Tax truths: 4 things you may not know about your taxes

When it comes to taxes, everyone has an opinion but hard facts are few and far between

When it comes to taxes, it seems that everyone has an opinion. Whether it’s the way they’re spent (or misspent), or whether we should pay less (or someone else should pay more), this surprisingly feisty topic is hardly neutral ground. Indeed, bring up taxes at a cocktail party and you’re likely to stir up a debate that could very well get ugly, especially around tax time. The problem is, much of the typical tax tirade isn’t based on facts. Here, we explain some common misconceptions.

1. More money, more taxes

Let’s say you get a raise that boosts your income into a higher tax bracket. Does this mean you can actually end up making less money overall? Good news for your chequebook: It still pays to earn more money, so why do people get confused? Canada uses what’s called a progressive tax system, which means that each bracket of taxable income is taxed at a different rate. Now here’s the really crucial part: that percentage is not a flat rate. In other words, the more your income rises, the higher the rate of tax you are likely to pay.

So, let’s say you earned $41,544 in 2011. The official federal tax rate is 15 percent. Everyone gets an income tax exemption of $10,527; you don’t pay any tax on that. So, in this case, the tax you owe is 15 percent of what’s left after you subtract that exemption, which amounts to $4,652.55 in federal income tax on a taxable income of $31,017.

Now, let’s assume you earn one extra taxable dollar on the last day of 2011. This would put you into the next tax bracket of 22 percent. What you need to remember is that you will only pay a 22 percent rate on that one additional dollar. The rest of your income will still be taxed at the 15 percent rate. This is what happens each time you step up in income. So, rest easy and enjoy that extra cash!

2. Who pays what?

Nothing fans the flames of a discussion about taxes more than the notion that some people aren’t paying their fair share. In the United States, some millionaires even staged a government protest in which they virtually begged the government to charge them more, arguing that compared to their less-loaded fellow citizens, they were getting off easy. (Hello! Why not just fire your accountants and give up all those tax credits you’re applying for? Just sayin’...)

So, do wealthy folks actually pay less tax?

Well, it depends. The truth is that top income earners in Canada pay up to 29 percent in federal income tax on any income they earn above $128,800. They pay the same rate on capital gains – but, only pay tax on half of it, which effectively works out to a 14.5 percent tax rate.

In the U.S, the tax rates for capital gains top out at 15 percent, while the top rate for wages is 35 percent. (We’re comparing federal taxes here for the sake of simplicity. States and provinces take their cut of capital gains too, but that’s a maze we dare not enter! You can find additional details at the Canada Revenue Agency and Internal Revenue Service websites.)

The point here is that a wealthy person, whether they live in Canada or the U.S., could be earning millions, and still only pay the same income tax rate as the person who earns the base amount of the top threshold (in Canada, a taxable income of $128,800). And, although the dollars in tax paid are greater, the rate is still the same.

No fair, right? Actually, it depends on whom you ask. Some say a certain amount of tax leniency at higher income levels helps bring in business. Plus, Canada’s millionaires still pay the highest percentage of the overall taxes that come in. Critics contend that this structure puts a greater burden on those who are already strapped for cash, which leads to our next point...

3. Those who earn more pay less

Okay, so it’s already clear that it’s possible for high-rollers to pay a much lower tax rate, if they play their cards right. But where things get really complicated is at the level of provincial taxes, especially sales tax. No matter where you live, you are probably used to forking out extra not only on your income tax, but everywhere from the hair dresser to doggie day care. Canadian provinces charge between 5 percent and 15 percent sales tax on many items.

Sales tax can skew what is often reported as a citizen’s overall tax burden because these are a flat-rate tax – everyone pays the rate that is charged in their province. In terms of an overall tax burden, this type of tax can be considered regressive because it is charged at the same rate, regardless of income. However, it does put some power back in the hands of consumers because they can choose how much tax they pay by how much they consume, and arguably, those with higher incomes spend more.

While sales tax will put some extra sting in the purchase of a designer handbag, the government doesn’t charge this tax on food and some other essentials. Economists assume that those who have more disposable income will buy more nonessential items, thus balancing out the tax burden. (Although for those of you who’ve lived on peanut butter to buy Prada, this equation may not add up.)

4. Do Canadians pay more?

So who pays more tax? When it comes to comparing Canada and the U.S., it’s a bit of a toss-up. In terms of federal taxes, the U.S., income tax rates top out at 35 percent. In Canada, the buck stops at 29 percent. The top rate of tax on long-term capital gains (investments held for at least one year) is similar: 15 percent in the U.S. vs. 14.5 percent in Canada - which does not distinguish between short- and long-term gains. (In the U.S., short-term gains are taxed at rates that are more closely aligned with regular income tax.) If you look a little closer, the picture gets even more complicated, because Canada and the U.S. divide their tax brackets differently. Plus, there are provincial and state taxes, too. These can vary pretty widely.

The best conclusion we can really draw is this: whether you pay more in either country really depends most on what state or province you live in, how much you make, and how you earn it. What is different in Canada, at least so far, is how much we spend. Canada, as a country, has a lot less debt and fewer major liabilities, which means we aren’t quite as desperate for extra income as our budget-busting southern neighbours.

What Einstein had to say...

Albert Einstein once said that income tax was one of the hardest things in the world to understand. He might be right. Unlike physics, taxes do not always conform to logic. One thing is certain though: whether you’re a millionaire or of meagre means, you’ll pay more than you’d like.

 

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