Individual Tax Series: Basics of Individual Taxation in Canada
- Rylan Kaliel
- Apr 2
- 10 min read
Updated: Apr 11
Understanding individual taxation in Canada is essential for every taxpayer. Whether you're new to filing taxes or looking for a refresher, this guide provides foundational insights to simplify your understanding and ensure you're well-equipped to manage your tax obligations effectively.
What is Income Tax?
Income tax is a mandatory financial charge imposed by the Canadian government on individual income, used primarily to fund public services such as healthcare, education, infrastructure, and social programs. Taxes are levied on various forms of income, including wages, investments, rental income, business profits, and more.
Who Must Pay Taxes in Canada?
In Canada, taxes must be paid by anyone considered a resident for tax purposes who has earned income during the tax year. Generally speaking, a person is resident in Canada if they live in Canada and have “ties” to Canada, such as a residence, bank accounts, employment, etc.
Residency is a critical concept, as your tax obligations depend on whether you're a resident, non-resident, or deemed resident. Typically, if you have significant residential ties to Canada you'll be considered a resident for tax purposes.
Taxable vs. Non-taxable Income
Not all income earned in Canada is subject to taxation. It’s crucial to understand which income types are taxable and which are exempt:
Taxable Income Examples:
Employment income (salaries, wages)
Business and self-employment profits
Interest and dividend income
Capital gains from investments or property sales
Rental income
Non-taxable Income Examples*:
Lottery winnings
Gifts and inheritances
Certain government benefits (GST/HST credit, Canada Child Benefit)
Amounts received from life insurance upon death
* Subject to some exceptions, it is advisable to discuss any of these incomes with a tax professional for appropriate guidance.
As a general concept for what is taxable, think about whether something was “earned”. For example, being employed and putting effort towards your work earns you a pay cheque. Lottery winnings are not necessarily earned, but something you receive through a game of chance. The term “earned” is used somewhat loosely here, so always consults with a tax professional if there is any uncertainty.
Understanding Tax Brackets and Marginal Rates
Canada employs a progressive tax system, meaning higher income levels are taxed at higher rates. Tax brackets outline the rate at which income in each bracket is taxed. Your marginal tax rate is the rate applied to your last dollar earned, which helps you understand how additional income will be taxed.
For instance, if your income spans multiple tax brackets, your total income isn't taxed entirely at the highest rate—instead, only the portion of your income that falls into each bracket is taxed at that bracket's rate.
As an example, let’s look at the tax rates Federally, which as of the time of writing this blog were as follows:
As an example, if you earned $125,000, you would be taxed as follows:
You’ll note that the first $57,375 you earned you were taxed at 15%. This rate doesn’t change if you earn more than $57,375, you instead get a locked in tax rate for this first “bracket” of 15%. For every dollar after $57,375 and up to $114,750 you pay a tax rate of 20.50%. For someone earning $125,000, you pay a tax rate of 20.50% on the next $57,375 of income. Once you’re income no longer exceeds the top end of the bracket, for example $125,000 does not exceed $177,882 of the third bracket, you only pay tax of 26% on the difference between your income and the lower end of this bracket, or in this example, tax of 26% on $10,250 of income (this is known as the “marginal tax rate”).
This goes against the common misconception of the more you earn the higher rate of tax you pay. Some might view this as if you earned $125,000 you pay a tax rate of 26% on the entire $125,000, which would be $32,500. Based on the above, we can see this is simply not true.
We discussed the Federal tax rates above, but it is important to note that tax in Canada is levied at both the Federal and Provincial levels. This means that in addition to the Federal tax rates noted above, there are also Provincial tax rates, which at the time of writing this blog were as follows for Alberta:
The Provincial tax bracket system operates in the exact same way as the Federal tax bracket system. What makes this complicated is that we would essentially have to combine the two tax brackets to get an idea of what tax rate we are paying at any given income amount, such as we would see as follows, continuing with an income of $125,000:
As you can see, with Federal and Provincial tax rates in place this can get confusing fast. Instead of only having 5 tax brackets Federally we have 10 in total. Instead of hitting 3 of the tax brackets, we hit 4. Imagine what happens when you have income above $200,000, it becomes tricky to manage how much each dollar is worth after taxes!
