Canada: Year End Income Tax Planning

Last Updated: December 14 2015
Article by David Rotfleisch

Canadian Tax Lawyer 2015 Top Year End Income Tax Planning Tips

Want to pay less taxes? The end of the year brings with it opportunities for tax planning that can lower taxes. Here are some tax savings plans to reduce your 2015 taxes.

Top Income Tax Planning Tips for Individuals

Many taxpayers already engage in the practice of tax planning – they just don't realize it. Some of the best tax planning strategies from our Canadian income tax lawyers and how reduce taxes follow.

RRSPs

RRSPs are a key tool for tax planning. An RRSP allows a taxpayer to receive a deduction for the amount contributed, while also allowing the capital to accumulate tax free until retirement.

Even though the deadline is February 29, 2016, taxpayers should contribute to their RRSPs as soon as possible because the longer the amounts have to increase in value, the more compounded growth.

Open Tax Free Savings Accounts

The tax free savings account is a relatively new tax saving measure, but it can be used to generate large tax savings. While deposits to a TFSA are not tax deductible like RRSPs, the accrued capital gains, interest and dividends earned in the account are not subject to income tax when earned or when withdrawn.

Use Family Members to Expand TFSA Limit

Normally, when a taxpayer gifts a spouse or child shares or other investment, attribution rules in the Income Tax Act apply, meaning that any income earned on the gifted shares accrues to the parents personally. However, because income earned inside a TFSA is free of tax, taxpayers can gift shares and other investments to family member's TFSA account without having the income attribute back to them. This is a boon for planning around the TFSA personal limit. Note that gifting shares may results in tax on any accrued gain. In the case of gift to a spouse, any loss will be denied.

RESP Contributions

Registered Education Savings Plans are a great way to not only save money for a child's education, but they also offer an attractive tax break. Though the amounts contributed to the plan are not tax deductible, the funds themselves accumulate tax-free. The government also provides a grant equal to 20% of your contribution to the RESP up to a prescribed maximum per year of $500 and subject to a upper limit of $7,200 over the life of the account. The funds are permitted to accumulate tax free, while the account allows for a maximum contribution of $50,000 over the life of the plan.

Dispose of Non-Qualified Assets in RRSPs

Many taxpayers manage their own RRSP through discount brokerage accounts and other similar products. The danger in doing so is that not all taxpayers are aware that not every type of investment are permitted for RRSP investing purposes. Non-qualifying investments are taxed at 50% of the value of the investment when placed into an RRSP.

Taxpayers can claim a credit on this onerous tax providing they dispose of the offside investments within the taxation year that they are purchased. Proper advice should be sought to ensure that all non-qualifying investments are disposed of before they trigger adverse income tax problems.

Plan for Retirement

Taxpayers who are nearing retirement and have an RRSP account will need to pay special attention to the rules of the program. If a taxpayer is turning 71 in the current taxation year, they must convert their RRSP to a Registered Retirement Income Fund ("RRIF") no later than December 31. If the taxpayer fails to do this then the full market value of the RRSP will be added back into income for the current year.

Also bear in mind that there are options beyond a simple RRIF; you can choose to receive an annuity, a lump sum payment or a combination of these options. If the taxpayer has a spouse, they may also consider creating a spousal RRSP so that they can contribute to the plan until the spouse reaches 71. In order to do so, the taxpayer must have unused contribution room left on their personal RRSP account.

Top Income Tax Tips for Charitable Deductions

As with any deductible expense, taxpayers should review their anticipated donations for the first quarter of 2016. If a taxpayer normally gives to specific charities in the early part of the year, they should consider donating before the end of 2015.

Donate Shares Instead of Cash

Taxpayers can also validly donate shares of publicly traded corporations to charity and still reap the tax benefits. Not only will they receive a charitable donation deduction, but the added benefit of donating in this way means that the shares will not be subject to the capital gains tax upon disposing of the shares to the charitable organization.

Utilize the New First Time Donor Tax Credit

New rules in the Income Tax Act offer an additional 25% of credit for charitable donations made by a taxpayer who has never claimed a charitable donation in the past. This "super credit" is only available for the taxation years 2013-2017, so taxpayers should plan accordingly.

Given that the first time credit will only be available to each taxpayer once, a good strategy would involve saving up all planned charitable donations for 2 or more taxation years to take advantage of the additional credit in one taxation year. The "super credit" is only available up to a limit of $1,000.

Top Employment Related Income Tax Planning Tips

While a general rule in Canada is that expenses incurred by a taxpayer with respect to their employment are not deductible there are certain exceptions. At the same time, depending on the taxpayer's relationship with their employer they may inadvertently trigger unforeseen tax problems.

Purchase Employment Assets

While the Income Tax Act does not generally allow for the depreciation of employment related capital property, employees are entitled to write off depreciation on cars, planes and musical instruments. Taxpayers planning on purchasing one of these products should do it late in the year to enjoy the benefit of accelerated capital cost allowance claims.

Similarly, tradespersons and apprentices are permitted to deduct the cost of their tools up to a prescribed limit. Qualifying individuals should consider doing this before the yearend to maximize deductions.

