds in the future.
- If you are currently taxed at a high marginal tax rate and expect your marginal tax rate will be lower in retirement, the RRSP is generally preferable.[6]
- If you’re currently in a low or middle tax bracket, and you expect a higher marginal tax rate in retirement, the TFSA contribution may make more sense.[6]
Income splitting
It may be possible for a family to reduce their overall tax payable if there are differences in marginal tax rates between family members.
Examples of this would be pension income splitting, use of a spousal RRSP, give money to your spouse for a TFSA contribution or spousal loans.
See also
Financial Wisdom Forum discussions
- Financial Wisdom Forum topic: "Effective Marginal Tax Rate"
References
- ^ a b c "Marginal Tax Rate". TaxTips.ca. March 17, 2022. Retrieved May 18, 2023.
- ^ TaxTips.ca - 2016 and 2017 Tax Brackets and Tax Rates - Canada and Provinces/Territories, Viewed July 27, 2017.
- ^ a b Ontario 2016 and 2017 Personal Marginal Income Tax Rates, Viewed July 27, 2017.
- ^ Effective marginal tax rate, Viewed July 27, 2017.
- ^ Annual estimations of effective marginal tax rate in Québec (in French), Viewed July 27, 2017.
- ^ a b Ernst & Young, Managing Your Personal Taxes 2012-13, pg 22, viewed November 19, 2012.