Have you ever heard someone question whether a promotion would be worth it because it would push them into another tax bracket?
That’s not how income tax rates work.
But it’s a common misunderstanding rooted in a confusion between average and marginal tax rates.
Your average income tax rate is the total income tax you pay as a percentage of your income.
Your marginal income tax rate is the tax rate that you would pay on an additional dollar of income.
In Canada, you pay income taxes to both the federal government and the province in which you reside.
These jurisdictions set marginal tax rates for different income levels. You can see the 2021 federal marginal tax rates in the table below from TaxTips.ca.
The columns have different tax rates for different types of income. Capital gains and dividends have lower tax rates than “other income” like wages.
If your only taxable income was from wages, and you made exactly $49,020, you would pay federal personal income taxes of 15% on those dollars, or $7,353 (it would be less than this because of various tax credits, but I’m ignoring those for simplicity).
If you were to make an additional $10,000, that income would be taxed at 20.50%, which works out to $2,050.
But your first $49,020 would still be taxed at 15%.
In total, you would pay $9,403 in federal personal income taxes on $59,020 in income, an average tax rate of 15.9%.
So, while the tax rate on the additional dollars earned from a promotion may be taxed at a higher rate, the promotion would not lead to higher tax rates on all your dollars earned.
While there are many reasons to turn down a promotion, that it might cause you to earn less overall because of a higher tax bracket is not one.
That’s actually why personal income tax systems are designed around marginal tax rates instead of average tax rates. Governments don’t want everyone turning down promotions because of the tax system.