Loans from your Employer

If a taxpayer has taken a loan from an employer it can lead to tax problems at the year-end if precautions are not taken. If the loan does not have a reasonable interest requirement, the CRA can assess for a taxable benefit received. The amount of tax is calculated as a percentage of the loan – in a manner similar to interest – however any interest that a taxpayer does actually pay will reduce the tax liability. If the interest is not paid within 30 days of the end of the taxation year, the employee will be deemed to have received an employment benefit.

Taxpayers should ensure that they are not only being charged reasonable interest on any loans from employers, but also that they pay that interest to ensure no adverse income tax problems.

Give Employees Non-taxable Gifts

Non-taxable gifts of up to $500 annually and non-cash long-service and anniversary awards (also under $500 annually) can be given to arm's length employees and can still be deducted as business expenses.

Top Income Tax Investing Tips

While RRSPs and TFSAs are a valuable tool for tax planning, they do have contribution limits. Many taxpayers may wish to invest their money held outside of these accounts. There are also many opportunities for tax planning around a taxpayer's investments outside of the RRSP and TFSA.

Capital Losses

Taxpayers who have incurred capital losses in the year can utilize them to reduce capital gains for the current year and they may be carried back to offset capital gains from previous years and allow the taxpayer to receive a refund of previously paid taxes. If you own capital property that has gone down in value, consider disposing of it in order to shelter any possible gains that you've made in 2015. This type of planning can be complex so suitable advice from one of our top experienced Toronto income tax lawyers should be obtained.

Delay Purchases of Mutual and Equity Funds

Investors thinking about purchasing mutual funds should consider waiting until the beginning of the new year to do so. A common practice of both mutual and equity funds is to make distributions once per calendar year. Taxpayers who purchase these types of funds will be allocated a full share of the fund's gains and income – meaning they will be allocated full year's worth for taxation purposes.

A better strategy is for investors to wait until the new-year before purchasing. By doing so, taxpayers will not need to bring the income, which was not even received, into their income until the next taxation year.

Review Interest Expenses

Taxpayers should always take some time near the year-end to review their debts and determine which interest expenses are properly deductible. Depending on what use a taxpayer puts borrowed money towards there are tax savings that may be available. Essentially, so long as borrowed money is utilized to earn business or investment income, it will be properly deductible.

A good tax-planning strategy involves the careful planning of borrowing practices. Taxpayers should always ensure that they borrow for business or investment purposes wherever possible while utilizing non-borrowed money for personal expenses. By doing so, taxpayers will be able to maximize their tax savings on the year. This type of planning should be carefully implemented by an experienced Canadian tax lawyer to avoid future tax problems.

Utilize your Capital Gains Exemption

Taxpayers who own shares of a qualified small business can make use of a lifetime capital gains exemption of up to $800,000. Taxpayers who have shares that have accumulated in a small business should consider disposing of them to a spouse or corporation they control in order to reap the tax advantage of the capital gains exemption.

Alternatively, taxpayers who can not claim the lifetime exemption may consider using the proceeds from the sale of small business shares to purchase shares in another qualified small business. By doing so, the Income Tax Act allows the capital gains to be deferred until subsequent disposal if the new shares qualify.

Top Income Tax Planning Tips when Carrying on a Business

When a taxpayer carries on business, be it personally or through a corporation, the opportunities for planning to reduce overall tax liabilities multiply.

Business Loss "ABIL"

If a taxpayer has an allowable business investment loss ("ABIL"), a loss on shares or a debt with a small business owned, it can be utilized to reduce overall taxable income. In order to claim an ABIL, ensure that shares have been sold or clearly establish the write-off of a bad debt that is regarded reasonably as being uncollectible.

Small Business Deduction

Canadian Controlled Private Corporations ("CCPC"s) with active income of less than $500,000 are permitted to utilize the small business tax deduction. An essential tax strategy for corporations with active income in excess of $500,000 is to declare a bonus to a shareholder of the company to reduce income to $500,000. The bonus must actually be paid within 180 days of the company's fiscal year-end and all payroll deductions must be taken and remitted.

Pay Salaries to Spouse/Family Members

Business owners are entitled to pay reasonable salaries to family members who work for the business. This is an effective method of splitting income and bringing down the overall tax rate. It also provides family members with contribution room in their own RRSPs.

Salaries must be reasonable in the context of the tasks the family members actually perform. Proper books and records are required in case of an audit in the future, so taxpayers should ensure strict compliance with the record keeping requirements of the tax act to avoid future unexpected tax problems.

Optimize Your Compensation Strategy

A compensation strategy normally includes a combination of salary, bonuses and dividends. Bonuses allow payment to be deferred until after year-end. If income may exceed $200,000 in 2016, consider paying bonuses and dividends before the end of 2015 to avoid a possible increase in the top rate of tax promised in the recent election campaign.

Timing of Expenses

Taxpayers in business should accelerate expenses to make purchases that can be deducted this year rather than waiting for the new year. Employees are entitled to write off depreciation on cars, planes and musical instruments. Tradespersons and apprentices are permitted to deduct the cost of their tools up to a prescribed limit. Individuals planning on purchases should do so late in the year to enjoy the benefit of depreciation claims this year.

Plan to purchase any capital property that before the tax year-end to be able to claim CCA deductions (at 50% of full rate) this year. Furthermore, until Dec 31, all manufacturing and processing (M&P) equipment qualifies for a 50 percent straight line depreciation rate which allows for faster write off then the normal declining balance that will kick in on Jan 1.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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