Personal Taxation Explained

1. Taxable Income

Taxable income is the portion of an individual's income that is subject to taxation. It is calculated by subtracting allowable deductions from gross income. Taxable income forms the basis for determining the amount of tax liability.

Example: If an individual earns $80,000 in gross income and has $20,000 in allowable deductions (such as RRSP contributions and charitable donations), their taxable income would be $60,000.

2. Tax Brackets

Tax brackets are ranges of income to which a specific tax rate applies. Income tax is progressive, meaning that as taxable income increases, it is taxed at higher rates. Each tax bracket corresponds to a different percentage rate.

Example: In Canada, the 2023 federal tax brackets include 15% on the first $53,359 of taxable income, 20.5% on the next $53,359 (up to $106,717), and 26% on income over $106,717 but less than $165,430.

3. Deductions and Credits

Deductions reduce taxable income, while credits reduce the actual tax payable. Deductions are subtracted from gross income to determine taxable income, whereas credits are applied directly against the calculated tax liability.

Example: An individual might deduct $5,000 in RRSP contributions from their gross income, reducing their taxable income. They might also claim a $1,000 tax credit for charitable donations, which directly reduces their tax payable by $1,000.

4. Capital Gains and Losses

Capital gains occur when an asset is sold for more than its purchase price. Only 50% of the capital gain is included in taxable income. Conversely, capital losses can be used to offset capital gains, reducing taxable income.

Example: If an individual buys a stock for $10,000 and sells it for $15,000, they have a capital gain of $5,000. Only $2,500 (50% of $5,000) would be included in their taxable income.