What Is Income Tax?

The Canada Revenue Agency, or CRA, is responsible for administering tax laws and government benefits on both a federal and provincial/territorial level. Similar to the Internal Revenue Service (IRS) in the U.S., the CRA is Canada’s tax authority.

Canada uses a graduated, or progressive, tax system, which means that your annual income is taxed at progressively higher rates as it increases. So you’ll pay one rate of tax at the first bracket of income, and another rate of tax at the next bracket. While Canadians pay both federal and provincial tax, there is a basic personal amount (BPA), which is the allowable amount of income that you can earn before you need to start paying taxes. For the 2023 tax year, the federal amount is $15,000. Each province also has its own BPA; for example, Alberta has the highest BPA at $21,003, while Ontario’s BPA for 2023 is $11,865.

While there is no specific age when you need to start paying income tax, the CRA requires you to start paying tax once you earn more than the BPA. Your income tax return is filed on an annual basis.

Each year the government of Canada makes changes to contribution amounts, tax credits, deductions, penalties, rebates and even tax brackets to account for the rising cost of living and inflation. There are also certain credits that are introduced for a particular time period, such as the Work-From-Home tax credit during the pandemic that has since expired. While the way you file your personal income tax return is the same across the board, there will be different opportunities for savings if you are a senior, new Canadian, student or are self-employed, for example.

Income Tax in Canada: A Brief History

In August 1917, Minister of Finance Sir William White passed the Income War Tax Act that introduced a tax on personal and corporate income to help finance the First World War—a “new departure in Canadian methods of raising money for Federal purposes,” according to the tax act digest. In short, the new tax affected both women and men having an income of $1,500 for unmarried persons, widows and widowers without dependent children (or $29,411 in today’s dollars), and $3,000 (or $58,823 in today’s dollars) for everyone else. There was a base tax rate of 4% and a “supertax” on all income above $6,000. Returns were due on or before February 28, 1918.

According to the Fraser Institute, only between 2% and 8% of individuals filed income tax during the early years of taxation due to the high income thresholds. In 2023, the CRA processed almost 32.3 million income tax returns.

The Second World World War introduced marginal tax rates, or the rate applied to your highest level of income. For example, taxable income between $10,000 and $15,000 had a marginal tax rate of 13.7% before the war, but 69% by 1942.

Thankfully, those tax rates have decreased since then and what was meant to be a temporary wartime measure has now become a significant means to fund government programs and services.

Depending on your annual taxable income, you fall into one of five federal tax brackets and one of several provincial or territorial tax brackets (the number depends on the province where you live), which are taxed at different rates. These are called tax brackets.

Canadians pay tax to the federal government as well as the province or territory where they live, which is why you’ll see tax rates for both.

Because Canada uses a graduated tax system, as noted above, you pay a different tax rate on different brackets of income. For example, if you make $65,000 in Ontario, you’ll pay 15% federal income tax on your first $53,359 of income, and 20.5% on the balance. You’ll also pay 5.05 provincial tax on the first $49,231 of income and 9.15% provincial tax on the balance.

You’ll find a list of federal and provincial tax brackets for the 2023 tax year here:

2023-2024 Tax Brackets and Federal Income Tax Rates

Income Tax Calculator

Forbes Advisor Canada has a tool to help you figure out how much income tax you’ll owe for the 2023 tax year. Find our Income Tax Calculator here.

Taxable vs. Non-Taxable Income in Canada

Canadians generate income from a variety of sources, but not all are considered taxable. According to the CRA, all income is taxable unless it’s specifically exempted by law, and includes sources such as wages or salaries, commissions, bonuses, royalties, rental income, spousal support payments, social assistance payments and RRSP income.

However, income generated from the following sources is not considered taxable: child support payments, life insurance payouts, lottery winnings, gifts, inheritances and certain government benefits, such as the Canada child benefit and disability benefits.

Here’s a comprehensive list of what is and is not considered taxable income in Canada: What Is Taxable Income And How Does It Work?

Tax Deduction vs. Tax Credit

Reporting your taxable income is just one part of the puzzle as there are opportunities to reduce the amount of tax you pay. A tax deduction reduces your taxable income, while a tax credit reduces the amount of income tax you owe.

When you apply a tax deduction to your taxable income, you effectively move down a tax bracket, so you pay a lower tax rate. A tax deduction reduces your net income.

For example, if you make $55,000 per year, your federal marginal tax rate (or the tax rate paid on the highest dollar of income) is 20.5%. However, if you contribute $5,000 to your RRSP, which is one of the most common examples of a tax deduction, then your taxable income will reduce to $50,000, which brings you to the 15% tax rate.

Unlike a tax deduction, a tax credit has nothing to do with your tax bracket as it is applied on the lowest tax bracket (15%), regardless of your income. Anyone who is eligible for a particular tax credit can apply it to their taxable income for a tax reduction. There are both federal and provincial tax credits, as well as refundable and non-refundable tax credits.

Refundable vs. Non-Refundable Tax Credits

There are two kinds of tax credits: refundable and non-refundable.

Refundable tax credits: These reduce the amount of tax you owe and any excess amount results in a tax refund from the government. For example, if you owe $650 in income tax but you claim $800 in non-refundable tax credits, then you will receive $150 back. Examples of refundable tax credits include the GST/HST credit, the Canada Workers Benefit and the Ontario Trillium Benefit. Any eligible refundable tax credits are applied against your total tax payable.

