As we approach the end of the year, it is time to consider options which may be available to you to reduce your year-end tax bill as well as planning that can be done for the future. A comprehensive tax plan requires balancing your current and future objectives based on an assessment of your current financial position, current tax laws, and potential future changes. This is a complex and dynamic assessment that should be reviewed on an annual basis. Below are a few planning considerations that may be applicable to you.
Registered Retirement Savings Plans (RRSP)
RRSP contributions are one of the most common ways to reduce your current year tax liability. The following are some key points to consider with respect to RRSP contributions.
Your available RRSP contribution room for the year is indicated on your prior year Notice of Assessment. Each year, your contribution room increases by 18% of your prior year earned income up to an annual maximum ($27,830 for 2021) less your prior year pension adjustment and prior year RRSP contributions.
Based on the above calculation of the lesser of 18% of earned income or the annual limit, you must report earned income of at least $162,278 on your 2021 income tax return to receive the maximum 2022 contribution room of $29,210. Earned income generally includes employment or self-employment income, but does not include passive income such as interest, dividends, rents, or royalties. Business owners may want to consider paying additional salaries or bonuses instead of dividends to maximize their contribution room.
RRSP contributions made within the first 60 days of each year can be claimed on your prior year income tax return. This date usually falls on March 1st but will be February 29th during leap years. It is always a good idea to assess if any additional contributions should be made during January or February of each year.
RRSP contributions can be carried forward to future years if you expect your income to be taxable at a higher marginal rate in the subsequent year.
Individuals who turn 71 during the year must terminate their RRSP. The funds can be withdrawn as a lump sum, converted to an annuity, or transferred to a Registered Retirement Income Fund (RRIF). Lump sum withdrawals will be fully taxable while transfer to an annuity or RRIF will continue to receive the benefit of a tax deferral.
Contributors can choose to contribute funds to their own RRSP, or to their spouse’s RRSP. Spousal contributions will be deductible on the contributor’s tax return subject to their contribution limit. The benefit of the spousal contribution is that future withdrawals will be taxable to the spouse. This may be advantageous if you expect your spouse to be taxable at a lower marginal rate in the future. This is also advantageous if the contributor is over 71 years of age, but their spouse is 71 years of age or under.
Tax-Free Savings Accounts (TFSA)
TFSA accounts are a great vehicle to reduce your tax bill as the income earned within the account is non-taxable. These accounts differ from RRSP accounts as the contributions to these accounts are non-deductible, and withdrawals from these accounts are non-taxable.
The contribution limit for TFSA accounts is calculated as of January 1st of each year. The annual contribution limit is calculated as your prior year contribution limit, less prior year contributions, plus prior year withdrawals, plus the current year annual limit ($6,000 for 2022).
As the contribution limit is only adjusted each January, you may want to withdraw funds before the end of December rather than early next year as your withdrawal will then be added back to your contribution limit on January 1st. For example, you can withdraw funds from your TFSA to top up your RRSP contributions. If these additional RRSP contributions trigger a tax refund when you file your tax return, you can then recontribute this tax refund to your TFSA.
Registered Education Savings Plans (RESP)
RESP accounts are a vehicle used to save for a student’s education. These plans allow for tax-deferred growth within the plan and the government provides matching grants and bonds to assist with the cost of their education.
The Canada Education Savings Grant (CESG) is a grant which matches contributions at a 20% rate on the first $2,500 of annual contributions ($500 maximum CESG per year) with a lifetime limit of $7,200. This grant is available until the year the beneficiary turns 18. While carry-forward CESGs are available, it is best to contribute early to maximize the lifetime grant and to maximize the tax-deferred growth in the account.
You should also consider withdrawals before year-end if the beneficiary has started their post-secondary studies. Educational Assistance Payments (EAP), which include the portion of the withdrawal arising from CESG and income earned within the plan, are taxable to the beneficiary. Often EAP can be received tax-free as the student will have tuition tax credits available.
Planning for Individuals with Disabilities
Various options are available if you or a dependent have a long-term disability.
The disability tax credit provides a non-refundable tax credit ($8,662 for 2021). A doctor must complete a prescribed form certifying the disability which must then be submitted to Canada Revenue Agency for approval. If you think this may apply to you, you should submit the form as soon as possible to receive approval in time to file your tax return. Prior year adjustments can be requested if approval is not received in time.
The Home Accessibility Tax Credit (HATC) is available to seniors or individuals eligible for the disability tax credit on certain home renovations up to $10,000 which improve accessibility in the home. Payment of these expenses before year-end will allow for a claim on your tax return.
