Calculating income tax deductions

Annie Chong, manager of Carswell’s payroll consulting group, fields questions from readers
|Canadian Payroll Reporter|Last Updated: 04/01/2011

QUESTION: Do I use an employee’s gross or net income to determine the correct amount of federal and provincial income tax to deduct at source? 

ANSWER:  Income tax source deductions are calculated on employees’ net taxable income amount. 

To arrive at this figure, add up the employee’s gross taxable income (including salaries, wages, car allowances, commissions, bonuses and vacation pay) and then subtract (if applicable) any employee contributions to a registered pension plan (RPP), a registered retirement savings plan (RRSP) — provided you have reasonable grounds to believe the employee can deduct the contribution — or to a retirement compensation arrangement.

Also subtract union dues (except  in Quebec); a deduction for living in a prescribed zone; alimony or maintenance payments required by a garnishee or court order the employer received and is dated before May 1, 1997; and any deductions that the Canada Revenue Agency has authorized in writing.

Do not deduct Canada Pension Plan contributions or employment insurance premiums to determine the amount subject to income tax.

The requirements for calculating income tax source deductions for Quebec are similar, but not identical, to the federal requirements.

Reporting retiring allowances

QUESTION: Now that retiring allowances are reported on the T4 form, do we have to include the amount in box (14)?

ANSWER: No, retiring allowance amounts are not included in box (14) of the T4.

Retiring allowances are reported in the “Other Information Area” on the T4 slip, using code 66 to report the portion of a retiring allowance that is eligible for tax-free rollover to an RPP or RRSP and code 67 to report non-eligible amounts. The lump sum tax deducted is reported in box (22) on the T4. 

Grossing up bonuses

QUESTION: We would like to pay a bonus in the net amount of $10,000 to an employee. In order to do this, how do we determine the gross amount? Are there any federal income tax requirements for grossing up an employee’s bonus payment?

ANSWER: This type of situation is not covered in the federal Income Tax Act; however, it is a common practise for employers to pay employees grossed up amounts so when they withhold taxes, they obtain the desired net amount.

In order to pay a net amount of $10,000, you must first establish the employee’s tax rate, as the following example shows. In the example, assume that the employee’s marginal tax rate is 36 per cent:
•use the whole number 1, minus the applicable marginal tax rate (36 per cent or 0.36). 1 - 0.36 = 0.64
•divide the desired net amount ($10,000) by the result to determine the grossed-up amount. $10,000 (net amount required) ÷ 0.64 = $15,625 (gross-up amount)
•verify your calculations:
gross payment required: $15,625;  
taxes required: $ 5,625 (at 36 per cent of gross); net amount required: $10,000.

TD1s for part-time workers

QUESTION: Our company recently hired a part-time employee to work 10 hours per week. The employee is gainfully employed with another company. How should he complete the federal and provincial TD1s?