A reader of Canadian Tax Resource asked me recently about why their overtime was taxed at nearly 40% when their regular pay was taxed at about 24%.
My regular bi-weekly pay is $3,000 and normally my employer deducts 23.9% or $717 from every pay.
Recently, I worked some overtime and on my last pay I got an extra $1,000 so my total gross pay was not $4,000. However, my employer took a total of $1,117 from my pay. Essentially, I had to pay $400 of extra tax on $1,000 of overtime. That’s 40%!
There are a couple of things to consider before we dive into how a $1,000 of overtime can be taxed at 40%.
Canada’s tax system is progressive. This means that you pay increasing rates of tax as your pay increases. For example, a resident of Ontario would pay 21.05% on the first $36,868, 24.15% on the next $3,878, 31.15% on the next $24,158 and so forth.
Marginal Tax Versus Average Tax
At $3,000 bi-weekly, you would be making $78,000 per year. The basic tax on $78,000 is about $18,650 or 24%. This is the amount of tax your paid on $78,000 and is called your average tax rate.
The marginal tax rate is the rate of tax you paid on the last dollar you earned. At $78,000 you would be at the one of the top tax brackets and would pay 39.41% on the next $3,450 dollars you earn. After that you will pay 43.41%.
If you make $78,000 per year and will pay 39.41% of tax on each additional dollar earned, a $1,000 of overtime would mean you pay almost $400 of additional tax.