Marginal Tax Rate:
The tax rate that applies to your highest-taxed dollar. Used to calculate the tax impact of additional earnings.
The Marginal Tax Rate relates to the fact that in a progressive tax system like Canada’s, the more you earn the harder your income is taxed. While some people think this means that once a person earns above a certain figure, all their income is subject to a higher tax rate, it’s a little more complicated than that.
In fact, if your income reaches a level above the first tax bracket, it’s separated into layers, or tiers, and each layer gets its own tax rate. These rates are the same for everyone, regardless of their total income.
For example, the first $100,000 earned is taxed at one rate, while the next $50,000 is taxed at another (higher) rate. If you earn $50,000, all your income will be taxed at the first-tier rate. If you earn $125,000, all the income above the $100,000 mark (i.e., $25,000 in this example) will be taxed at a higher rate than the first $100,000.
A person’s income usually spans several tiers or tax rates. The highest rate triggered is called the marginal rate because it’s at the upper margin of your income.
Why does it matter?
Your marginal rate matters for issues of tax planning. The tax impact of additional earnings, e.g., a cash bonus, or the sale of taxable assets at a profit, is determined by one’s marginal tax rate. Similarly, the tax savings triggered by business expenses or RRSP contributions are also dependent on your marginal rate.