How Tiered Income Taxes Work

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If anyone ever tells you that getting a raise is a bad idea because you will pay more tax and get less money, turn around and run away.  Don’t take any more financial advice from that individual for the rest of your life.  Getting a raise at your work is never a bad idea.  I repeat NEVER BAD.  Some people misunderstand income taxes to the point that they think that moving yourself into a higher tax bracket will mean less take home pay.  This is not true, because both in the United States and Canada, income tax works on a tiered based system.  Still confused?  Keep reading.

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Let’s look at a simple example of someone named Joe.  Joe works at an accounting firm making $43 000 a year.  Based on Canadian Federal tax rates listed on the CRA website, Joe pays 15% to the Canadian government in income taxes.  This means his taxes amount to $6 450 ($43 000 x 15%).  Joe’s boss decides to give him a raise to $46 000.   Should he take it?  Of course he should!

Even though Joe makes $46 000 now, that doesn’t mean he pays $10 120 ($46 000 x 22%) in income taxes.  That’s the wrong way to calculate his new taxes.  What Joe really ends up paying in income taxes is $7 043.22.  How does that happen?  Joe only pays the higher income tax rate on the money he makes over $43 954.  The real way to calculate his taxes is $43 954 x 15% + ($46 000 – $43 954) x 22%.  The 22% tax rate only applies to each dollar made over $43 954, not to his entire salary that he is making.

Since Joe is only paying $ 7043.22, his effective income tax rate is only 15.31%.  That’s no where near 22%.  Those who think that Canadians pay 50% in income taxes when they have high salaries are wrong.  It’s a myth because many Canadians don’t understand how income taxes are calculated.  Even a single person making $150 000 a year in Ontario only pays an effective tax rate of 32.37% on all their income including both provincial and federal taxes.

The situation is no different in the United States.  They too have income tax brackets similar to the Canadian government.  Surprisingly, the highest income bracket in the United States at 39.6% is higher than our Canadian federal income tax rate of 29%.  Who’s the socialist country now?

At each higher tax bracket that Joe reaches, he will have to pay more tax on the next dollar earned.  At the end of the day, Joe will pay more taxes in total $7043.22 versus $6 450, but the total amount of money that he takes home will also be higher $38 956.78 versus $36 550.  Don’t let the tax brackets fool you into thinking that you will pay more taxes and take home less pay.  Know the facts!

Just remember that getting a raise will always be beneficial to you.  Paying taxes is inevitable no matter where you live.  If you pay more income taxes (and the government hasn’t raised them), then that’s good.  It means that you are making more money than you did before.  Don’t always think of paying more taxes as a bad idea, it can actually be beneficial to you too.

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2 thoughts on “How Tiered Income Taxes Work

  1. Pingback: Using Your RRSP Correctly « Financially Yours

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