TAXES 101 - Unit 1
Everyone hates taxes, except for the government. Those crooked losers love to take us for as much as they can as often as they can and then spend it however they want.
What I want to do is empower everyone with a little bit of a basic tax education, so you can understand a little bit more about how taxes in this country work and from there, it will enable everyone to know how to save a little bit, or a lot in tax expenses over the course of your life.
Tax Planning is a great part of Financial Planning in my opinion, because it can actually show real results immediately without the unknowns of what comes with investment planning.
The First and Most Important Thing You NEED to Know About Taxes
I have a friend who is one of the most successful tax lawyers in Edmonton and he deals with a lot of very successful professionals and businessmen who have no idea what I am about to teach you, even though it's the very first thing everyone should know about taxes. I will admit that I didn't understand this until I started learning about financial planning. Almost everyone I encounter, doesn't really understand how they are taxed and it makes everyone think that they are paying way more money than they actually are.
GRADUATED TAX RATES
Almost everyone in Canada understands that they pay more in tax as they make more money. That is true, but that doesn't mean you're somehow getting screwed because you make more money.
You've all heard people say that they take home less money after they got a raise. Well, that is not actually possible and I am about to show you why.
Beside here you can see a fancy little picture that shows the Tax Brackets in Alberta in 2017. These brackets change every year with inflation and can change when the government, either Federal or Provincial decides to change the rates.
Each Province has different tax brackets, but I'm from Alberta, so I always just show Alberta rates. #Berta #AlbertaStrong
So if you look at the chart, it shows income brackets and the super common misconception is that you pay the tax rate on everything you make depending on what bracket you income lands in. I completely get how people would make this assumption, but it's wrong. So someone who's making $100,000/year would see that he or she lands in the 36% tax bracket, so they think they owe 36% on everything. That's far from the case.
You see, everyone is treated equally and each individual starts a new year from zero. Now, whether you make $15/hour or are Connor McDavid, who's going to make $12.5 million, you both pay the same rate of tax on each specific dollar you make. So, everyone owes 0%* on the first $11,635 they make, no matter how long that takes.
*This number is somewhat misleading because you do owe tax, but there's a credit that takes it back to 0%, so I am just simplifying it for you.
Now we go back to the guy or girl who's making $100,000/year and you see that only $8,169 of his income is taxed at that 36% tax rate. $100,000 - $91,831 = $8,169.
$45,915 of their income is taxed at 30.50%.
$91,831 - $45,916 = $45,915
$27,226 of their income is taxed at 25.0%
$45,916 - $18,690 = $27,226
And so on....
Now, if you add up all of that, the Average tax you pay will be much lower. So let's take a look at another graph that shows the average rate of tax that people pay based on a few different incomes.
It's still a lot of tax, but it's definitely a lot less than what people think they're paying if they aren't paying attention. I think the misconception comes, because any time people get extra income for whatever reason, it will be taxed at the highest rate. For example, if this $100,000 person got a $10,000 Christmas Bonus, they'd immediately know they owed 36%, because the company would take that amount off and then you'd feel ripped off that you only got $6,400 after-tax.
That concept will be important for the lesson next week. Understanding this graph will also help to illustrate why RRSPs make a lot of sense, but we'll get more into that in the final lesson in five weeks.
Please share this if you learned something.