Capital Gains Tax Comparison: Canada vs. USA

When it comes to capital gains tax, the policies of Canada and the United States differ considerably. Understanding the nuances of each country's tax laws can help investors and individuals make informed decisions about where to invest. This article aims to provide a clear comparison, helping you identify which country may offer more favorable tax structures based on various factors.

Canada's Capital Gains Tax Structure

Canada's capital gains tax treatment offers significant advantages to taxpayers. Unlike the US, Canada has a partial inclusion rate for capital gains, currently set at 50%. This means that only 50% of the gain is taxable, making it a highly attractive option for investors.

Taxation Rate

In Canada, when a taxpayer realizes a capital gain, only 50% of that gain is added to their taxable income. For example, if a taxpayer sells an asset for $10,000 and their cost base was $7,500, the capital gain is $2,500. However, only $1,250 (50% of $2,500) is included in the taxpayer's taxable income.

Income Tax Brackets

The tax rate applied to the taxable portion of capital gains depends on the individual's income tax bracket, which can range from 15-33% at the federal level plus provincial taxes. The outcome is a lower effective tax rate on capital gains compared to ordinary income.

Suppose a Canadian taxpayer in the 30% federal tax bracket has a capital gain of $2,500 (50% of $5,000). $1,250 (50% of the gain) is taxable. At the 30% rate, the tax on the capital gain would be $375 ($1,250 * 30%). If additional provincial taxes apply, the total will be slightly higher, but it still represents a significant discount compared to ordinary income tax rates.

United States' Capital Gains Tax Structure

The United States has a more complex system for capital gains, classifying them into two categories: short-term and long-term. The distinction between these categories can influence the rate at which the gains are taxed.

Short-Term Capital Gains

Short-term capital gains refer to gains from assets held for one year or less. These are taxed at the same rate as ordinary income, which can range from 10% to 37%, depending on the individual's income level. High-income taxpayers may also be subject to the Net Investment Income Tax (NIIT) of 3.8%.

Example Calculation

For instance, if an individual in the 37% tax bracket earns a short-term capital gain of $10,000, the tax would be $3,700 if there are no other deductions or credits applicable.

Long-Term Capital Gains

Long-term capital gains refer to gains from assets held for more than one year. These are subject to reduced tax rates, which can be 0%, 15%, or 20%, depending on the taxpayer's income level.

Example Calculation

If a taxpayer with an income level that qualifies for the 15% long-term capital gains rate realizes a gain of $10,000 from a long-term asset, the tax would be $1,500 instead of $3,700.

Future Changes and Considerations

The Canadian government has proposed increasing the capital gains inclusion rate from 50% to 75% starting from the 2023 tax year. If this proposal is enacted, the Canadian long-term capital gains tax will become more onerous.

Countries' Long-Term Tax Incentives

Despite these changes, for the present, Canada offers a more favorable capital gains tax structure than the US for long-term investments. Both countries provide a 50% tax discount, but Canada's 50% inclusion rate is more advantageous for short-term gains.

Conclusion

The more favorable option ultimately depends on individual circumstances, including income level, the type of assets held, and the duration of the investment. However, for investors prioritizing short-term gains, Canada currently offers superior tax benefits compared to the US.