Taxable Income
Completion requirements
Lesson 2: Personal Taxes - Taxable Income
Constructing Knowledge
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At the end of every year, people are required to file paperwork with CRA to declare all income. You will hear this referred to as "doing taxes".
When employers calculate and deduct income tax from their employee's paycheques, they are doing so based on employee gross pay. However, employees can contribute to charities, Registered Retirement Savings Plans (RRSPs) and Tax-Free Saving Accounts (TFSAs) to reduce their taxable income. In doing so, they also reduce the amount of income tax owed to the government. The reduced income is call taxable income.
When employers calculate and deduct income tax from their employee's paycheques, they are doing so based on employee gross pay. However, employees can contribute to charities, Registered Retirement Savings Plans (RRSPs) and Tax-Free Saving Accounts (TFSAs) to reduce their taxable income. In doing so, they also reduce the amount of income tax owed to the government. The reduced income is call taxable income.
Taxable Income
The amount of income remaining, for tax purposes, after all eligible deductions are taken off of gross income. For tax purposes, many people make charitable donations or pay into savings programs to lower their taxable income so they can reduce the tax owed to the government. |
This example is designed to illustrate taxable income. You will not be required to perform this type of problem in your coursework.
EXAMPLE
Raven makes $45 000 a year. She wants to start saving and decides to put $5 000 into a RRSP. How much money would she have had taken off of her gross pay for income tax? How much tax would actually be kept by the government?
Solution
Deduction taken off her paycheque:
Earnings of $45 000 are in the second tax bracket so must be calculated in two parts.
| Income tax | = first bracket tax + second bracket tax |
| = (25% × $43 561) + (32% × $1439) | |
| = (0.25 × $43 561) + (0.32 × $1439) | |
| = $10 890.25 + $460.48 | |
| = $11 350.73 |
Income tax of $11 350.73 would have been deducted from Raven's paycheque and sent to the government.
Because RRSP accounts are an eligible tax deduction, the deduction lowers her taxable income, and the income tax kept by the government would be calculated differently.
| taxable income | = Gross income − deductions |
| = $45 000 - $5000 | |
| = $40 000 |
A taxable income of $40 000 is in the first tax bracket only.
| Income tax | = 25% × $40 000 |
| = 0.25 × $40 000 | |
| = $10 000 |
Notice that Raven initially overpaid the government by $1 350.73. Her taxable income was lower than her gross income because of the tax exempt RRSP she purchased. If Raven files her taxes, she will receive a refund cheque from the government for this overpayment.
When a tax return is filed, a calculation is made to establish whether a person has paid the right amount of taxes through the deductions on their paycheques. Often, a person who was able to lower their taxable income through savings programs and other deductions will receive money back from the government.
Points to Ponder
If you are under the age of 18 and earn income through a job, it is optional to file a tax return. Most students who file a tax return will receive a cheque from the government returning any tax money taken off their paycheques.
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