How income tax is calculated in Canada
Income tax calculations are not completely straightforward, which is why you, almost always, need a tax-calculator to help you. Figuring out your personal income tax isn’t just a matter of knowing tax bracket you’re in and multiplying your income by the tax rate. Your tax rate actually continuously increases along with every dollar of your income. This is because your average tax rate is the result of blending the amount you pay in each bracket.
What does this mean? Well, as everyone knows, the higher your income the higher “tax bracket” you are in. However, you continue to pay the same, lower, tax rate on the amount of your income that falls in each of the lower the tax brackets below that one. Here’s an analogy:
Imagine there are several buckets of different sizes; each of them represents a tax bracket. Your income is the water which we will use to fill the buckets one at a time. It goes into the first bucket until it’s filled, then the second, then the third, and so on until you have no more water (income).
The government comes along and drains off (taxes) a bit of the water from each bucket. Each bucket gets “taxed” at a different, but typically increasing (except for Alberta) rate. The last bucket is drained by the largest percentage, and this is what is called your “marginal” tax rate.
Your average tax rate is the volume of all the water drained off by the government divided by the volume you had to begin with.
If you’re still a little confused by how this works, I’ve built this handy Canadian tax calculator which shows your total taxes, average tax rate, and how much tax you pay for each individual tax ‘bucket’.