What is important to take away from this is that the taxes we pay are not simply based on the final bracket we end up in, but rather a combination of all of the tax brackets. In the above example, we are taxed $34,333, which really represents a tax rate of 27.47% (also known as the effective tax rate), not 36.00%.
What is Income?
Above we noted various forms of income and indicated that it is amounts that you earn. However, what really constitutes the income that is subject to tax is a bit trickier. We have all heard of tax deductions, so let’s see how they play into income.
When we refer to income we are referring to taxable income. Taxable income comes after two main stages of deductions, which can be illustrated as follows:
As we can see, our tax deductions come in the second step, in the form of deductions against income. We have another set of deductions that comes after net income for tax purposes, which are certain special deductions, such as the principal residence exemption, the lifetime capital gains exemption, and more, many of which will be discussed in a later blog post.
For us to determine what tax we have to pay, we have to go through the calculations of taxable income and then use the tax brackets above to figure out our taxes payable. Since we have already discussed income, let’s work through each of the above stages to get an understanding of each.
Tax Deductions
Tax deductions can are amounts that can lower your net income for tax purposes and thus your taxable income directly. Tax deductions can be extremely valuable as the amount of tax they reduce depends on where you are in your tax brackets. Imagine a situation where two persons have different incomes but the same tax deduction. If Person A has an income of $15,000 and Person B has an income of $400,000 but both get a $100 tax deduction, the value of this deduction is as follows:
As we can see, Person B saves more than twice the amount of taxes as Person A, as tax deductions are based on the marginal tax rate that the deduction is applied to. Tax deductions operate in the reverse of how we would calculate income, they are first applied to the highest tax rate applied to the person as this income net of tax deductions, ultimately, taxable income, goes down, so does the tax rate applicable to each additional dollar of deductions.
Tax deductions can be contrasted against tax credits (discussed further below) in that they apply at the marginal tax rate, whereas tax credits may have a fixed tax rate that is applied to them, which is typically a lot lower than the marginal tax rate. This makes tax deductions very valuable.
Some of the more common tax deductions, many of which will be covered in later blog posts, are as follows:
Home office expenses
Childcare expenses
Moving expenses
Union dues and professional fees
RRSP contributions
Carry charges and interest expense
Tradepersons tools
Net Income for Tax Purposes
The rationale behind having net income for tax purposes is essentially two-fold: (1) it is a good stopping point to review income after the majority of deductions; and (2) net income for tax purposes is used for various calculations of other amounts. Net income for tax purposes is simply your income less your more common deductions.
Special Deductions
“Special deductions” represent unique deductions that don’t necessarily arise that often. Some examples would be the deduction for a sale of a principal residence, the lifetime capital gains exemption, and many others (the more common ones will be discussed in a later blog post).
As noted above, one of the intentions behind net income for tax purposes is to calculate a number without these special deductions for various other calculations. As such, these special deductions come after net income for tax purposes in the calculation of taxable income.
Taxable Income
Taxable income is the amount that you are taxed on. In the calculations in Understanding Tax Brackets and Marginal Rates noted above, you would use taxable income. This figure effectively represents the amount of income, net of all deductions, that you should be required to pay tax on.
To pull this all together, let’s say you had the following for the year:
Income.......................................................................................... $125,000
RRSP contributions (deductions) ................................................ ($10,000)
Lifetime capital gains exemption (special deductions)............. ($13,000)
Based on the above, we would expect the following to arise:
To take it a step further, we would anticipate that the following taxes would be payable.
As a result of the deductions, we save $7,579 in taxes and decrease our effective tax rate to 21.40%, a reduction of 6.06%. We can see the clearly see the power of deductions in play here.
This isn’t the end of our deductions though. Now that we have our taxes payable amount, we also have tax credits, which further reduce the amount of taxes we have to pay, which will be explained below.
