Tips & Advice

How a Pay Raise Affects Your Taxes

If you’ve earned a salary increase this year, congratulations! Being recognized for your work is an amazing feeling. But what tax implications come from that extra cash? How can you soften any potential hit at tax time? Let’s take a look at how your raise affects your taxes.

Raise in Salary- Self

Depending on the size of your pay increase, you might not see a difference in your bottom line at tax time. That’s because once your salary increases, your deductions should as well. The income from your raise may push you into the next tax bracket But don’t worry – it’s not as bad as it sounds.

There’s a common misconception about tax rates that once you jump to the next one, you have to pay a higher rate on ALL your income. That’s actually not the case. In Canada, the tax system is tiered. Here’s an example:

  • Nick’s annual review earned him a pay raise of $2.00/hour. His income in 2016, prior to the raise, was $43,000. For 2017, he expects to earn about $47,000.
  • The lowest tax bracket for 2017 caps at just under $46K. This means that the first $46,000 is taxed at a rate of 15%. For 2017, Nick has moved into the next tax bracket – the 20.5% rate.
  • This doesn’t mean that ALL of Nick’s $47,000 is taxed at 20.5% – just the amount above that first tax bracket. The first $46K remains at the lowest rate.
  • Bottom-line – Nick’s $4,000/year raise makes very little difference at tax time. And his payroll department should deduct the proper amounts from his weekly pay to cover the small increase, so he may not see any difference when it’s time to file.

Raise in Salary- Spouse

If your spouse receives a pay raise and you’ve previously claimed the spousal amount, your claim may decrease on your next return. Income is deducted dollar for dollar from the credit.

Raise in Salary- Dependant

Similar to the spousal amount, the amount for an eligible dependant factors in the dependant’s income. If you’re a single parent and your teenager begins to earn more money, you’ll see a smaller credit at tax time.

Effects on Other Credits and Benefits

A raise in taxable income could have other tax consequences. Depending on the size of the increase, your income may exceed the limit for credits such as the age amount. Additionally, the medical expense credit exempts the first 3% of your income as a deduction. If your pay increases, so does your 3% threshold. To learn more about claiming medical expenses, check out our 3 Tips For Claiming Your Medical Expenses as a Tax Deduction.

Most benefit programs such as the Canada Child Benefit, GST/HST Rebate, Ontario Trillium Benefit, and Old Age Security have income limits as well. Although these credits are not recalculated until the following July, your pay increase may result in a lower payment or exclusion from the benefit completely.

You Have Options

If your tax situation changes, so should your payroll deductions. If you picked up a second job or no longer have certain credits (like tuition) to apply, speak to your payroll representative about increasing how much income tax is deducted from your pay. By simply filling out a new Form TD1, Personal Tax Credits Return, you can bank a few extra dollars each pay cheque to cut your tax bill next spring.

To lower your tax burden, lower your taxable income or increase your credits. Consider using your pay increase to purchase RRSPs. You have until the end of February to contribute if you want to claim the contribution on the current tax return. Or donate a portion of your raise to a registered charity. Ask your payroll representative about donating directly through payroll deductions.

References

Canada Revenue Agency: 2017 Personal Tax Credits Return