It pays to understand how you are taxed in Canada

Posted on February 28th, 2012.

Whenever I speak to a professional in any industry I always notice that they are adamant about certain things. A Dentist may be adamant that you use a certain brand of toothpaste, or a Realtor might be adamant that you have a home inspection performed. One of the things that I am adamant about, and this is very apparent to those of you who have already read my acclaimed book: InSync Income, The must read guide to investing for income in Canada, is that investors should learn how they are taxed.

Why am I so adamant? Well, I am a big believer in efficiency, and efficiency comes from looking at as many aspects of a problem as possible. Many investors who are choosing one investment over another do not take into consideration the different ways that those investments are taxed. Big mistake!

Most people have heard the terminology “average tax rate” and “marginal tax rate”. I think a good place to start is to touch on those. In Canada, people with lower incomes are taxed at a lower percentage rate since the tax rate “steps up” as income increases-so in Ontario for example you would pay 15% on the lower end and 46% on the higher end. The average part comes from the fact that since everybody will start out at the low rate but all have different ending points for their income, the average rate of taxation will vary.

It is very important to understand that different types of investment income and gains are taxed differently. Here is a summary:

  • Interest Income: Taxed the same way as regular income. (GICs, Bonds, other interest-bearing investments)
  • Capital Gains: Taxed at half the normal rate of regular income. (gains on stocks and other investments bought and sold at a profit)
  • Dividends: Taxed in a special way that is lower than interest income, and is taxed lower than capital gains at low income levels, and higher than capital gains at high income levels. (common and preferred shares)

Interest income is generally taxed the same as any other income and is therefore considered the least advantageous from a tax standpoint. Capital gains, although generally hard to come by are taxed at half that rate and can be deducted against previous and future capital losses under certain circumstances. A dividend is VERY advantageous at low income levels due to the nature of the tax calculation. In fact, an investor who earns $30,000 in dividends (and no other income) that is considered “eligible” will likely not pay any income tax whatsoever. A GIC investor with $30,000 income would pay almost $4000 in tax. That is significant.

I would encourage every investor to become tax savvy. I provide some great additional info in the “preferred share” chapter of InSync Income. Another great resource is from an accounting firm called Ernst & Young. They provide an excellent tax calculator that can help answer tax questions and help with various “what if” scenarios. I highly recommend reviewing and bookmarking this site for future reference.

Although you can learn a lot from reading books and researching on the internet, there is really no substitute for professional advice geared towards your specific financial situation. My recommendation is to seek out an appropriate financial professional prior to implementing a new or making any changes to a financial strategy, Invest with advice for best results.

Frank Weiler

The Income Investor’s Advocate

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