Tax Planning

Tax Planning is a very vast subject. here are a few tips to save money by doing some planning.

TAX PLANNING – INCOME SPLITTING

A Canadian taxpayer’s income tax bracket and therefore the income tax liability depends on the absolute amount of the taxpayer’s income because the higher the income the higher the income tax bracket and the percentage of income tax paid. Income splitting is a tax planning strategy whereby one taxpayer transfers a portion of his/her own income to another taxpayer who is taxed at a lower tax rate. There are various income-splitting techniques that can be used.

INCOME SPLITTING TAX PLANNING- SALARIES

A small business owner can often income split with a spouse by employing the spouse in the business as a T4 employee or by having the spouse own shares of the corporation and receive dividends. Any salary paid must be reasonable and supported by the actual work done. A written employment agreement is very advisable. If the spouse or children are going to own shares of the business, care must be taken to avoid the income tax attribution rules that attribute income or capital gains on the property back to the spouse who originally owned the assets.

Maximize CCA (Tax Depreciation) – Buy Capital Assets Just Before Business Year End

If you purchase business capital assets immediately before your business year-end, you can claim a capital cost allowance (income tax depreciation) of 50% of the capital cost allowance rate in that year. If you buy the asset just after the year’s end then you claim that same rate, but only in the next year, postponing your income tax deduction by one year.

Sell Business Capital Assets After Business Year End

By disposing of capital assets (business property) after the business taxation year end you defer income taxes on the capital gain and depreciation recapture until the next year end.

Consider Income Tax Effects Of Dividends Vs. Salary/Bonus

Owners of a business should consider using a mix of salary or bonus and dividends to minimize overall taxes for the individual shareholder-owner and the corporation. This should be done every year and requires income tax planning and calculations done by the corporation’s accountant.

Consider Setting up a Private Pension Plan

Contributions to employees’ registered pension plans, including plans for the shareholders, are tax-deductible to the company as business expenses. The employer’s pension contributions to the RPP are not taxable for the employees. Private pension plans can be set up for owners and managers instead of a Registered Retirement Savings Plan and are an effective tax planning tool.

Repay Shareholder Loans Within 2 Corporate Year Ends

Shareholders and owners can always take funds from the business as shareholder loans or draws, but there are tax implications and rules that have to be followed. If the shareholder loan amount is repaid within two business years ends (ie. by the end of the following business year), the amount of the loan is not deemed to be a taxable benefit to the shareholder/owner (borrower). If it is outstanding for 2 corporate year ends then subsection 15(2) of the Income Tax Act includes the full amount in the income of the shareholder. However, if the shareholder did not pay interest on the loan, or paid interest 30 or more days after the end of the taxation year, then the shareholder is deemed to have received a taxable benefit for the unpaid interest.

Three D’s of tax planning

Tax planning must include strategies to deduct, defer and divide. The concept of effective tax planning can have a different meaning and emphasis depending upon your personal circumstances. Add in the fact that governments introduce new tax legislation every year and we begin to understand why Albert Einstein said, “The hardest thing to understand is income tax“.

Deduct, defer and divide

The three ‘D’s’ to investing are deduct, defer and divide. You must be able to understand all of these important functions in order to do effective tax planning.

• • Deduct – A deduction is a claim to reduce your taxable income. A deduction will reduce your tax bill by an equal amount to your marginal tax rate. Some common deductions include:
    • • Pension plan contributions
    • • RRSP contributions
    • • Safety Deposit Box Fees
    • • Interest expense
    • • Union/professional dues
    • • Alimony/maintenance payments
    • • Employment expenses
    • • Moving expenses
    • • Professional fees
    • • Child care expenses

• • Defer – A deferral strategy is to try to push having to pay tax now into future years. Deferring tax means you might eliminate the tax this year but you will eventually have to pay the tax down the road. Generally, tax deferral has 2 advantages: (1) It is better to pay a dollar of tax tomorrow than it is to pay a dollar of tax today and (2) Tax deferral typically puts control of when you have to pay the tax in the hands of the taxpayer instead of in the hands of the Canada Custom Revenue Agency (CCRA).RRSPs, RESPs, and various investment income strategies are the most common forms of tax deferral for the ‘average’ Canadian.

• • Divide – Often called income splitting, dividing taxes implies the ability to take an income and spread it among a number of different taxpayers. For example, if you have one person paying tax on $70,000 vs. having 2 people (say husband and wife) paying tax on $35,000 each, you would rather have the second scenario. Unfortunately, you cannot arbitrarily decide who is going to claim what amounts for income. There are, however, strategies to divide income within the rules of the CCRA:
    • • Spousal RRSPs help split the income in retirement.
    • • Splitting CPP retirement benefits with your spouse.
    • • Pension splitting for retired couples.
    • • Investing non-RRSP savings in the lower income family members.
    • • Investing the child tax benefit in your children’s name.
    • • Utilizing RESP contributions.
    • • Payment of wages to family members (through a business).
    • • Use of partnerships or corporations to earn business income.
    • • Utilizing either inter-vivo or testamentary trusts.

My two cents

I’ve always said that good tax planning far exceeds good investment planning. While taxation gets more and more complicated with every budget, the fact remains that you must understand the basic concepts of tax deductions, tax deferral, and income splitting (dividing).

Sometimes tax planning will bring immediate benefits but often the benefits of tax planning take time to feel the rewards. Many people are scrambling to get their taxes done for the current year but it is probably too late to do any planning for the previous year.

The key foundation stones to effective planning include:

1. 1. Maintaining and retention of good records.

1. 1. Keeping informed and up to date.

1. 1. Knowing your needs and your goals.

1. 1. Assembling a team of good professional advisors.

I’ll leave you with one final quote by Marc Denhez “Anyone who believes that Canada’s only two official languages are English and French has never read the Income Tax Act.”

Obviously, if you are confused with the tax act and all the different rules then seek the help of a qualified professional to help you do some effective tax planning.

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