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Tax Time: Deducting Home Business Costs

Tom Drake — Mon, 30 Jan 2012 10:00:07 +0000

Increasingly, more people are operating businesses out of their homes. These businesses might be full-time ventures, or they might be part-time side hustles. In any case, chances are that you are paying expenses related to your home business. In such situations, it is possible to not only deduct some expenses from your home business income, but you can also deduct these home business costs against your other, “regular” income.

What Home Business Expenses Can You Deduct?

There are a number of home business expenses that you can deduct. However, you need to make sure that the deductions you take are related to your efforts to earn money. Otherwise, you could find yourself on the wrong side of the CRA. Make sure that you keep proper documentation of your expenses so that you can prove the appropriateness of your business deductions.

Some of the items that you can deduct as home business expenses include:

Internet-related costs: Domain registration, web development, web hosting, and other fees.
Dues: If you join a professional organization related to your business, you can deduct the dues.
Office supplies: Make sure these are just used in your home office, and not used for personal purposes.
Advertising: Online and offline ad costs are deductible.
Travel: You can deduct business-related travel, including mileage for driving, hotel costs and airfare. You can also deduct the fees related to conventions and conferences in your business field.
Entertainment and meals: Business meals and entertainment is deductible, but only 50% of the cost can be deducted.
Bank charges and interest: Your related bank fees and interest charges can be deducted.
Payment to others: Payment for business-related services are tax deductible, as are salaries and contracts paid to employers and hired workers.
Courier and postage: When you mail items, or have them sent via courier, you can deduct the costs.
Use of your home: In some cases (make sure you qualify according to the CRA), you can deduct costs related to the business use of your home. This includes utilities, taxes, mortgage/rent payments, and insurance costs.

Add up all of the expenses you pay in order to keep your home business running, and consider deducting them. Remember, too, that some of your costs are only partially deductible, since you might use your Internet connection for business 70% of the time. Determine the percentages involved, and be careful not to deduct personal use as business use.

Deducting Your Home Business Expenses

Your taxable income will be reduced, even though a deduction isn’t a dollar for dollar reduction in what you owe in taxes.

In order to claim home business expenses, you will need to fill out a form T2125. The form contains sections that may or may not relate to your home business. If you aren’t selling actual goods, for example, you won’t need to fill out Part 4, which deals with tangible inventory. Your business expenses will be listed on Part 5 of the T2125.

Because you will need to list your total income for the year, make sure you have been keeping track throughout the tax year. Indeed, it is best to keep good records of your income and expenses throughout the year so that you can reference your information easily. Financial software and bookkeeping software can help you with this. As long as you keep good records, and your business deductions are truly for business expenses, you shouldn’t have a problem with the CRA.

Tax Time: Deducting Home Business Costs originally appeared on Canadian Finance Blog on January 30, 2012.

Tax Breaks 2010: Businesses and Individuals

Guest — Mon, 18 Apr 2011 09:00:00 +0000

The tax deadline is coming faster than anybody wants it to. The due date for filling out Canadian income tax returns is May 2, 2011 since April 30th is on a Saturday. As you’re filling out your tax return you should be aware of some of the tax breaks allotted to both individuals and businesses as they could save you a bunch of cash.

Tax Cuts for Businesses

• Computer Capital Cost Allowance (CCA). If your business bought new computers or purchased software for new or existing computers after January 27, 2009 but before midnight, January 31, 2011 than your business can claim 100% of the cost on your tax reruns. It is unclear whether or not smart phones and tablets, such as the ipad, would also be included.

• Apprenticeship Job Creation Tax Credit (AJCTC). This is a non-refundable tax credit for up to $2000 for each apprentice an employer can claim. An apprentice is someone working in a prescribed trade for the first two years of their apprentice contract. Keep in mind the contract must be registered with a federal, provincial, or territorial government.

• Investment Tax Credit for Child Care Spaces. Baby sitters and day care centres can become expensive and can also be a pain for their parent. As a result, some businesses have created child care spaces for the children of their employees. If your business has done this then you are eligible for a tax cut of a non-refundable amount for each new child care space you create

• Small Business Deduction. Canadian private corporations claiming the small business deduction now have a tax rate of 11%, which is down from last year’s rate of 12%.

• Corporation Tax Rate Reduction. As of January 1, 2010 the tax rate will be 18% for corporations but will decrease to 16.5% on January 1, 2011 and will further decrease to 15% on January 1, 2012.

