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Tax rate on Actual income vs Taxable income

On the T1 Summary, should not “Effective tax rate on…Actual income” be calculated as:
Total payable (line 435000) ÷ Total income (line 15000)?
In every tax return I look at, the effective rate on Actual income equals the effective rate on Taxable income.

Good catch I would say.

The only file I have found that seems to calculate correctly is one with AMT involved so I suspect something in the calculation needs to be coded at bit different.

Have you looked at a return that reported taxable dividends and/or taxable capital gains. It looks to me as if “Actual income” is taxable income minus dividend gross-up plus non-taxable portion of capital gains. There may be other adjustments.

I would suggest that net income before adjustments (line 23400) would be a better base than taxable income. After all line 23400 is, apart from the clawback, the elusive “income” that the Income Tax Act seeks to tax. If you used line 23600 you would have to adjust “Effective tax” to exclude line 42200. As it is, TaxCycle appears to be calculating a “Total payable” that includes the social benefits repayment as a percentage of a “Taxable income” and an “Actual income” that exclude it.

I guess this little area could use a little more thought and work put into it.

The calculation of the rate of tax on actual income is, indeed, as keith1 thought it was above; simply removing the dividend gross-up and adding back the 50% of non-taxable income.
We did this to keep it simple but we can see how it may be too simple. Regardless what we do, I fear it will be impossible for it to be entirely clear to every reader what it means.

Some thoughts:
If we think of “actual income” as the net cash in our pockets before paying tax, we would need to take Net income (23600), add back the clergy residence deduction and deduct CPP/QPP and EI amounts (lines 30800 to 31217 of the non-refundables section).
As for 'Tax", that would be the total of federal and provincial tax payable (lines 42000 plus 42800). The social benefits repayment as well as CPP and EI on self-employment would be ignored as they are already deducted from actual income above.

We have the Canada workers benefit (line 45300) as well as various provincial credits (479 forms) that are paid directly on the return which are essentially reducing the amount of tax paid.
Then there comes the credits like the GST, Trillium and Canada child benefits which are considered a deemed overpayment of tax. We could wish to reduce the tax amount by these payments.
With these last two elements, some clients would have a negative rate of tax, receiving more than they paid. Since “effective tax rate” does not account for these and in wishing to be somewhat comparable between the two rates, I would suggest not accounting for them in either.

All further discussion is welcome before we make any change.

That really does get complicated doesn’t it.

Something is significantly wrong I would say in the coding though, because as Nezzer has said most files he checked, and I as well, the rate is the same for both calculations.

They are the same when the client has no dividend income or capital gains.

Thanks Allen (and Keith) for explaining.

From my perspective, clients often want to know, “What’s my tax rate?”
I give the T1 Summary (to all my clients), and point to the effective tax rates on this sheet. Then I say the software has a bug because the two numbers shown are generally the same, and I quickly, manually, do the calculation of line 43500 over line 15000. This seems (to me and most clients) an appropriate measure of “my actual tax rate”. Most of my clients understand that their non-taxable benefits (GST, CCB, CAI, Trillium, etc) are not reported as income on the T1.

If TaxCycle is open to changing what is displayed on the T1 Summary, may I suggest considering, “What is this information used for?”
TaxCycle has decided to include these 2 numbers. Who uses them and why? Perhaps there are practitioners who have a different client base than I do, and this calculation of actual income is useful to them. For me, it isn’t.

Personally, I would like to see 3 calculations, all using line 43500 in the numerator:

  1. Tax rate on taxable income (using line 26000 as denominator)
  2. Tax rate on net income (using line 23600 as denominator)
  3. Tax rate on total income (using line 15000 as denominator)

This eliminates the whole question, “What is actual income”, but would not give the calculation TaxCycle is currently using.
Perhaps you could make the “Tax rate on actual income” configurable?
Thanks!

I like it the way it is so you can show a client how good you are helping him structure large amounts of income as capital gains and save him tons of tax.

“Taxable Income” being actually Total Income (Line 15000) then and not Taxable Income (Line 26000).
That is the confusion then. If the calculations remain the same maybe changing the “Taxable Income” title to “Total Income” would make more sense.

As Allen (of TaxCycle) has said Actual and Taxable incomes are the same unless there are capital gains or dividends. There is no point to telling clients what their tax rate would be on Total income, because Total income isn’t taxable.

There is also no point to telling clients what their tax rate would be on “ACTUAL INCOME”, because “ACTUAL INCOME” is not defined, and therefore any calculation based upon an undefined concept is meaningless, or worse, even misleading.
One would need to define it first, which would be seriously challenging.
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If I was to speculate about what might be in a client’s mind if they were to ask the question: " “What’s my tax rate?”, One guess would be that they could be wondering about their “Average Tax Rate” on their “Line 150 Gross Income”. (Notwithstanding that tax is not calculated directly on Line 150, and nor is a “cash figure”, since it could contain gross-ups, and also lower inclusion rates).
Or perhaps they are wondering what their “Marginal Tax Rate” is if they earned an extra dollar at their exiting range of income.
Other clients might be thinking of different unnamed or undefined ratios.
Either way, one simple ratio would not cut it as an answer to that type of question, so that would lead to further discussion if the client wanted to understand the taxation of specific items.
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The client would perhaps need to say:
“Well, what I was asking you, if you took Line 150, reduced it by dividend gross-ups, added back my other 1/2 of capital gains, but left my GIS tax exempt payments in there, then for some reason I just feel like knowing what the answer to that calculation might be. Also, what would that figure be if the GIS exempt payments were taken out? Or what would it have been if my Principal Residence sale was included in income? Or what happens if I get divorced, what Income figure is the Court going to use for spousal support calculations? Or how much extra tax would I pay if I earned an extra $100? Or…”

@dklassencga

“Taxable Income” as listed has nothing to do with Taxable Income (Line 26000).

Confusing.

I thought it seemed to me to be actually Total Income (Line 15000). Not sure exactly what is behind that calculation now as that doesn’t appear to be the case always.

“Actual Income”. I understand what is being produced here and that title at least isn’t going to be confused with a particular line item.