Understanding Payroll Deductions: Personal Income Tax Rates, CPP/QPP, EI and Basic Exemption

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The automation of the tax preparation and filing process has been a boon to individuals and tax preparers alike.   Gone are the days of struggling to find the right box on the return, adding everything up 5 times and still getting different results, and hoping that the CRA can read your chicken scrawl.  Present day tax software not only guides you through every step of the process, it also helps to optimize your allocations thereby reducing your taxes payable.  There is however at least one downside to automation: Since we are more removed from the actual calculations, our understanding of our tax situation is somewhat diminished.  We have an idea of what we expect to pay, which we can see every week on our paycheques (or for self employed individuals, the breathtaking moment when we see the final result on our tax return), but often we are not really sure how these amounts are derived.  Below is a discussion of the  tax rates, deductions and maximums to improve our comprehension of this somewhat complex topic:

Personal Tax Rates:

Federal Income Tax Rates

  • $40,970 or less:  15%
  • $40,971 - $81,941: 22%
  • $81,842 - $127,021: 26%
  • $127,022+ : 29%

Quebec Income Tax Rates

  • $38,570 or less:  16%
  • $38,571 - $77,140: 20%
  • $77,141 +: 24%

It should be noted that only the portion of the income that exceeds the limits are taxed at higher rate.  For example, if your taxable income for the year is $50,000, for federal purposes the first $40,970 is taxed at 15% and the balance of $9,030 is taxed at 22%.  As such your taxes on $50,000 is actually 15%X40,970 + 22%X9,030 =  $8,132 and your tax rate on $50,000 is 16.26%

CPP/QPP Rates and Maximum Earnings:

This represents the amounts contributed to the Federal/provincial pension plan, that will (hopefully) ultimately be paid back to us upon retirement.   If you are an employee, you pay an amount equal to 4.95% of your salary up to a maximum of $2,163.15 for 2010.  Your employer is required to contribute the same amount.  If you are self employed, you are responsible for paying both amounts upto a maximum of $4,326.15.  The maximum pensionable earnings for CPP/QPP purposes is $43,700 after which no further contributions are required.

Employment Insurance (EI)

EI is also deducted directly from your pay at a rate of 1.73% up to maximum earnings of $43,200.  As such the maximum amount payable is $747.36.  In Quebecthe maximum amount payable is $587.52.

If you are self employed you are not required to pay EI premiums, nor are you entitled to benefits.  You can however opt in to a EI program for self employed individuals , for which the benefits are limited.

Note that when a corporation employs a person who controls more than 40% of the corporation's voting shares; the employee is not required to pay EI premiums.  By the same token they are not entitled to EI benefits. 

Basic Exemption:

All Canadian taxpayers are entitled to a basic federal exemption of $10,382 for 2010 ($10,505 in Quebec).  This means that if you earn less than $10,383 annually, you are not required to pay any federal income taxes.  As an employee this is usually built into the deductions at source that are deducted from your paycheque. 

If you are self employed, you are required to remit these amounts at the end of the year when you file your tax return, or via instalments.  

As an employee,  all of these deductions are calculated for you by your employer and remitted on your behalf.  At the end of the year, if you only have employment income and your employer is calculating them correctly, your taxes payable should be close to nil.  If your are self employed, it is important to have an understanding of approximate amounts payable and ensure that (if you are not paying instalments) you have allocated the funds to pay your tax liability.  

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Ronika Khanna isMontreal accountantwho helps small businesses achieve their financial goals.  To receive regular updates of articles pertaining to small business, accounting, tax and other topics of interest to business owners you can sign up here.  You can also follow her on Facebook or Twitter