Tax Cuts for Individuals

• Children’s Fitness Tax Credit. Fitness should be a part of everybody’s life, especially that of a child. If your own kids or the children of your spouse or common-law partner have been enrolled in gyms, play sports, or are involved in other fitness-related extra-curricular activities, you may be able to claim up to $500 per child on your tax returns.

• First-time Home Buyer’s Tax Credit. If you bought a home for the first time in 2010 then you may be eligible for a tax credit up to $750.

• Pension Income Splitting. If you choose to split your pension then you can reduce your overall tax paid.

• Public Transit Tax Credit. Between car payments, insurance payments, gas, and repairs an automobile can quickly become a black hole for cash. If you opt out of using a car and instead take advantage of public transit then you may be eligible for a non-refundable tax credit to help cover the cost of public transit.

• Tradesperson’s Tool Deduction. If you are a mechanic, plumber, electrician, or work as a tradesperson in general, you may qualify for a tax deduction for the cost of your tools.

As you can see, there are a number of tax deductions and credits there for the taking. Look closely at what might apply to you.

Author Bio: Charles Wood is a journalist and freelance author; when not contributing his financial savvy on the web, Charles writes poetry and fiction on his trusty typewriter.

Tax Breaks 2010: Businesses and Individuals originally appeared on Canadian Finance Blog on April 18, 2011.

What You Need To Know About Canadian Tax Benefits

Guest — Tue, 29 Mar 2011 09:00:00 +0000

The way we interact with our government is constantly evolving, especially when it comes to taxation in these troubling economic times. More than ever, families are finding deductions, credits and other tax benefits to be somewhat of a saving grace.

The Canadian Government collects almost three times more from personal taxes than it does from corporations; it may seem unfair, but this is because of fantastic amenities like socialized medicine.
If you’re new to Canada, the Canadian Immigration Tax Benefit can help you get situated. If you’ve immigrated, you probably aren’t yet aware that Canada does not impose estate taxes or duties.You also may not be aware that taxation is based on residence, not citizenship. If you’re living in Canada, expect to file taxes this year. Which brings us to…
Canada taxes residents on their world wide income. Non-residents only pay Canadian tax on certain sourced income or capital gains.
A lot of people don’t realize the tax benefits you file for will be paid out the following year.
Canada Child Tax Benefits are calculated on a sliding scale using a family’s net income. When applying for Basic Child Benefits, if your income is over $40,970, you will receive less in benefits than other households. If you have one child, the reduction rate is 2%, and if you have two or more children, the rate is 4%. There are five additional credits that parents can claim – find the correct child tax credit that applies to your unique financial situation.
New Canadian Permanent Residents can reduce Canadian taxes by planning in advance of their arrival into the country. They are allowed to establish a properly structured offshore trust to shelter non-Canadian sourced income and capital gain for up to five years after their arrival in Canada. During this five-year tax holiday, the new resident can acquire Canadian citizenship and choose to become a non-resident for Canadian tax purposes.

There are many opportunities to help you balance your wallet and optimize what you could be getting back next year. Make sure you don’t miss the chance to file for benefits that can help you pave the road to a smart financial future.

Author Bio: Olivia Mungal is an award-winning writer with pieces of her work archived in the Library of Congress. With a background in Law, she tackles convoluted economic issues in entertaining and engaging ways.

What You Need To Know About Canadian Tax Benefits originally appeared on Canadian Finance Blog on March 29, 2011.

What To Do With Your Tax Refund

Alan Schram — Wed, 23 Mar 2011 09:00:19 +0000

Ah, taxes. The time of year where so many people agonize over where they are going to find enough money to pay the government, while so many others gleefully spend their massive tax refund. It’s an amusing dichotomy, and it makes for some interesting anecdotes as I see the way friends and acquaintances plan to deal with their financial situation. If you’re like me, you will be getting a tax refund this year. Thanks to some old student tuition credits, my wife and I will both be getting some money back on our taxes, and so we have to figure out exactly how we are going to deal with the money. While we already have an idea of what we are going to do with the money, others may not. Here is what you should do with your tax refund.

First, take 10%, and buy whatever you want. Splurge. You deserve it. Not only will it make you feel good, but it will keep you from becoming bitter or disappointed with what you are going to do with the rest. Take the other 90% and dump it into one (or more) these categories, preferably in the following order.

Emergency Fund (if you don’t have one)
Debt Repayment
Emergency Fund (if it is less than 3-6 months of expenses)
Savings
Retirement
Vacation

Start An Emergency Fund

If you don’t have one, this is the absolute perfect way to jump start an emergency fund. I know you want to take the money and go visit your parents, or take the kids to the zoo, or pay off your credit card, but if you don’t have an emergency fund, start one immediately. It provides peace of mind to know that you have money in case of any sort of disaster, and you will save money in the long run setting aside a grand or two now.

