PAYABLE ON COMMISSION INCOME
Before you learn how to calculate your income tax, you must first understand how the Canadian tax system works.
The Canadian personal income tax system is a progressive tax system. This means that the more you make, the more you get taxed on.
The chart below shows the marginal tax rates for Canadians residing in Ontario in 2022:
|Income range||Marginal tax rate|
|$0 – $11,141||0%|
|$11,141 – $14,398||5.05%|
|$14,398 – $46,226||20.05%|
|$46,226 – $50,197||24.15%|
|$50,197 – $81,411||29.65%|
|$81,411 – $92,454||31.48%|
|$92,454 – $95,906||33.89%|
|$95,906 – $100,392||37.91%|
|$100,392 – $150,000||43.41%|
|$150,000 – $155,625||44.97%|
|$155,625 – $220,000||48.35%|
|$220,000 – $221,708||49.91%|
Marginal Tax Rates
I have simplified the above chart to summarize all major marginal tax rates. However, there are additional income ranges and marginal tax rates. There are also basic personal tax credits that everyone is entitled to.
The best way to explain this system is to use an example.
In this example, we’ll assume the Realtor earns a net commission income of $80,000. To calculate the tax payable, we have to go through the entire list of marginal tax rates.
Here’s how it works:
Between $0 and $11,141, you get taxed nothing.
Between $11,141 and $14,398, you get taxed at 5.05% Ontario tax rate.
= ($14,398 – $11,141) x 5.05% = $164.48.
Between $14,398 and $46,226 you get taxed at 20.05%.
=($46,226 – $14,398) x 20.05% = $6,381.5
And so on.
We have to go through the above calculation for someone who nets $150K in business income. Then, add them all up in the tax payable column, and we will come up with a total tax payable of $44,642.
See the table below:
However, this person’s overall tax rate is different. Your income is taxed at a different marginal tax rate depending on how much you make.
There are two main concepts here: the average tax rate and marginal tax rates.
Average Tax Rate Vs. Marginal Tax Rate & Income Tax
Average Tax Rate
To calculate the average tax rate, you divide your total tax liability by your taxable income.
The average tax rate for a single person who makes a taxable income of $150,000 and pays
$44,642 in 2022 in Ontario is:
= 29.76% ($44,642/$150,000).
Marginal tax rate
The marginal tax rate is the tax rate applied to your highest chunk of taxable income.
A Realtor who nets $150,000 commission income may decide to close one extra deal before the end of the year.
Let’s assume the realtor makes $10,000 in commissions.
This additional $10,000 is then taxed at the marginal tax rate of 48.35%.
The realtor’s total overall tax liability = $46,642 + $4,835 = $51,477.
The realtor’s new average tax rate = $51,477/$160,000 = 32.17%.
Yes, an extra deal of $10K will only give you an after-tax pay of 52% – the government keeps $4,835, you keep $5,165.
Essentially, if you net $150K already, you are splitting this extra deal 50/50 with the government.
What if you contribute to your Registered Retirement Saving Plans (RRSPs)?
Similarly, all contributions are considered a tax deduction when you contribute to your Registered Retirement Saving Plans (RRSPs). But, again, this tax deduction gets taken off from your top marginal tax rate.
Say with this new deal; you now net $160,000 commission income. You want to save some taxes by contributing $10,000 to your RRSP.
This $10,000 contribution is coming off the top marginal tax rate. This means you can save $4,835 tax payable.
Why are these two definitions important?
As a Realtor, your net commission income is subject to tax.
From the example earlier, for someone who already nets $150,000 commission income, doing one extra deal and adding an extra commission income of $10,000 results in an additional $4,835 of tax liability.
The marginal tax rate from $155,625K to $220K is 48.35%.
The new tax liability is now $51,477.
The new average tax liability is 31.08%.
You cannot simply take your income tax paid at the end of the year and divide it by how much your net taxable income is to come up with your tax rate. You get taxed more than your average tax rate!
Recognizing the marginal tax rate on the additional commission income allows you to make an informed decision on whether you should set up a Personal Real Estate Corporation or not.
CPP – You Pay Double
Now, on top of the personal income taxes you have to pay, as a self-employed realtor, you’re also required to contribute to the Canada Pension Plan (CPP), similar to all other Canadians.
The only difference is that because you are your own employer, you’re required to contribute to the employee and employer portion of CPP.
CPP is calculated as 5.70% of your net earning with a basic exemption amount of $3,500 in 2022. Both employer and employee are required to contribute 5.70%.
In 2022, self-employed realtors who net more than $64,900 in 2022 are required to contribute a maximum of $3,499.80 as an employee and another $3,499.80 as an employer. That is a combined total of $6,999.60!
What if you incorporate?
Well, this is a topic for another day.
As a minimum, if you incorporate, you can choose not to contribute double amount of CPP by paying yourself a dividend.
As a minimum, you can choose to retain as much profit as possible in the corporation which has a tax rate of 12.2% in Ontario, instead of the 50% that you see above.
If you need help setting up a PREC for income tax purposes, CLICK HERE to book a 30 minute one on one consultation with one of the professional Accountants on my team.
Until next time,
Cherry Chan, CPA, CA
Your Real Estate Agent Accountant