Financial Foundations: Income Tax

Hi! I’m Nick, and welcome to Financial Foundations. I’m going to cover several concepts of investing that may seem confusing and show you that they’re actually simpler than you think. Let’s talk about Income Tax.

An income tax is a payment made by individuals and/or companies to the government to help pay for the many benefits that we receive by living in our great country, such as schooling, medical care, and transportation to name a few.

In Canada, our federal and provincial governments have something called a progressive tax-rate system, also known as a graduated tax-rate system. Essentially, in this system, you pay higher taxes as you make more money. Whether or not you think this is fair, our governments have decided that those who earn larger incomes should pay a greater share of their income towards the cost of the many public benefits we all receive.

There are different tax-rate schedules for the different types of income that people can earn such as regular employment, business income, or investment income which includes interest, dividends, and capital gains. In addition, the Federal Government of Canada has its own tax-rate schedule while each province has a different tax-rate schedule.

Now, as people earn larger incomes, they only pay the higher tax-rate on the amount of money that lies between that specific rate’s margin. Still confused? Let’s look an example to get a better understanding.

Let’s say that Nick Corp has grown a ton over the past decade and has bought it’s own country… NickLand! Let’s say that you live in NickLand and make $100,000 each year. In order to pay for the many services that NickLand provides its citizens, NickLand taxes people based on their incomes.

Look at this chart! This is the tax schedule that NickLand uses to determine how much the government will tax a certain citizen. So you make $100,000, right? So because you made over $80,000, you would get taxed 30% on all your money right? Wrong! You would only get taxed 30% on the amount of income that is over the $80,000. So you would only be taxed 30% on $20,000 because 100,000 minus 80,000 is 20,000.

So, what will you be taxed on the rest of your money? Well, you would be taxed 25% on your income that lies between $40,000 and $80,000. So you would be taxed 25% on only $40,000 of your income.

And finally, you would be taxed 20% on the amount of your money that lies between $10,000 and $40,000. So you would be taxed 20% on only $30,000 of your income. You would not be taxed at all on the first $10,000 you made.

Are things starting to make sense? Income tax can be confusing and so it can take some time to get a good understanding.

So, why is this important? Well, what not everyone realizes is that your income can be categorized into two types. Gross Income is the amount of money that you make before you pay your taxes, and Net Income is the amount of money that you keep after you pay your taxes. It’s important to know that you don’t get to spend all your money, but only the net income that you keep.

There’s a basic explanation of income tax for you! I’m Nick and thanks for joining me on Financial Foundations. See you next time!