Debt Repayment

If you have debt, pay it off as quick as you can. While it is difficult to slog through the year paying off your student loans $50 at a time (I would know), dropping a couple thousand on it at once could significantly reduce the interest that you are paying, as well as give you a huge motivational boost that will (hopefully) last you one more year.

Increase Your Emergency Fund

Even if you already do have an emergency fund, if you don’t have any more debt remaining, then it is definitely worth it to make sure that your emergency fund is big enough. How big, exactly, is a matter of debate, and it basically comes down to make sure that you are comfortable with it. So take a look at how big your emergency fund is, calculate how long that might last you if you or your spouse were to lose your jobs, for example, and decide if you need to grow your emergency fund some more.

Savings

You are saving for something, right? Maybe a new car, or a house, or saving simply for the sake of saving. You can use your tax refund to push you that much closer to achieving your savings goal.

Retirement

If you already own your home, your cars, you don’t have any debt, then it is definitely past time you made sure your retirement savings were maxed. No matter how young or how old you are, there is no harm in putting aside money for the day when you won’t be working anymore. Invest your tax refund to max out your RRSP contribution and ensure you are taking advantage of any pension plan your employer might offer.

Vacation

If, and only if, you already have a huge emergency fund, no debt, everything you could possibly hope for AND have maxed out your retirement savings, then please, go take a vacation. You are obviously working hard enough already, so take some vacation time and spend your tax refund on a great experience. It is far better to spend money on creating memories, rather than owning things, so go to Greece, or the Caribbean, or go and stay a week at a hotel in town.

How are you going to spend your tax refund?

What To Do With Your Tax Refund originally appeared on Canadian Finance Blog on March 23, 2011.

10 Things To Know About Tax Planning

Jim Yih — Tue, 22 Mar 2011 09:00:33 +0000

Everyone is busy getting their taxes organized and files for 2010. IF you have not done so already, there’s only one month left so it’s time to get cracking.

As much as the focus is on the past year, it’s an opportune time to start thinking about the current year as a real opportunity to do some tax planning. Rather than re-invent the wheel, I thought I would share some of my past articles on taxes and help you think more about planning than preparation.

It’s time to do some tax planning

This article on tax planning is a great starting place as it highlights the difference between tax planning and tax preparation. For those of you that are working with financial professionals, don’t expect tax planning without asking. Not all financial advisors or accountants do tax planning.

Marginal Tax vs Average Tax

This is one of my most popular articles as it outlines what I think is the most important aspect of tax. Sometimes we complicate things more than we need to. The starting point of tax planning is simply understanding how marginal tax rates work and how they differ from the average tax rate. Far too many people think we pay half of our money to tax.

Tax tips from a blunt bean counter

Every year I try to get an accountant to provide some practical tax tips. Mark Goodfield is a CA and managing partner with Cunningham LLP. He is also known as The Blunt Bean Counter. This meat and potatoes article is really worth a read.

Common mistakes people make on their tax return

Mike Oseen, with Grant Thorton is also a Chartered Accountant who knows a lot on tax. I asked him to share the biggest mistakes he sees on a regular basis when it comes to tax preparation.

Tax smart investment tips

In my experience, people tend to focus more on investing that taxes when it comes to wealth accumulation or financial planning. In this article, I highlight some key strategies to becoming a TAX SMART investor. It’s not how much you make that counts but rather how much you keep after taxes that is most important.

Top timeless tax tips

At the risk of getting repetitive, I thought this article was great because it shares the four basic tax-planning strategies I talk about on a very regular basis in my workshops. I can’t stress how important it is to have a basic foundation and understanding of taxes.

Income splitting strategies in retirement

Income splitting is a key strategy for couples. This article outlines the three key income-splitting strategies for retirees. It’s very important to plan ahead when it comes to these strategies.

Three D’s of Tax Planning

Deduct, defer and divide make up the three key tax planning strategies. This is MUST KNOW information and something I personally recognize as a key to financial success.

RRSP Guide: The basics of RRSPs

RRSPs remain one of the easiest tax strategies available to most Canadians. RRSPs are popular because they provide significant tax benefits in the tax deduction and tax deferral. This guide really has it all and will help you make better decisions about RRSPs.

