With a net average tax rate of 25.6%, federal, provincial, and territorial income taxes can consume a large portion of your take-home pay.
The average Canadian earns $59,300, which means tax alone can take $15,200 out of their paycheck, leaving them with a take-home income of just $44,100.
In this article, we'll be giving some practical strategies on how to reduce tax as an employee and help you reclaim some of that lost income.
Here are the 11 ways you can reduce your taxes as an employee:
Personal income taxes are imposed on individuals for earning and receiving income through wages, salaries, self-employment, or other sources such as interest, dividends, and rental income.
In Canada, the federal government collects Federal income taxes on behalf of all provinces and territories. Each province and territory also has its own tax system, which is separate from the federal one; it is possible to owe both levels of taxes.
Income tax is calculated based on your province of residence and the amount of money you make.
The more you earn, the higher the percentage rate of tax you will pay. This means if you make more money, the government takes a more significant portion of your paycheck in income taxes.
The CRA (Canada Revenue Agency) uses what is called an income tax bracket system to determine how much individuals should be paying in income taxes. This system divides your earnings into different bands/ranges. The higher the band, the more tax you pay.
So, when it comes to reducing tax as an employee, it's crucial to understand how taxes are calculated and where you fit in the tax code.
To make things as clear as possible, let's look at an example:
Say you live in Ontario and earn $60,000. Your federal taxes will be calculated as follows:
This means your total federal tax for the year will be: $1,985 + 5,900 + 4,802 = $12,687
Your provincial taxes would also be calculated separately. Let's say, in this example, you pay 8.82% in Ontario taxes on the first $43,906 of your income = $3,867
So your total tax bill for the year would be: $12,687 + 3,867 = $16,554
Based on this example alone, it's clear to see just how much taxes can take up from your paycheck.
An RRSP allows you to save retirement money while reducing your taxes. Any money you contribute to a retirement plan is deducted from your taxable income for the contribution year, meaning it will reduce the amount of tax you owe for the same year.
For example, in addition to earning $60,000 a year, you contributed $6,000 to your retirement plan.
This means that rather than paying taxes on a taxable income of $60,000, you would only pay taxes on $54,000 ($60,000 - $6,000). This could save you around $1,400 in tax for the year!
As the name would suggest, the amount you invest will continue to grow tax-free until it is withdrawn.
You can reduce the amount of taxes you owe by taking advantage of deductions and credits; these can be used to decrease the amount of income subject to tax.
You may be eligible for certain income-based tax credits, such as the Canada Workers Benefit (CWB), previously known as the Working Income Tax Benefit (WITB). These credits are designed to help low and middle-income families reduce the burden of taxes by providing credits.
Health savings accounts in Canada are an excellent way to reduce taxes while saving for health-related expenses.
Contributions to a Health Savings Account (HSA) are tax-free and can be used to cover the cost of prescriptions, medical procedures, and other qualified healthcare expenses in a similar manner to health insurance.
Contributing to an HSA is a great way to save on taxes because you won't have to pay taxes on any money that is withdrawn from the account.
It's also an excellent way to save for future health expenses, as the money in an HSA can be used to cover medical costs not covered by your employer or provincial health plan.
Tip: Employers, if you plan on creating a Private Health Services Plan (PHSA), there is a helpful page by the government of Canada that goes over the requirements.
In a similar fashion to the HSA, you can also save on taxes by contributing to a college fund.
A Registered Education Savings Plan (RESP) is a charitable contribution savings plan that allows parents and guardians to save money for future college expenses.
The tax-deductible contribution is capped at around 18% of your previous year's earned income, up to a maximum amount that changes yearly.
Even better, the Canada Education Savings Grant (CESG) will also match 20% of the first $2,500 you contribute to an RESP each year. This means the government will grant you up to $500 tax-free for each child enrolled in an RESP towards their education.
Since most contributions are made with after-tax dollars, employee contributions to RESP plans won't be counted as income when filing taxes. With that said, there are also no additional deductions in the same way that RRSPs work.
When it comes to time to withdraw, there are a variety of tax-preferred strategies available, so you won't have to worry about a big tax bill when it comes time to pay for your child's college tuition.
If you support a specific charity or cause, you can reduce your taxes by making a charitable contribution.
As long as you're donating to a registered charity, you are eligible for non-refundable tax credits for up to 33% of the donated amount. Depending on the province of residence, you can be eligible for additional credits on top of the federal credit.
You can claim up to 75% of your net income in donations each year, and donations can be carried forward for up to five years.
You can also donate investments (such as stocks and bonds) to a registered charity. Not only will this result in a tax credit, but it can potentially eliminate the capital gains tax on eligible securities.
A charitable contribution is a great way to reduce taxes and support a cause you feel passionate about. It's a win-win situation!
