otto-taxes

It’s tax day for the nine Financial Uproar U.S. readers, but it isn’t a big deal. I know you kids are up with what’s down (or is it down with what’s up? Lingo confuses me) and had your taxes all completed by January 2nd.

Whenever I think of someone scrambling to finish their taxes, I’m reminded of The Trouble With Trillions, one of my favorite Simpsons episodes.

Homer: Marge, how many kids do we have? Oh, no time to count, I’ll just estimate! Uh . . . nine!
Marge:Homer, you know we don’t have–
Homer: Shut up! Shut up! If I don’t hear you, it’s not illegal! Okay I need some deductions. Deductions… Oh, business gifts! [hands Marge the sailboat painting from above the couch] Here you go, keep using nuclear power.
Marge: Homer, I painted that for you.
Homer: Okay, Marge, if anyone asks, you require twenty-four hour nursing care, Lisa’s a clergyman, Maggie is seven people, and Bart was wounded in Vietnam.
Bart: Cool!

Let’s take a minute and talk about tax brackets, one of the most misunderstood concepts of personal finance. I’m going to consult the Canadian Government’s federal tax guide for this, because yes, I was just talking about U.S. taxes a minute ago. I just like confusing people. Makes me feel smart.

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There’s obviously provincial taxes on top of these, but we’ll ignore those. Let’s keep this exercise as simple as possible.

For your first $44,701 in income, you’re paying the feds 15%. Pretty straightforward, huh?

For your next $44,700 in income, you’re paying 22%. No, I don’t know where there’s a dollar difference STOP ASKING GEEZ LOOK THIS CRAP UP YOURSELF.

Let’s stop there. What’s your tax rate so far?

It’s a simple question. You paid 15% on the first half of the income, and then 22% on the other half. So if you made exactly $89,401 in 2014, you’d pay income tax of 17.5%.

Here’s where it gets a little more complicated. Say you made $100,000 hitting up fat kids for their lunch money, and for some reason are declaring it as income. What’s your tax rate?

On the surface, it looks to be a pretty simple calculation. You’re paying 26% of each extorted dollar back to the feds, probably going towards Stephen Harper’s hair gel.

But is it that simple? Or should you look at the average tax rate paid?

Let me communicate this in a table.

Income Percent Taxes Total Tax Paid
$44,701 15% $6,705
$44,700 22% $9.834
$10,599 26% $2,755

In total, on $100,000 in income, you’re looking at a tax bill of $19,294. My crack math skills tell me that’s a tax rate of 19.3%.

The point is this. Even though each additional dollar is being taxed at a 26% rate, the amount you pay is still being weighed down by all your previous income in lower brackets. Instead of being in the 26% bracket, I’d argue someone who makes $100,000 is in the 19.3% bracket, which grows at 26%.

Is it shoddy accounting? Well, maybe. But wouldn’t you do the same in your portfolio if you were looking at straight dividend yields? Or if you ran a store and was looking at your total margin? So why should taxes be different?

“I refuse to make more. It’ll put me in the next tax bracket.”

Raise your hand if you’ve ever heard a version of that idiotic statement.

(You did it, didn’t you? Nice work, dingbat. Now Phyllis from accounting things you’re extra special.)

I think you should do everything legally possible to avoid taxes. You can start a business for the deductions and the ability to shelter the earnings inside the company. You can use spousal RRSPs or income splitting or buying assets in the lower earning spouse’s name. Hell, you can even pay her to look pretty, although I’d advise pretending she does your books.

I’m all for minimizing taxes.

But after that, you should pay. Without taxes, Canada’s healthcare system resembles Murica’s, toll roads exist everywhere, and we’re all going to school at Bill’s barn, which smells exactly like you’d expect. Okay, maybe not, but the point stands — taxes pay for these things. If you use them, you should pay.

If you’re successful enough to make it into the 3rd or 4th tax bracket, I say stop bitching and go to work. You’re in a position that millions of people would kill to find themselves in, and you’re not taking advantage of it to screw over the government? That’s more shortsighted than Martha Stewart’s decisions around her Imclone stock.

Again, take all the legal steps you can to minimize your tax bill. But after that, I expect you to go out and build all the wealth you can, taxes be damned. Like my dad likes to say, embrace paying taxes. The more taxes he pays, the happier he is, because he knows a high income translates to wealth. I think we’d all be better off if we had the same attitude.

Tell everyone, yo!