The Tax Free Savings Account (TFSA)

The new Tax Free Savings Account is creating a lot of buzz and it is battling the RRSP as the best form of savings. As much as I love the TFSA, I think it is very narrow sighted to give up on the RRSP. The RRSP has tremendous tax benefits and the best strategy may be to do both.

10 Things To Know About Tax Planning originally appeared on Canadian Finance Blog on March 22, 2011.

TurboTax 2010 Online Review

Alan Schram — Wed, 16 Mar 2011 09:00:07 +0000

Last year was the first year that I had ever filed my own taxes. In previous years, my parents would take my tax information to our family accountant and she would helpfully let me know just what I was getting back. It was convenient, but it felt disconnected from reality. Coupled with getting married and moving across the province, I decided that it would be best if I learned how to do our own taxes. Thankfully, the internet has made just about everything easier – including filing taxes. So when I went to do my taxes there were a number of options available to walk me through the process. I ended up using QuickTax, which is now known as TurboTax. This year Tom was able to secure me a code to write a TurboTax review, which I used to file my taxes this year. I used the standard version of TurboTax Online, which would normally cost about $35 to file for both my wife and I.

What’s Changed

Unsurprisingly, besides the name change from QuickTax to TurboTax, not a lot has differed from this year’s edition of the tax filing software. I clearly remember a lot of the exact same screens from the previous year. Even better, the website remembers me, too. It was able to pull in last year’s data and fill in all my personal information, saving me a good 20 or 30 minutes of time inputting my name, address, phone number, etc. Coupled with previous experience with the exact same software, I was able to complete my tax return in about an hour. This is significantly less than it was the last time around, which is encouraging as I had mentally prepared myself for a bit of a slog.

What’s Good

The best part about tax filing software is that it does all the hard work for you. It simply asks you the questions that you need to answer, and when you’ve done the simple task of transcribing information from your T4 slip, you’re practically done.

In addition, even if the software seems simple, it was actually quite helpful when I came across a bit of a more difficult question. I was wondering whether or not I would be able to claim some of my spouse’s student tuition credit that she had carried forward from a previous year. Once I navigated to the appropriate section, I was able to click “help” and see if TurboTax was able to answer my question. Within that section of help, it had a FAQ, and one of those questions was just what I was wondering. Sadly, I am unable to claim student tuition credit that is being carried forward, but at least TurboTax did not leave me in the dark.

What’s Bad

Just like last year, TurboTax will often include extra “screens” which are actually just advertisements for additional services. While I understand that advertising is a required part of providing a free service, it was frustrating to think that I was getting ads on a product that I had “paid” for. I was better able to recognize and dismiss the ads this year, which meant I was not being held up for commercials during tax preparation.

A second complaint would be during the deductions section of the program. In order to simplify the questions being asked, TurboTax did not include all the information necessary for me to make an accurate statement. For example, the program asked me if I could claim a deduction based on paying union dues. I do pay union dues, so I selected that I could. However, once I got to actually making the deduction, it said that I could only make a claim if I hadn’t already claimed it on my T4, which I had. Not a huge deal, as I could simply click through to continue on, but frustrating when it happened twice.

Overall, TurboTax is definitely worth considering if you plan on filing your taxes at home and online this year, at least if you have a quick and simple return like I did this year. What tax software – if any – do you use?

TurboTax Online 2010 Giveaway

Thanks for reading the TurboTax review, and now we’re giving away 1 code each for TurboTax Online to three lucky winners. You get a code by email to use on the TurboTax website!

How To Enter:

To enter to win a code for TurboTax Online 2010, fill out the entry form below before the end of day on March 20th.

In addition to your first entry when filling out the contest form, you can get up to 5 bonus entries by doing any of the following:

Subscribe to the Canadian Finance Blog email, where you’ll get each article, 7 days a week with no spam emails. Please make sure you use the same email when you enter the draw.
Follow Canadian Finance Blog on Twitter and add your Twitter ID in the entry form.
Tweet one of our posts during the giveaway period (you can find a Tweet button at the bottom of any post).
Like the Canadian Finance Blog Facebook page and add your Facebook name in the entry form.
Like one of our posts during the giveaway period (you can find a Like button at the bottom of any post)

This contest is open to anyone in Canada and will have three winners of one online code each. The deadline for entries is Sunday, March 20th at 11:59PM MST and the winners will be contacted by email on Monday. There will be three winners, chosen with a random number generator from Random.org. If the winner does not reply within one week, a new name will be drawn. Good luck!

Oops! We could not locate your form.