A wide range of tax credits and deductions available in Canada can help reduce your taxes.
These include things like:
Taking advantage of these different tax credits and deductions can really make a difference when it comes to reducing your taxes.
A Tax-Free Savings Account (TFSA) is a great way to save for the future while also reducing your taxes.
Contributions to a TFSA are not deductible from your taxable income, but any money earned in the account (including interest and capital gains) is tax-free when withdrawn.
This means you won't have to pay tax on any of the money you withdraw from the account. Furthermore, any unused contribution room can be carried forward and used in future years.
It's worth noting that TFSAs have an annual contribution limit which varies by year, so it's essential to keep track of your contributions to ensure you don't exceed the limit.
For example, the contribution limit for 2023 is $6,500.
The Medical Expense Tax Credit (METC) is a non-refundable tax credit that can help reduce the income tax you must pay.
This credit covers eligible medical expenses paid by an individual, their spouse, or common-law partner for themselves, their dependents, or specific individuals, such as your or your spouse's or common-law partner's children who were under 18 years of age at the end of the tax year.
Eligible expenses include things like prescription medications, orthopedic shoes and devices, medical aids (such as a wheelchair), and specific amounts paid for long-term care.
METC will also cover medical supplies, dental care, and travel expenses.
You can claim the total of the eligible expenses less either $2,479 or 3% of you or your dependant's net income, whichever is lesser.
Generally, you can claim all amounts paid, even if they were not paid in Canada. This means overseas medical expenses are also eligible for the METC.
To qualify, you must have paid these expenses in the current year or in any of the preceding two years. The credit can be used to reduce your income tax payable for those years.
So if you've incurred a lot of medical expenses, even if the bills are relatively small, you should consider claiming the METC to help reduce your taxes. Just remember to keep all your receipts and invoices for eligible medical expenses, as you must provide them when filing your taxes.
If you support a spouse or common-law partner, an elderly relative or a disabled family member, you may be eligible for the Canada Caregiver Credit (CCC).
The CCC is a non-refundable tax credit that can help reduce the amount of taxes owed by caregivers. Depending on who you are supporting, you can claim amounts up to $9,875, which is equal to 15% of the maximum allowable amount.
To qualify, you must support someone who, because of physical or mental impairment, depends on you to "consistently provide them with some or all of the basic necessities of life, such as food, shelter, and clothing."
The person you are caring for must be related to you in one of the following ways:
You must provide evidence to support your claim for the CCC when filing your taxes, so make sure you keep all relevant documents and records. The CRA may ask for a signed statement from a medical practitioner confirming the dependency of the person you are supporting.
The First-Time Home Buyers' Tax Credit (HBTC) is a non-refundable tax credit that helps individuals and families cover some of the costs of buying their first home.
Eligible homebuyers can claim a tax deduction of up to $10,000 on the purchase of a qualifying home. You don't need to apply for or be approved for the rebate, and you can claim it when filing your tax return.
In order to be eligible, you must meet specific criteria such as:
The HBTC can result in a $1,500 rebate on the taxes you owe, so it's definitely worth taking advantage of if you are eligible.
If you have a spouse or partner who earns less than you, transferring some of your income into their RRSP or TFSA may be beneficial. Doing so can reduce the overall amount of tax you owe as a couple.
You can also split your pension income with your spouse or partner to take advantage of their lower marginal tax rate.
One of the most important rules to remember is that the spouse receiving the retirement funds must keep the funds in the RRSP account for three years. If the money is withdrawn earlier, the original income earner will be taxed on it.
Pension splitting is particularly beneficial for seniors, where one partner earns more from their pension than the other.
The higher-income earner can share up to 50% of their pension income from RRSP, RRIF(Registered Retirement Income Fund), and Annuity sources with their lower-income partner.
It's important to note that Canada Pension Plan (CPP), Quebec Pension Plan (QPP), and Old Age Security (OAS) pensions cannot be split between spouses.
Understanding how your taxes work, how to apply for tax credits, deductions, and other ways to reduce the amount of taxes you owe is vital to ensuring you're maximizing your savings each year.
By working through the tips listed above and determining which deductions and credits you're eligible for, you can learn how to reduce tax as an employee and ensure you're taking home as much of your hard-earned money as possible.
For more tips and strategies on how to optimize your finances, make sure to check our blog regularly. As the market-leading payroll software made for Canadian small businesses, Knitpeople specializes in expert financial advice and advice specific to Canadians.
To find out more about how Knitpeople can help your business streamline payments and HR with simple but powerful payroll solutions, book a demo or start your free trial today!
Disclaimer: This article provides general information and should not be construed as tax advice. Since tax rules may change over time and vary by location and industry, please consult a CPA or tax advisor for advice specific to your personal or business needs.
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