Canadians are obsessed with taxes.
In a country with a relatively high personal income tax rate, taxes come up a lot in general conversation. The other day I was working at an advanced polling station for the Toronto Mayoral election and found myself sitting between two 30-something parents with young children. With the one on my left talking past me to the one on my right, I was caught in yet another conversation about taxes. It went something like this:
“Childcare is so expensive!”
“Yes, but I got a nice tax refund last year when I claimed my childcare expenses.”
“Now with subsidized daycare the costs are lower.”
“Yeah, but this year I’ll have to pay more taxes instead of getting a refund. That sucks.”
(Actual conversation.)
Here are other examples of the ways people look at taxes.
“I know it makes sense to put my cash in a GIC but then I’ll have to pay taxes on the interest.”
“My business is doing really well, but I don’t want to take any more salary from my corporation because I’ll have to pay taxes on it.”
“I should use the income from my business to buy a new <insert piece of equipment here> so I can lower my taxes.”
You see the dichotomy? These folks would end up ahead financially by paying less for daycare, earning more income, or spending less on expenses, but it’s the taxes they are focused on.
It reminds me of a comment my partner made to me a while ago. Near my sister’s place, we can buy gas at a much lower price than in the city. Every time we go there, we fill up. One day he joked, “We should drive around the block a few times before going to the gas station so we can get more cheap gas.” That thinking isn’t dissimilar to the tax examples.
Of course, everyone would prefer to pay less tax. But is it possible that your perception of how your income taxes are calculated and paid getting in the way of the facts? If your perspective shifted a little, might you feel a little less annoyed?
Here are a few misconceptions and misunderstandings about taxes that might helpful to clear up.
The self-employed advantage
A commonly-held belief is that self-employed people get more tax breaks than salaried employees. Yes, self-employed people do indeed have more opportunities to reduce their taxable income by claiming expenses, but if they’re doing their taxes right, it’s not actually an advantage.
I was a salaried, corporate employee my whole career – until just a couple of years ago. There was little I could claim to reduce my taxes beyond RRSP contributions, childcare expenses, and donations. Hearing about self-employed people keeping their receipts for everything to they could “write it off” made me a little jealous. (To learn more about tax write-offs, hear from David and Johnny Rose.)
But here’s the thing: claiming expenses against income is simply a reflection of the profitability of the business – and how much money you’re actually making. More expenses mean less profits. So yes, it’s great to claim expenses but isn’t it better to not have to pay these expenses in the first place?
The temptation is to claim expenses not related to the business – like taking your friend out for lunch and claiming it was business-related. That is indeed an advantage for self-employed people. The downside to this approach is that it’s tax evasion.
Going up a tax bracket
When you earn more money you don’t “go up a tax bracket” – you simply pay a higher tax rate on the portion of your income that’s in the next bracket.
The Canadian tax system is tiered. Yes, the more money you make, the more you pay in taxes as a percent of your income. However, everyone pays exactly the same tax rate on the first $30,000 of income, and the next $10,000 and the next $15,000 and so on. It’s just that as you make more money, that additional money is taxed at a higher rate.
For example, if someone makes $49,000, they will pay 20% tax on that $49,000*. If someone else makes $80,000 they also pay 20% on the first $49,000, but then they pay 24% on the next $4,000 and 30% on the next $27,000. (Rough numbers but generally accurate – you can see the brackets and rates here). Therefore, if you make $20,000 more this year than last year, you’re only paying more tax on the portion of that income that’s in the next tax bracket, not on your entire paycheque.
Will you have less take-home pay if you earn more money? No, never. You’ll always be better off earning more. Paying more taxes usually means you're making more money - isn't that a good thing?
A tax refund isn't a windfall
A tax refund isn’t necessarily a good thing. It feels great, but what it means is that you’ve overpaid on your taxes and the government is paying you back.
We all love a tax refund. It feels like free money - but of course it’s not. What it usually means is that you had some costs that not everyone had and/or you paid more taxes during the year than you had to.
(Side note: Let’s set the record straight on the terminology. A tax return is the document you file with the CRA every year. A tax refund is the money you get back if you over-paid your taxes. A tax return is not a tax refund.)
What are some reasons you might get a tax refund? Often it’s because you had to spend money on something and the government gives you a break by giving you a deduction or credit for it. Common examples include childcare expenses, medical expenses, donations you made, and interest you paid on a mortgage for your rental property. You see what’s happening here? You had to spend money in order to get the tax benefit. Yes, you get a tax refund but if you didn’t have the expense in the first place, you would have been better off. So don’t get too excited about the deduction you got to make for your prescription costs last year – it’s better to not have had to pay it in the first place.
(Making an RRSP contribution, however, is usually a win-win since you’re saving for your future and getting tax deduction.)
On the topic of credits and deductions, did you know that you can request to have your employer take off less tax from every paycheque if you have regular expenses that qualify for a deduction or a credit? Have a look at form T1213. You can request to pay lower taxes year-round for things like RRSP contributions, childcare expenses, medical expenses, and other items. You probably won’t get a tax refund in May, but that’s ok - you paid less during the year. That's a win.
Say goodbye to resentment
The question of how you feel about paying taxes is highly personal and it’s not for anyone to judge whether you’re “right” or “wrong” to feel that way. However, understanding why you’re paying the tax you are is a really important component of making good decisions. It can also help you feel less resentful once you realize that your neighbour's tax refund isn't actually a good thing.
*Minus the basic personal amount, which is tax free.
Photo credit: Alexander Grey, Unsplash