Tax Credits
Tax credits reduce the amount of taxes payable you have to pay after your taxable income has been taxed. Some examples, many of which we will cover in a future blog post, include:
The basic personal amount
Tuition tax credits
Medical expenses
Disability tax credits
Charitable donations
The key difference between a deduction and a tax credit is that most tax credits have a locked in tax rate you get a deduction at. Typically, this tax rate would be the lowest tax bracket, such as 15% Federally and 10% in Alberta (Provincially). This means that you get less of a reduction on your taxes then you would for a deduction if you are in a higher tax bracket. The below will illustrate this potential impact.
As can be seen, on $16,129, a deduction is worth $887 more than a tax credit.
There are some exceptions, such as charitable donations, which can have multiple different tax rates depending on the amount you donated and your taxable income, however, for most tax credits the above holds true.
Taxes Payable, After Credits
Once we have calculated our tax credits, we can finally get to how much we actually owe in taxes. Let’s use the figures to ease our calculations.
The above would represent a reduction to taxes that results in an effective tax rate of 18.18%, which is a 3.23% reduction in taxes payable from the amount calculated for taxable income and a whopping 9.29% reduction from just being taxed on our income of $125,000.
The above illustrates why it is so important to understand your deductions and make the best use of any tax credits you can receive. By ensuring we take our deductions, we have saved more than $11,000 in taxes!
The last thing to consider is withholding and instalments, which is the essence of why many of us receive a tax refund.
Tax Withholdings and Instalments
Tax withholdings come up most often in employment. I’m sure many of you have seen your paystub and seen the line for income taxes withheld. This is a requirement put on your employer to take a certain amount of what you earn and pay it to the government from each paycheque. These are what we call, tax withholdings.
Tax instalments may arise as well, more often in a self-employed situation. In a year, if your return notes that you have net taxes owing* of more than $3,000 you are required to pay amounts, often on a quarterly basis, to the government. These are what we call, tax instalments.
* The definition of net taxes owing is essentially your taxes payable, after credits, less tax withholdings. This is discussed more below.
When you have calculated your taxes payable, after your credits, you then compare this against the sum of your tax withholdings and tax instalments. If you have tax withholdings and tax instalments greater than your taxes payable, after your credits you would have a tax refund. Where the opposite is true you would have taxes payable, or a balance owing.
Let’s assume we have tax withholdings of $10,000 and tax instalments of $15,000. We would see the following results, using the numbers above.
As can be seen, in this situation we would have a tax refund. More on this in a future blog post.
Filing Status and Deadlines
Your tax filing status is generally determined on whether you are employed or self-employed in Canada—most individuals file their taxes independently. However, families can optimize benefits through coordinated filing (such as pension splitting between spouses).
Tax returns are generally due:
April 30: Standard deadline for employed individuals
June 15: Deadline for self-employed individuals (though taxes owed must still be paid by April 30 to avoid interest charges)
Missing these deadlines may result in penalties and interest on amounts owed.
Understanding Notices and Assessments
After filing your tax return, the Canada Revenue Agency (CRA) will generally issue a Notice of Assessment (NOA), which confirms the accuracy of your reported income, deductions, credits, and taxes payable or refundable. Reviewing your NOA promptly ensures any necessary adjustments are identified and corrected quickly.
Where the CRA later disagrees with amounts on a tax return they may issue a Notice of Reassessment (NORA). This will detail where they disagree with amounts shown on the return and often includes an accompanying page to explain what they have changed.
CRA My Account – A Helpful Tool
The CRA’s online service, My Account, provides secure and convenient access to your tax information, including:
Viewing tax slips and assessments
Updating your personal information
Tracking refund status
Making payments
Filing adjustments
This service simplifies managing your tax obligations throughout the year. Further, authorizing a representative to assist in preparing your taxes can be accepted through the My Account.
Why Understanding Individual Taxation Matters
Having a clear grasp of individual taxation enables you to:
Comply confidently with tax obligations
Maximize deductions and credits
Plan finances more effectively
Avoid penalties and unnecessary interest charges
Building a solid tax foundation can alleviate anxiety around tax time, making financial planning smoother and more strategic.
Stay tuned as we dive deeper into income, discussing the general flow of income.
Need professional accounting guidance? KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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