The Next Tax Bracket - Terrifying? Or Not So Much?

So, you’ve recently been promoted, and you are finally getting that well-deserved raise that you’ve been wanting. Then, somewhere in the depths of your memory, you recall these things called “tax brackets”. Maybe… just maybe, this raise is going to increase your tax burden.

Is that sinking feeling in your stomach really warranted?

I have been to more than one cocktail party where the topic of “tax brackets” has come up and I am often surprised at the reactions I hear. People seem terrified to move up the tax ladder.  Many people seem to have an unreasonable fear that they will suddenly lose more than the extra they will earn if they take that step. 

The bad news is that it is true that when you make more money, you pay more taxes.  

The good news is that moving into the next tax bracket doesn’t subject every dollar you make to the new tax rate.  That’s not how the Canadian tax system works.  

Fair warning: I’m going to get into a little bit of detail, but, hopefully, not so much that I lose you.  Hang in there and we will get through this together.

The first piece of good news is that if you make $47,630 in taxable income, you are in the lowest tax bracket and pay 15% in federal income tax.  Let’s keep things simple, we’ll ignore non-refundable tax credits and provincial income tax for this little blog.  So, on $47,630, you will pay $7,144.50.   

If you make more than $47,630, congratulations, you’re doing pretty well.  Now, let’s consider what’s really going to happen.  Let’s say you make $47,650, $20 more than the upper limit of the lowest tax bracket.  Moving into this next tax bracket means you are going to pay 20.5% in federal income tax.  But what exactly are you paying the new 20.5% tax rate on?

The assumption a lot of people make (which has them quaking in their boots) is that the entire $47,650 is going to be taxed at 20.5%. That would mean having to pay a tax bill of $9,768.25.  How in the world did an extra $20 somehow cost you an additional $2,623.75?

The second piece of good news is that is not how it works. You only pay the 20.5% tax rate on the additional $20. The first $47,630 is still being taxed at the 15% rate. Only the extra $20 is being taxed at the 20.5% rate, resulting in a new tax assessment of $7,148.60 - only $4.10 more.  Wasn’t that extra $20 worth it?  

So, everyone needs to take a deep breath on the whole tax bracket thing. It is always better to make more money.  Sure, you have to pay a little more tax as you move from one tax bracket to the next, but it is not as punitive as you may have thought.

If you have comments or thoughts on this topic, or if there is something else you’d like to hear about - please message me directly or let me know in the comments section below.