Non-refundable tax credits: Similar to refundable tax credits, a non-refundable tax credit reduces the amount of tax you owe towards $0 but does not result in a refund. An example of a non-refundable tax credit is the First-Time Home Buyers’ Tax Credit, which is a $10,000 tax credit that reduces your income tax payable by $1,500 ($10,000 credit X 15% tax bracket). Any eligible non-refundable tax credits are applied against your total payable.

While tax filing software can make calculating your income tax easier, it can be useful to understand the steps that go into calculating how much you owe or get back as a refund:

1. Income from all sources is reported as your total income (line 15000).
2. Any net income deductions (such as an RRSP deduction) are subtracted from your total income, resulting in your net income (line 23600). Your net income is used to determine how much you’re entitled to under applicable tax credits and paid benefits.
3. Your net income is reduced further by a set of taxable income deductions (such as a capital gains deduction), resulting in your taxable income (line 26000). Your taxable income is the amount the CRA uses to determine how much federal and provincial tax is owed.
4. Your taxable income is multiplied by your tax bracket rate, giving you the federal tax owed.
5. Your federal tax owed is further reduced by any non-refundable tax credits, such as the home buyers’ amount (line 35000) to get your net federal tax (line 40600).
6. Your provincial/territorial tax (line 42800) is added to get the total payable (line 43500).
7. The total payable is reduced by the total income tax deducted from your paycheque and/or other income (line 43700) and the total amount of refundable tax credits, such as the Canada Workers Benefit (line 48200).
8. You will either get a refund, have a balance owing or nil, meaning there is no refund or balance owing.

Over 2.5 million returns have already been processed for the 2023 tax year, as of March 4, 2024. But don’t worry—you still have time to file your return.

The deadline to file your taxes for the 2023 tax year is April 30, 2024. This is also the deadline to pay any taxes due to avoid any penalties and interest. The late-filing penalty is 5% of your 2023 balance owing, plus 1% for each full month that you file after the due date, to a maximum of 12 months.

If you or your spouse/common-law partner are self-employed, the deadline is June 17, 2024 (since June 15, the actual deadline, is a Saturday).

There are multiple ways to file your income tax return. Options include:

• File yourself online using NETFILE-certified tax software
• File through an accountant or tax-filing service that uses EFILE-certified tax software
• Mail in a paper tax return

To date, for the 2023 tax year, 44.3% of tax returns have been filed via EFILE, 50.6% by NETFILE and 4.8% by paper.

The CRA also maintains a list of free tax clinics where volunteers complete tax returns for people with modest incomes and straightforward filing needs.

For a complete rundown of how to file your income tax, Forbes Advisor Canada offers this comprehensive guide: Where To Do Your Taxes In Canada.

If you submit your income tax return by mail, it can take up to eight weeks to get your refund. If you submit electronically using NETFILE or EFILE, you can expect a refund in about two weeks. You can sign up for direct deposit on our CRA account to get your money back even faster.

Documents You Need To File Your Income Tax

Sometimes the most daunting part of tax preparation is collecting all the documents, or tax slips, you need to file your return. As your financial or work situation becomes more complicated, so does the documentation you need.

Besides your personal information, name, date of birth, address and social insurance number, you’ll need to provide proof of all sources of income, including employment income, investment income, income from an RRSP and any other income that doesn’t have a corresponding tax slip, such as tips.

CRA requires official tax slips that you’ll get from your employer or from the CRA directly; your most important tax slip is likely your T4-Statement of Remuneration Paid, that summarizes all the income paid to an employee during a calendar year. It also shows how much you contributed to Employment Insurance (EI), Canada Pension Plan (CPP) and how much income tax was deducted at source. If you have investment income to report, for example, your financial institution or bank will provide you with access to a T3-Statements of Trust Income or T5-Statement of Investment Income.

You’ll also need to provide proof of any deductions that reduce your taxable income,  such as RRSP contributions, childcare expenses or charitable donations. These tax slips are available from the source of the deduction.

There can be a lot of documents required for filing your tax return. Forbes Advisor Canada provides an extensive list here: Tax Prep Checklist: Everything You Need To File Your 2023 Taxes.

Arguably the best way to reduce your income tax is to take advantage of investment strategies that allow you to build wealth tax-free while also getting a tax deduction.

For example, when you contribute to an RRSP, not only do you save money towards your retirement, but you get a tax deduction that reduces your taxable income. Your money also grows tax-free within the account. You can generally contribute up to 18% of your previous year’s earned income up to an annual maximum (for 2023, the annual limit is $30,780).

Or, if you’re saving for your first home, contributions to a First Home Savings Account are also tax deductible.

It’s also important to take advantage of as many tax deductions for which you are eligible, such as medical expenses not covered by insurance, self-employed business expenses or moving expenses. The CRA maintains a complete list of deductions, credit and expenses here. An accountant can also find ways to reduce the amount of tax you need to pay and get the biggest refund that you’re entitled to.

Tax season is probably the least favourite season of the year, but armed with some knowledge and organization, even the most fervent tax procrastinator can learn to file with confidence and even ease.