TurboTax 2010 Online Review originally appeared on Canadian Finance Blog on March 16, 2011.

UFile: Interview and Giveaway!

Tom Drake — Tue, 15 Mar 2011 09:00:00 +0000

I recently had the opportunity to interview Joanne Birtch, Vice president Marketing and New Business Development, Dr Tax Software Inc. to discuss UFile as we get into the tax season.

Tom: Joanne, thanks for joining us on Canadian Finance Blog. Can you tell us what sets UFile apart from other tax software options available to Canadians?

Joanne: UFile is unique from other tax software in that it uses the same tax calculation engine as our professional product. Professionals look for reliability and advanced optimization features that help them reduce the tax payable by their clients. UFile delivers these feature to consumers with an easy to use, customized interview method. UFile is also fully Canadian-owned and is developed, produced and supported entirely in Canada.

Tom: How about the different versions, what options are best for what type of person?

Joanne: UFile is offered ONLINE and for installation on the user’s computer. Both products can do all kinds of tax returns. UFile does not charge more for more complex tax returns. Whether you use UFile ONLINE or install it on your computer is dependant on the number of returns you prepare. The UFile for Windows Standard Edition (installed) can do up to 8 tax returns and the Plus edition can do up to 16 returns.

Tom: One of the things that impressed me most about UFile is that there are a couple situations where UFile is actually free to use. Can you explain those in more detail?

Joanne: UFile can be used for free if your family income is $20,000 or less OR if you are a post-secondary student regardless of your income. While other online software charges for EVERY family member, UFile does not charge for dependants. UFile’s pricing is simple: $15.95 for the first person in the family and $9.00 more for the spouse. UFile also has a special day in February were those over the age of 59 may use UFile for free by accepting our offer that day (they may file whenever they are ready).

Tom: Thanks Joanne for taking the time to let our readers know about Ufile.

UFile Online 2010 Giveaway

We are giving away 10 codes for UFile Online to 5 lucky winners. You get one to use for you (including your spouse and dependants) and another to give to a friend!

How To Enter:

To enter to win two codes for UFile Online 2010, fill out the entry form below before the end of day on March 20th.

In addition to your first entry when filling out the contest form, you can get up to 5 bonus entries by doing any of the following:

Subscribe to the Canadian Finance Blog email, where you’ll get each article, 7 days a week with no spam emails. Please make sure you use the same email when you enter the draw.
Follow Canadian Finance Blog on Twitter and add your Twitter ID in the entry form.
Tweet one of our posts during the giveaway period (you can find a Tweet button at the bottom of any post).
Like the Canadian Finance Blog Facebook page and add your Facebook name in the entry form.
Like one of our posts during the giveaway period (you can find a Like button at the bottom of any post)

This contest is open to anyone in Canada and will have five winners of two online codes each. The deadline for entries is Sunday, March 20th at 11:59PM MST and the winners will be contacted by email on Monday. There will be one winner, chosen with a random number generator from Random.org. If the winner does not reply within one week, a new name will be drawn. Good luck!

Oops! We could not locate your form.

UFile: Interview and Giveaway! originally appeared on Canadian Finance Blog on March 15, 2011.

TurboTax 2010 Review

Tom Drake — Tue, 01 Mar 2011 10:00:57 +0000

TurboTax is out for the 2010 tax season and I’ve had a chance to try it out over the past week and put together a TurboTax review and giveaway. Intuit has rebranded their Canadian tax software from the previous QuickTax name. This was done to align all their global tax programs under the TurboTax name.

So other than just the name, what else is new? While only so much can change with tax software from year to year, TurboTax does have some improvements to it’s step-by-step guidance, including better tracking of where you’re at while filling out your return.

Another simple feature I found useful was the ability to flag pages to easily come back to them later. This helped me a couple times as I often find myself missing some number or piece of paper, but I would just flag it and move on to the next step.

While TurboTax Standard will cover the needs of most Canadians, there is also the Premier version that includes help with investments and rental properties and the Home & Business version that includes everything from Premier and also helps you maximize your business deductions and expenses. Keep in mind that the Standard version can handle investments and business income and expenses, but just as straight tax forms, not with any wizards or optimizers. You can compare TurboTax versions on Intuit’s site.

There’s also a TurboTax Basic. I’ve never tried it but it appears to be stripped down to a walk through for just T4s and donations. But considering it does have all the tax forms included, this could be an option for those looking for a step up from doing taxes manually on paper.

