Common misconceptions about taxes
Canadians may be leaving money on the table at tax time because they do not have a good understanding of what can be claimed on their tax returns. Less than 25 percent of Canadians provided the right answers when asked questions about their tax returns, according to a survey by Leger Marketing for H&R Block Canada.
Tax Quiz failings include:
- 82% of Canadians do not know how much a $1,000 RRSP contribution would save them in federal tax, assuming a taxable income of $50,000.
- Six out of 10 Canadians with children in the household are unaware that the lower-income spouse claims the childcare expenses.
- 40% of married or common-law Canadians do not realize that they each need to file their own return, with the other spouse’s information included.
- Only a quarter of Canadians answered correctly that they should file an Alberta return if they moved from Ontario to Alberta before December 31 to take a new job.
- Three in four Canadians with children in the household do not realize that they are not entitled to claim any tuition or education credits unless their child transfers them.
- Only 27% of Canadians correctly said that healthcare premiums paid to the group plan at work are a medical expense.
Despite the fact that Canadians failed this quiz, tax is the one thing we all have in common … we have to pay it. From my personal experience, I see the same thing. I think taxes are really misunderstood so I thought I would share some of the common misconceptions I hear over and over again.
“I lose 50% or more to taxes.”
It’s very difficult for the average Canadian to really figure out how much tax they pay especially when you include all forms of tax from all three levels of government like sales taxes, import duties, excise taxes, gas tax, payroll tax, etc. The Fraser Institute in Canada tries to estimate this through their calculation of tax freedom day. This is a theoretical date when the average Canadian family is released of its tax obligation for the year. Tax freedom day has lead many people to believe 50% of their money goes to tax in some way shape or form. In 2020, Tax Freedom day was June 14th. In theory this means we pay 46% in tax, not 50%.
But for most people, when it comes to income tax, we pay less tax than we think. It’s critically important to understand the difference between marginal tax and average tax.
Related article: Marginal Tax vs Average Tax
“I should have never taken that raise, I lost it all and more to taxes.”
This is a simple misunderstanding of Canada’s progressive tax system (marginal tax) where the more you earn the more opportunity you have to pay tax. The misconception is that moving into a higher marginal tax bracket will subject all your income to a higher tax rate – this is not the case. The truth is, only the income that is in the higher tax bracket is taxed at the higher rate. All of the money you earned below the new tax bracket remains taxed at the lower rates. It’s so important to have an understanding of basic tax planning tidbits.
The bottom line is you should never, ever, ever turn down money! Enjoy every pay increase you receive without tax worries and remember that those higher paycheques means more money in your pocket.
“My goal is to pay no tax!”
There is a simple solution to this goal. Simply make no money and you will pay no tax. The irony is that you should try to pay as much tax as possible because it means you are also keeping more money in your pocket. Our progressive tax system still encourages people to make as much money as you can. Generally you are not ‘penalized’ for making more money. Sure you will pay more tax when you make more money but as I mentioned earlier “Never, ever, ever turn down money” because paying more tax also means more money in your pocket.
Related article: A list of things that are not taxed in Canada
“I should have never bought RRSPs because they tax me when I take it out anyway.”
Quite often, this statement comes from those that are already retired who want or need to withdraw some money from their RRSPs. When you take money, you have to pay tax at your marginal tax rate, which means that if you want to spend a dollar, you need to take out at least a $1.33 to net a dollar. What retirees often forget is they got a tax deduction a long time ago when the money went into the RRSP. In other words, the government lent them money when they made the contribution. Although they have to pay that money back when the money is withdrawn, in most cases, they got a bigger deduction when they put the money in than the amount of tax they are paying when they take it out. For example if you put the money in while you were working an in a 36% marginal tax bracket and you take it out when you are in a 25% marginal tax bracket, you just made 11% in a return based on tax. This 11% is on top of any investment your return through investing. Sure, you might dislike the thought about paying 25% when you take it out but don’t lose sight of the benefit you got when the money went in.
Related article: Proper use of RRSPs
If you understand the proper use of RRSPs, you will know that even though you pay tax when the money comes out, the RRSPs can still very much work in your advantage.
Do you know any other misconceptions about taxes?