The total income that you make in a year versus the income that you keep after taxes can be two very different amounts.
So exactly what is net income in Canada, and how is it calculated?
Net income in Canada at the personal level is the remaining income you get to keep in a specific year after considering the impact of income taxes and other factors such as RRSP contributions. For corporations, net income is calculated as total revenues minus total expenses.
I will cover what net income is in Canada in more detail below.
The General Definition of Net Income
Gross income and net income are two terms that you should understand at both a personal level as well as when thinking about a business. Gross income in both cases refers to income from all possible sources, typically within a year.
Businesses or corporations are typically able to subtract most costs of doing business from their gross income. Once these are subtracted, businesses are required to pay taxes, after which the final income figure is considered net income.
As an individual, you will likely be unable to subtract a lot of the costs of your day-to-day life from your gross income. There are, however, some credits and deductions in Canada that you can take advantage of to reduce your taxable income, including:
- Some self-employment expenses
- Some work-from-home expenses
- Childcare expenses in some cases
- Student loan interest
Your remaining personal income is then typically taxed based on which income bracket you fall into. Canada has a progressive tax system in place, meaning that individuals that earn a higher taxable income have to pay a higher tax percentage than individuals that earn less.
After your tax liability is considered, or the amount of tax that you owe on your total income is paid, you will be left with your personal net income.
Different Sources of Income
Canadians can have multiple sources of income that contribute to their total income within a specific year. Examples of income sources include:
- Your wages from your job
- Rental income from properties that you may be renting out
- Investment income from portfolios that are generating income
- Interest from savings products (high-interest savings accounts, GICs, etc.)
Investment Returns and Personal Income
When looking at investment returns specifically, returns are taxed differently based on how they are obtained. The three main classifications of investment returns in Canada are:
- Capital gains
- Dividend income
- Interest income
I will cover each in more detail below.
What are Capital Gains?
Capital gains are realized when you sell an asset for a profit. This covers a wide range of assets, including:
- Stocks
- Funds
- Cars
- Collectibles
- Real estate
A capital gain is calculated as an asset’s selling price minus its purchase cost. If this comes out to a positive number (or a profit), it is considered a capital gain. If you are selling an asset for less than you bought it for, it may be considered a capital loss in some cases.
Capital losses can sometimes be used to offset capital gains. When considering an investment portfolio, this is considered tax-loss harvesting. Capital gains are added to your income for a specific year once they are realized or once an asset is sold.
Capital gains are the most tax-efficient form of investment return. Only 50% of a capital gain is added to your taxable income for the year, making it an extremely tax-efficient form of investment return.
Dividend Income and Taxes
Income from dividends, or dividend payments, are taxed more favourably than regular income but less favourably than capital gains.
Dividends are taxed by first being “grossed up” by 38% and then receiving a 15% tax credit on the grossed-up amount. Make sure to read more about dividend taxation to get the full picture.
If you have the option of earning interest income or dividend income, dividend income is generally the better choice because you will end up paying less in taxes on your returns.
Interest Income
Investment interest income is taxed the same as regular income. Sources of interest income include:
- High-interest savings accounts
- Guaranteed investment certificates (GICs)
- Coupon payments from bonds
Interest income is usually earned from low or lower-risk investments. The government does not offer tax incentives for interest income partly because it does not encourage investing in businesses.
Interest income typically does not fluctuate as much as other sources of investment returns. It is usually earned through long-term lending agreements.
Interest income is added to your other sources of income to add up to your total gross income for the year.
Frequently Asked Questions
Canada Net Income Calculator
You can use a net income calculator in Canada to determine your after-tax or net income and your average and marginal tax rates.
If you are looking to have an accurate estimate of your net income, you will need to have some information handy, including:
- Employment income
- Capital gains
- Self-employment income
- RRSP deductions
After factoring in both provincial and federal taxes, you will soon come to find that the progressive tax system in Canada can be very unpleasant for high-income earners.
Wealthsimple currently offers a robust net income calculator. If you are thinking of opening a discount brokerage account, Wealthsimple Trade is a top option in Canada and also offers a free $25 sign-up bonus.
Net Income for Tax Purposes
Net income in a given year can be found by checking line 23600 on your tax return. The government uses this figure to see if you are eligible for federal, provincial, or territorial tax credits.
The Canada Revenue Agency may also look at your net income amount to calculate other figures that depend on this amount. These can include:
- The Canadian child benefit
- The GST/HST credit
- Social benefits repayment
Is Net Income Before or After Taxes?
Net income always refers to income after taxes have been subtracted. Income before taxes is referred to as taxable income.
Net Income vs Taxable Income in Canada
Net income refers to your personal income after income taxes have been subtracted. Taxable income refers to your total taxable income before income tax is paid.
Keep in mind that taxable income can be different from your total amount of income in a year (also considered your gross income).
If you are in a very high tax bracket, you can expect your taxable income to be very different (much higher) than your net income.
Conclusion
Given the complexity of Canada’s tax system, it is important to wrap your head around terms that are very different, including gross income, taxable income, and net income.
Keep in mind that your income for tax purposes within a specific year is the sum of all of your different income sources. This can include things such as your investment portfolio or rent from a rental property.
When it comes to investment returns, different types of returns are treated differently when calculating income in a specific year.
If you don’t particularly enjoy paying taxes, be sure to read my guide outlining practical tips on how to pay less tax in Canada.
