Where Did All Of My Money Go?
The unfortunate reality of payroll taxes!
Over the past decade, I have coordinated payroll for numerous companies within various industries. It never ceases to amaze me how little the average person understands payroll tax. I truly believe there should be a mandatory course covering everyday financial transactions, where if a student doesn’t pass the course they don’t graduate high school. Sure, the average high school student may not absorb the information at that point in time; however, there could easily be an app or online resource these students can reference when they are finally working full-time.
The motivation behind today’s article is from a conversation I had last week with an acquaintance that recently lost her job. Unfortunately, this is one of three individuals I know who were terminated in the past few weeks. She was presented with her final cheque, along with all of her personal items boxed up. The cheque included:
- her prorated salary (she didn’t work the full pay period);
- her two week’s severance;
- and her outstanding vacation pay.
What does this mean for her?
Her gross income on this one cheque is much greater than her average gross income that she has been paid previously. Therefore, she could be left with far less money compared to the deductions calculated if she had three cheques processed separately, or if the accountant adjusted the income tax deduction (although this would not be done without the employee’s authorization).
How does this work?
The quick answer is income tax is usually calculated by annualizing your current paycheque to determine the income tax for the pay period. So if you are paid on a bi-weekly basis, your gross income is multiplied by 26 (number of pay periods in a year) to figure out the total annual income tax liability (referring to tax tables), which is then divided by 26 (to determine income tax on a bi-weekly basis). Your other source deductions have their own schedules, which is an entirely different article.
The problem in this situation is that the individual lost their job (without cause), which means she needs as much money as possible to survive while finding a new job. The problem that most people don’t realize is that payroll accounting is far more simplistic than an individual may require. Accountants processing payroll cannot forecast the overall income tax liability of their employees, because most employees have various tax benefits and obligations. Usually, no two employees have the same situation; therefore, employees need to be proactive with their source deductions.
An illustration I threw together, assuming a similar situation as the story above and other everyday examples:
Aside from losing a job, when else would this situation occur?
The following scenarios should be considered for individuals who are concerned if they are being deducted too much or even too little:
TOO MUCH TAX BEING DEDUCTED:
- Requesting your vacation pay on top of your regular pay to have funds for your holiday or just to be paid out. If it is on the same cheque then you risk moving up to the next marginal tax break, which means your average tax rate will be higher.
- Cashing out banked hours while working a full pay period (same result as above).
- Any potential payroll error where hours that weren’t paid on the previous pay period(s) are added to the current pay period.
- Collecting a catch up paycheque for previous pay periods that weren’t paid to you, especially when they are all on one cheque.
TOO LITTLE TAX BEING DEDUCTED
- When working a second/third job and you have claimed the TD-1 Federal and TD-1 Provincial tax credits on both jobs. These are mandatory documents that need to be signed when you first join a company. To learn more – Payroll 101
- You had unpaid extended leave during a pay period where your gross income is now lower; thus, pushing you to a lower marginal tax bracket.
Knowing how much you will owe in Income Taxes at year end gives you a distinct advantage of avoiding being paid too little throughout the year and/or being hit with a significant tax bill when you file your taxes at year end. Most payroll accountants should be able to accommodate adjusting your tax rate each pay period. If you have a part-time job while working a full time job, you should avoid claiming the tax credit on the TD-1 Federal and TD-1 Provincial tax slips at the part-time job. As well, you may want to request increasing your income tax deductions on either or both jobs to avoid a tax bill later on.
If it is too late to fix your situation for 2014, use the tips in this article as a guideline for 2015.