I recommend TurboTax and have used it to prepare my family’s taxes for the past two years now. It’s a great program and worth the money if you want the smoothest experience while doing your taxes. If you have a simple enough return, you might also consider the lower cost UFile or even the free StudioTax.

TurboTax Premier 2010 Giveaway

TurboTax Premier includes everything in Standard, plus powerful tools to help you easily claim investments & rental property income.

How To Enter:

To enter to win a copy of TurboTax Premier 2010, fill out the entry form below before the end of day on March 6th.

In addition to your first entry when filling out the contest form, you can get up to 5 bonus entries by doing any of the following:

Subscribe to the Canadian Finance Blog email, where you’ll get each article, 7 days a week with no spam emails. Please make sure you use the same email when you enter the draw.
Follow Canadian Finance Blog on Twitter and add your Twitter ID in the entry form.
Tweet one of our posts during the giveaway period (you can find a Tweet button at the bottom of any post).
Like the Canadian Finance Blog Facebook page and add your Facebook name in the entry form.
Like one of our posts during the giveaway period (you can find a Like button at the bottom of any post)

This contest is open to anyone in Canada. The deadline for entries is Sunday, March 6th at 11:59PM MST and the winners will be contacted by email on Monday. There will be one winner, chosen with a random number generator from Random.org. If the winner does not reply within one week, a new name will be drawn. Good luck!

Oops! We could not locate your form.

TurboTax 2010 Review originally appeared on Canadian Finance Blog on March 1, 2011.

Canadian Tax Software Options

Tom Drake — Mon, 28 Feb 2011 10:00:24 +0000

If you’re looking to use tax software to file your income taxes this year, you might be wondering which program you should use and what are the major differences? Here is a general idea of what you can expect from each choice.

Tax Software

When it comes to tax software, two names probably come to mind; TurboTax and Ufile. Both have installable programs as well as online versions.

TurboTax might still be more familiar to Canadians as QuickTax, which is what it was known as until they changed the name for the 2010 version. I find TurboTax to be the most user friendly and complete tax software, though certainly not the cheapest. Tomorrow I’ll have an updated review for TurboTax 2010.

UFile is another great choice. It’s lower price makes it a good option, especially if you have a simple return to file. Making it an even better deal, students and those with a family income under $20,000 can use the online version of UFile for free. And those that are using the online version do not need to pay extra to file for their dependants.

Free Tax Software

Well not always as visually polished as the commercial programs, free tax software can often cover what you need. Plus, did I mention it’s FREE?

StudioTax is a solid program that you might want to try. I used it to file my 2008 tax return and found it did the job just fine. The 2010 version finally includes Quebec provincial returns, now making it a rather complete program. I recommend it to anyone that wants to try out a free program to prepare their taxes.

Udotaxes is another free option you can try out. While it doesn’t have a complete interview feature to walk you through every step, if does have a quick wizard to get you started and then a regular tax form layout.

What tax software have you used recently? Any features you liked or any problems you had?

Canadian Tax Software Options originally appeared on Canadian Finance Blog on February 28, 2011.

Average Tax Rate Explained

Tom Drake — Mon, 04 Oct 2010 09:00:09 +0000

The amount of tax you pay can be expressed in two different ways, marginal tax rate and average tax rate. While marginal tax rate is the tax rate paid on the last dollar you earn, your average tax rate is simply calculated as your total income tax divided by your total taxable income.

What Is Your Average Tax Rate?

Using are example from the marginal tax rate post, our Albertan went from an income of $40,000 (paying $6,760 in taxes) to now making $45,000 (paying $8,291 in taxes). In that example, this person went from a marginal tax rate of 25% to his new marginal tax rate of 32%.

However, as an average tax rate, the percentage would be calculated as:

$6,760 divided by $40,000 = 16.9%
$8,291 divided by $45,000 = 18.4%

So while the marginal tax rate increased by 7%, the 32% rate is only taxed on the final $4,030. The average tax rate only went up by 2.5%.

How To Use Average Tax Rate

Average tax rate is not really as useful of a number as marginal tax rate. With marginal tax rate, you can look to reduce your taxes by eliminating the highest rate of taxes you pay. It also lets you know what you’ll owe in taxes on the next dollar earned.

The only real benefit of knowing your average tax rate is that you can see how much of you money is paid in federal and provincial taxes. This can help you create a budget showing how every dollar of your gross income is spent, not just your net income; what you get on your pay cheque. Including your taxes, benefits paid, CPP, etc. in your gross income budget can be a great way to truly see where all your money goes.

Average Tax Rate Explained originally appeared on Canadian Finance Blog on October 4, 2010.