Reduce income tax paid in Canada

I have looked into the various options available to reduce the income tax paid to the Canadian government, and I have found that stocks can be more tax friendly.  I have used the combined federal and BC income tax rate for the examples below.

A single person making $70,000/year with:

  • employment as the sole source of income.

He/she will be paying about $14,628 in taxes for the year ending 2011 in Canada.

  • interest income in the form of bonds paying interest, bank interest, or stocks that pay dividends in a foreign country.

He/she will be paying about $14,787 in taxes for the year ending 2011 in Canada.

  • capital gains as the sole source of income.

He/she will be paying about $4880 in taxes for the year ending 2011 in Canada.

  • non-eligible Canadian dividends paid out by a Canadian corporation.

He/she will be paying about $6025 in taxes for the year ending 2011 in Canada.

  • eligible Canadian dividends paid out by a Canadian corporation.

He/she will be paying about $3356 in taxes for the year ending 2011 in Canada.

Now if we look into a situation where a single person is making $40,000/year with:

  • employment as the sole source of income.

He/she will be paying about $5825 in taxes for the year ending 2011 in Canada.

  • interest income in the form of bonds paying interest, bank interest, or stocks that pay dividends in a foreign country.

He/she will be paying about $5985 in taxes for the year ending 2011 in Canada.

  • capital gains as the sole source of income.

He/she will be paying about $1558 in taxes for the year ending 2011 in Canada.

  • non-eligible Canadian dividends paid out by a Canadian corporation.

He/she will be paying about $634 in taxes for the year ending 2011 in Canada.

  • eligible Canadian dividends paid out by a Canadian corporation.

He/she will be paying about $0 in taxes for the year ending 2011 in Canada.

The $0 is not a typo.  If he/she makes $51,000/year instead of $40,000 then the taxes owed will be about $94.  Therefore, $50,000+ is the approximate threshold where taxes must be paid.

Other income details

When it comes to other income such as interest on bonds, bank interest and foreign dividends, the income tax rate is unusually high.  The reason for this is that:

  • since the interest paid to him/her is not taxed before being paid out, he/she is responsible for paying the taxes on the interest.
  • dividends paid by a corporation located in China, India, USA, Russia, etc. is not required to pay taxes in Canada.  The corporation is required to pay taxes in the county that the corporation is located in.  Therefore, the Canadian shareholder is responsible for paying the taxes on the income earned (foreign dividends) since the foreign company will not pay his/her Canadian taxes.

Capital Gains Details

The income tax on capital gains is much lower possibly due from the fact that it is classified as a business.  It could also be that since various financial corporations buy and sell stocks to make a profit, the government wants Canada to be a business-friendly country.  50% of the total capital gains for the year is taxed.

Canadian Dividends Details

Non-eligible Canadian dividends

The reason for the minimal amount of tax owing is due from the fact that since the corporation is Canadian, the corporation will pay the taxes on the non-eligible Canadian dividends to the Canadian government on the shareholder’s behalf.  If the shareholder’s income is too high (falls under a higher tax bracket), the shareholder will pay the excess income tax on his/her tax return.

Eligible Canadian dividends

Canadian corporations that meet the requirements for the enhanced dividend tax credit are taxed at a much lower rate than non-eligible Canadian dividends, as well as, the shareholder.  Therefore, a shareholder of these corporations will also benefit by paying the excess income tax owed at a lower tax bracket.

In the case of dividends, the corporation will determine what it must pay in taxes before deciding on the amount to pay out as dividends.  Therefore, a corporation will pay the shareholders 30 cents in dividends/share while keeping 5 cents/share.  The 5 cents/share will go to the Canadian government to pay the shareholders share of the taxes.

The negative tax on Canadian dividends will grow or shrink with the change in the corporate tax rate.  Currently, in the 2nd period of 2012, the dividend’s negative tax bracket is getting smaller.  This is due from the fact that the corporate tax rate is reduced.  Therefore, it is quite possible that the dividend will increase with a lower corporate tax rate and decrease with a higher corporate tax rate.

I have not looked into how much taxes he/she will pay when combining income from more than one source due from the fact that there are too many combinations.  Nevertheless, this should provide you a better understanding of how different income types are taxed.

I have used the following article as a reference for this post.  http://www.taxtips.ca/taxrates/understandingtables.htm

As for personal income tax deductions, there are many that can be used and can change every year.  The list of deductions that will reduce the income tax payable vary from person to person.  Therefore, talking to a knowledgeable tax preparer or a friend who does his/her own taxes may provide some good tax saving advice.

taxes

Leave a Reply