WHY ARE MY #!$@!# TAXES SO HIGH WHEN I RELEASE VACATION PAY ON A REGULAR CHEQUE?
As some of you have noticed, if you release vacation pay on a regular paycheck, you pay much higher taxes. Everyone wonders why.
It’s all in how taxes are calculated for each pay period, and what the different tax brackets are.
In Canada, there are two types of income tax: Federal (Canada-wide) and Provincial (each province sets its own tax rates). They both come off your paycheck as one combined amount.
Alberta’s annual (yearly) income tax rates are as follows (as of 2017):
You pay
10% on the first 125,000 (Bracket 1)
12% on the next 25,000 (Bracket 2)
13% on the next 50,000 (Bracket 3)
14% on the next 100,000 (Bracket 4)
15% over 300,000 (Bracket 5)
The Federal annual (yearly) tax rates are as follows:
You pay
15% on the first 45,282 (Bracket 1)
20.5% on the next 45,281 (Bracket 2)
26% on the next 49,825 (Bracket 3)
29% on the next 59,612 (Bracket 4)
33% on anything over 200,000 (Bracket 5)
The government calculates tax amounts annually. But, when you’re paid every two weeks, you only pay a portion of your full yearly tax from each pay.
Here’s how it’s calculated:
Let’s say a person makes $20 per hour, and works full time, which would give them 80 hours every two weeks.
$20 x 80 hours = $1,600.00 gross pay for the pay period.
To calculate the income tax for that amount, we have to convert it to annual income. If you’re paid every two weeks, there are 26 pay periods in one full year.
So, it’s calculated as $1,600.00 (gross pay) x 26 (the number of pay periods) = $41,600 annual pay.
Taxes are calculated as shown above:
In Alberta, this would mean the person falls under Bracket 1, and they would pay 10% of their income toward Provincial Income Tax.
$41,600 x 10% = 4,160.00
For Federal taxes, the person also falls under Bracket 1. Again, the calculation is:
$41,600 x 15% = 6,240.00
The total tax payable for the year is 4,160 + 6,240 = $10,400.00.
Now, you can’t pay all that tax in one paycheck, so the total taxes are broken down by dividing the tax by the number of pay periods.
$10,400 / 26 = $400
It’s usually never that simple, since people take sick days or get paid overtime, or get a raise or whatever, and things fluctuate. But, that’s basically how the calculations are done.
At year end, when you get your T4, the government looks at what you should have paid versus what you actually paid for the entire year, and you either owe or get a refund.
And, when taxes are calculated each pay period, previous amounts are never taken into consideration. The calculations are for THAT pay period, and nothing else.
Vacation pay is meant to cover actual vacation days (i.e. time off with pay). So, if you worked one full week and took a week’s vacation, you’d still get your 80 hours paid (40 worked hours + 40 vacation hours), and your taxes would be normal.
It’s when you release vacation pay on top of your regular income that things get wonky.
Let’s say you make $20/hour, you worked a full two weeks, and you’re releasing $4,000 in vacation pay.
Normally, you’d pay only $400 toward taxes on a regular pay. The vacation pay drastically changes the calculations.
Now, we have $20 x 80 hours = $1,600 + $4,000 vacation pay = $5,600.00 gross pay for that payday.
Let’s do the calculations on that:
$5,600 x 26 pay periods = $145,600
You don’t make that much, but that’s what THIS pay is calculated on. That’s what the computer thinks you make this time around. These calculations are hard-coded into any payroll program, and they cannot be changed.
$145,600 will put you in Bracket 2 for Alberta, which means you’re now paying:
145,600
-125,000 x 10% = 12,500 / 26 = 480.77
– – – – – – – – – – – – – –
20,600 x 12% = 2,472 / 26 = 296.64
480.77 + 296.64 = 777.41 in Provincial taxes
Now for the Federal tax:
$145,600 will put you in Bracket 4, and it’s calculated as follows:
145,600.00
– 45,282.00 x 15% = 6,792.30 / 26 = 261.24 (Bracket 1)
– – – – – – – – – – – – – –
100,318.00
– 45,821.00 x 20.5% = 9,393.31 / 26 = 361.28 (Bracket 2)
– – – – – – – – – – – – – –
54,497.00
– 49,825.00 x 26% = 12,954.50 / 26 = 498.25 (Bracket 3)
– – – – – – – – – – – – – –
4,672.00 x 29% = 1,354.88 / 26 = 52.11 (Bracket 4)
261.24 + 361.28 + 498.25 + 52.11 = $1,172.88 in Federal taxes.
So, in total, you pay $777.41 (Provincial) + $1,172.88 (Federal) = 1,950.29 in taxes because of that extra $4,000 that you released.
That’s a pretty substantial increase, and this is why it’s best to use your vacation pay for actual vacation days.
If you have any questions, ask Diane.