Marginal and average tax rates occupy a prominent place in the Canadian tax mechanism. Tax rate, tax bracket, marginal tax, average tax — there sure is a lot of tax-related terminology floating around, isn’t there?
This blog will guide you through the nuances of the complex Canadian tax system.
Canada has a progressive tax system, meaning that tax rates increase as income increases. The marginal tax rate is the additional tax rate at which every additional dollar of income is taxed in a progressive system. The average tax rate shows the percentage of the total tax you pay on your total taxable income.
Understanding Average Tax Rate vs Marginal Tax Rate
When tax professionals analyze an individual’s tax situation in Canada, they often direct some of their focus to these two statistics of each person. These statistics, which come in the form of percentages, are a product of the tiered tax brackets, and together they can play a role in directing your tax accountant to the strategies that best suit each individual.
These two percentages are a taxpayer’s Average Tax Rate and Marginal Tax Rate.
When it comes to filing your taxes during tax season in Canada, you’ll notice that there’s a marginal tax rate imposed that is used to calculate the amount of tax you pay. There’s also an average tax rate, which is the percentage of total tax you pay on your annual taxable income. While both of these rates are different, they’re equally important.
You’ll notice that when you get your marginal tax rate and average tax rate, they are unique to you. This is because everyone's annual income is different. It’s also because Canada has a progressive tax system, meaning the more you make, the more tax you pay. This means that the taxes the Canadian government collects from each individual are tailored to their income.
What is the Main Difference Between the Average and Marginal Tax Rates?
The primary difference between marginal and average tax rates is that your average tax rate measures your actual tax burden. On the other hand, marginal tax rates are more so a concept that can be applied as a method of forecasting your tax liability.
In other words, average tax rates measure tax burden, while marginal tax rates measure the impact of taxes on incentives to earn, save, invest, or spend an additional dollar.
Marginal Tax Rates and How They Work
In Canada, there are marginal tax rates that are based on annual taxable income. These rates are put into place for each additional dollar of income above the previous Canadian tax brackets up until your last dollar of income.
When it comes to financial planning, having a general idea of your marginal tax rate is helpful because it gives you an idea of how much money will be yours to spend, save, and invest.
You start with the basic tax rate for income, up to $55,867, and every amount above that is subject to an increased marginal rate. In total, there are seven tax brackets.
As your income increases, you could end up paying more than one marginal rate. However, if your income falls, you’ll only reduce your tax rate if you fall under the marginal rate with your total income. Otherwise, the same marginal tax rate applies.
There are federal, provincial, and territorial income tax rates for four main types of personal income: income from capital gains, income from eligible dividends, income from ineligible dividends, and employment or self-employment income.
The federal income tax rates for Canadian tax brackets in 2024 are:
- 15% on the first $55,867 plus
- 5% on income over $55,867 up to $111,733 plus
- 26% on income over $111,733 up to $173,205 plus
- 29% on income over $173,205 up to $246,752 plus
- 33% on income over $246,752
Average Tax Rates and How They Work
Average tax rates for Canadians are different from marginal rates. Your average tax rate measures the total amount of tax divided by the total taxable income. This number is then the percentage of tax you paid for the year, which is your average tax rate. Ultimately, it’s an accurate reflection of overall tax liability.
It’s important to remember that the average tax rate isn’t just based on your annual working income. It also includes any additional income you’ve earned for the year. This means that withholding taxes, capital gains taxes, and dividend taxes are included in this average tax rate.
Tax Rate Formulas
When you’re calculating marginal and average tax rates, there are formulas you can use to find this. That said, to calculate, you’re going to know what the taxpayer's taxable income is. You’ll also need to know what taxes were paid on the annual income.
Marginal Rate Formulas
When it comes to calculating a taxpayer's marginal rate, there’s no specific formula. However, you can calculate it based on the total annual income. From there, you can determine which marginal tax rates will have to be paid and calculate the actual tax burden for each rate.
In Canada, on top of your federal taxes, you also have to pay provincial and territorial taxes. These income taxes are based on your income as well. However, the margins are different based on the province that you live in.
Let’s take a look at how this would work based on your annual income.
For example, if your entire income is $90,000, the effective tax rate on the first $55,867 is 15%. On amounts from $55,867 to $90,000, then you pay the marginal rate of 20.50%. This is the same process that works for all income amounts. You do not pay 20.50% tax on the entire income, only the portion of income above $55,867.
Average Rate Formulas
Calculating a taxpayer's average tax rate is very simple. Essentially, you take the taxes paid for the year and divide them by the total income earned for the year. The number you get is the percentage of income that is paid in taxes. Here’s an example.
For instance, your total income was $50,000, and your total taxes paid was $5,000. In this case, your average tax rate is 10%.
Is the Average Tax Rate Higher than Marginal?
The average tax rate is usually lower than the marginal tax rate because the average tax rate shows the total share of tax on an individual’s taxable income, while the marginal tax rate only shows the tax rate imposed on additional dollars of income.
How Marginal Taxes Can be Minimized?
When you file your annual income taxes for the tax year, you’ll get a total of your gross income as well as your net income. Your net income is your total income after you pay taxes. If you're employed, you’ve already paid these taxes, but that doesn’t mean that you can’t save more tax and reduce your tax liability.
Whether you do your own income taxes or have them done by a tax professional, there are tax credits as well as tax dedications you can claim. These tax credits reduce your tax paid and increase your tax savings. Since you’ve most likely already paid the tax, though, you’ll receive a tax refund.
To lower your taxes, there are many strategies you can adopt:
- Tax deductions: Tax deductions decrease your total taxable income and, consequently, the amount of tax you pay. Deductions can also sometimes kick you down a tax bracket so you wouldn’t have to pay higher marginal taxes on additional dollars of income.
- Increase RRSP contributions: Higher contributions to a Registered Retirement Savings Plan (RRSP) also lower your taxable income and reduce the effect of high marginal tax rates.
- Take advantage of eligible tax credits: Tax credits reduce your tax liability directly. For instance, if you owe $8,000 in taxes and receive a $3,000 tax credit, your tax liability will be reduced to $5,000. There are several federal and provincial/territorial tax credits that Canadian individuals and families can receive to lower their taxes and take home a higher net income.
Final Words:
Every year, we’re faced with filing our taxes. For some Canadian citizens, it could be daunting to figure out how to optimize their tax returns. Fortunately, the Canadian government offers a variety of tax credits that can help families reduce their overall tax burden.
With the cost of living on the rise, understanding tax definitions and any benefits you can claim could help you with your living expenses. Filing Taxes accountants we’ll provide professional guidance on what tax deductions are available to you and highlight which ones you may be eligible to claim to maximize your tax return.
Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances and ensure you comply with CRA reporting and payroll deductions.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.