Registered Disability Savings Plans (RDSP) are available for individuals eligible for the disability tax credit. Similar to the RESP, these plans allow for tax-deferred growth and the government provides matching grants and bonds to the plan. You should consider opening or contributing to a plan to maximize the potential grants, bonds, and tax-deferred growth.
Income Splitting with a Prescribed Rate Loan
Each taxable individual in Canada must file their own income tax return and will be subject to tax at marginal rates. For families, this may lead to one individual being subject to tax at a higher marginal rate than other members of the family. A prescribed rate loan may allow you to split income with a family member who is subject to tax at a lower rate.
Prescribed rate loans can be utilized to loan funds to a family member, such as your spouse, to invest in a non-registered investment account. The income earned in the account will be reported by your spouse if certain conditions are met. Interest must be charged on the loan at Canada Revenue Agency’s prescribed rate, which is currently 1%, and the interest must be paid no later than January 30th of the following year. The prescribed rate in effect at the time of the loan will apply for the duration of the loan. As interest rates are expected to rise in the future, this is a great time to consider if this strategy can be beneficial to you.
Tax Loss Selling
Capital losses can only be claimed against capital gains on your income tax return. A common strategy amongst investors is to trigger capital losses before the end of the year to offset realized capital gains.
It is advisable to review your non-registered investment account or contact your broker to assess the capital gains realized to date. You can consider disposing of certain securities currently in a loss position if significant capital gains have been realized.
You must consider the settlement date of the transaction. Sales of securities typically do not settle until two business days after the trade date. As the settlement must occur by December 31st to claim the capital loss on your income tax return, you must ensure the trade is completed in a timely manner.
You must also consider the superficial loss rules if you intend to repurchase the securities which you sell at a loss. The loss cannot be claimed if you repurchase an identical security either 30 days before or after the settlement date. The superficial loss will be added to the adjusted cost base of the repurchased securities.
Realize or Defer Capital Gains
Similar to tax loss selling, you can consider either realizing additional capital gains prior to year-end or waiting until early next year. The optimal approach depends on your personal situation.
You should consider realizing capital gains if you are expecting to be in a higher tax bracket in the future, or if you have significant realized capital losses during the year or capital loss carry forwards. While this strategy may increase your current year tax bill, your future income taxes may be significantly reduced.
Capital gains are currently subject to a 50% inclusion rate which means that 50% of the total capital gain is taxable. There have been suggestions that this inclusion rate may be increased in the future. We do not currently know if or when this increase will occur, but this risk should be considered as part of your planning.
Alternatively, deferring capital gains until next year may be advisable if you are already in a higher tax bracket. By waiting until January to realize capital gains, you can defer payment of taxes by an additional year. This can be a particularly effective strategy if you expect to be in a lower tax bracket next year as you will save tax on top of deferring it.
Charitable donations can be claimed as a non-refundable tax credit on your tax return, and unused contributions can be carried forward for up to five years. Total donations more than $200 are eligible for greater tax savings as the total credit can be in the range of 50% depending on your province of residence.
Donations to registered charities, registered Canadian amateur athletic associations, registered national arts service organizations, certain registered public bodies, the United Nations and its agencies, universities outside Canada, and others may qualify for the donation tax credit. An official receipt should be received to support the claim on your income tax return.
Donations to United States charities may also qualify for the donation tax credit if the charity is generally exempt from United States tax and it could qualify as a registered charity if it were resident in Canada. These donations can only be claimed against income sourced from the United States up to 75% of this income.
Donations of marketable securities can be particularly beneficial. The fair market value of the marketable security will be eligible to claim as a donation tax credit. Furthermore, any accrued capital gain on the donated securities will not be subject to tax on your tax return.
Medical Expense Tax Credit
The out-of-pocket cost of certain medical expenses paid for you or your dependents can be claimed as a non-refundable tax credit on your income tax return. The amount eligible for the credit is the amount paid minus the lesser of either 3% of your net income, or a fixed amount ($2,421 as of 2021). You can claim medical expenses paid in any 12-month period which ends during the year.
You can time the payment of certain medical expenses to maximize your credit. For example, you may want to purchase a new pair of prescription eyeglasses now rather than wait until next year so the amount paid can be claimed on your tax return.
If your medical expenses are minimal this year but you expect to incur large expenses next year, make sure to save all invoices and receipts as you can potentially claim these expenses next year.
These are just a few suggestions that may be applicable to you and your family. There are many additional planning points to consider related to business owners or trust and estate planning.
For more information, please contact email@example.com or 1 844-GYTD-CPA