With this year's Halloween holiday being curtailed due to Covid, it seems like the general public is embracing the December holiday season with more gusto than usual. In fact, I've witnessed one large retail chain break open their holiday goodies while my pumpkin was still on my front porch BEFORE the end of October. Perhaps we are just done with 2020 and already looking forward to 2021. With that in mind, and before we put 2020 behind us, let's look at some yearend tax planning before 2021 is upon us.
File a Tax Return
Many new businesses experience start-up losses in the first few years, especially so for 2020 with Covid hitting everyone's bottom line. If you personally carry on a business, you should file a return for every year, even the loss years. That's because your business's loss can be used to reduce income from other sources in the current year, or it can be carried back three years and forward twenty years. The loss will reduce income from any source – be it the business itself, from employment – even from investment income. But to claim the loss, you must file a tax return for the year.
The year-end of an individual who is a sole proprietor or an active partner in a partnership created since 1995 is December 31. Self-employed taxpayers and their spouses (if not separated) have until June 15 to file a return, although any taxes owing must be paid by April 30.
Lower Your Tax Installments
If you pay taxes on an installment basis, you've probably received several notices from CanRev informing you of how much your installments should be. If your income has gone down in the last couple of years (and presumably so for 2020), think twice before you send in your cheque.
CanRev's installment calculations are based partly on your income tax position two years ago and partly on last year's. Instead of using CanRev's method, you are legally entitled to base your installments on last year's tax position. You can even base your installments on the current year's estimated tax position, if lower; but in this case be careful - penalties may apply if you underestimate your taxes and your installments turn out to be lower than the other two options required.
If your income has gone down in the last couple of years, using one of the other two options can mean that you can reduce your quarterly installments' without suffering interest penalties. But if you underinstall, CanRev will start to charge you interest. The interest rate is currently 5 per cent. However, this rate is compounded daily - worse still, it's nondeductible. So this is an expensive way to enhance your cash position. For seriously delinquent installments, there is a 50 per cent interest surcharge slapped on.
If, during the year, it becomes apparent that you have paid more installments than you need to, you might consider the possibility of purposely not following the installment schedule by paying deficient or late installments. Actually, this is quite "legal."
By the way, if you've overinstalled or paid early, CanRev gives you a credit (known as offset or contra-interest) against interest on late or deficient installments for the year. Very basically, the rule works as if you had deposited the installment in a bank account and earned interest (at CanRev's prescribed rates – currently 3 per cent for individuals and 1 per cent for corporations) to the extent that the installment is early or excessive. These "credits" can then be used to apply against interest penalties on deficient or late installments. The flip side of this, of course, is that you can reduce interest charges on a late or deficient tax installment by overpaying other installments, or paying them before their due date.
Deductions for most normal business expenses are based on whether the expense has been incurred by year end, rather than whether the item has actually been paid for, e.g., office supplies, auto and other repairs, etc. Exceptions include compound interest charges - regular ("simple") business interest can be expensed when payable, site investigation and utility service connection charges, and disability-related equipment and building modifications.
Consider accelerating purchases of equipment, capital and other expenditures before yearend. Examples include auto and equipment purchases (half of the normal depreciation can be claimed this year - next year, you claim the full depreciation rate), auto repairs, and so on. Note: even though the depreciation rules restrict the write off on capital purchases, you can claim a full GST credit, for the year of purchase. So, if you buy by the end of the year, the credit will allow you to reduce the GST you owe.
If you "accrue" a salary to family members (this must be reasonable in relation to the business service they perform) you can claim a deduction as long as you actually pay the expense within 179 days of your business' year. This may allow the recipient to defer tax on the amount until next year.
Some may think that as an employee, the ability to tax plan and reduce your taxes is somewhat restricted. However, where there is a will, there is a way.
Reducing your source deductions
For employees, one unlikely source of cash could be the source deductions withheld on your paycheque. Many people regularly get tax refunds because of deductions such as support payments, carrying charges on investments, and so on. If you're one of them, call the payroll division of your local tax office. Tell them you want to apply for a reduction of source deductions under section 153(1.1) of the Income Tax Act (if you cite the section number, they'll know you mean business). They'll send you a form and ask you for some info to back up your application. If you do, they'll probably cut your withholding so you can pocket the money. Most tax offices are quite cooperative when it comes to this procedure.
According to the CRA, there is no specific minimum amount below which they will not consider an application. Although technically, you are supposed to show that, without a reduction you're a hardship case, the CRA seems to be pretty easy on this requirement.
One item that may get you a source-deduction slash is an early 2021 RRSP contribution. Contributing early in the year also means your earnings will compound on a tax-sheltered basis sooner rather than later.
Warning: if you are basing your application on a tax shelter, questionable deduction or other aggressive tax planning, an application for reduced source deductions could bring unwanted scrutiny. Better to leave well enough alone.
- If possible, you should defer the receipt of employment income if your tax bracket will be lower in 2021.
- Employees are entitled to claim tax depreciation (called Capital Cost Allowance - CCA) on automobiles, aircraft and musical instruments, depending on the circumstances. If you're entitled to deduct CCA and you're considering purchasing a new asset, you should do so prior to the end of the year. This will accelerate capital cost allowance claims by one year. The asset must actually be available for your use to qualify for a CCA claim.
- Reduce "operating cost" tax. If the personal use of a company owned car is less than 50 per cent, consider notifying your employer by December 31 if you want the taxable operating cost benefit based on one half of the standby charge, less any reimbursements you paid. Other ways of reducing your operating benefit include reimbursing your employer for operating costs, reimbursing your employer for 100 per cent of the personal use portion of actual operating costs and minimizing your personal driving.
- Reduce "standby charge" tax. Standby charges are calculated using the vehicle's original cost. After a few years, when the vehicle is worth less, consider buying it from your employer to avoid the high standby charge. Alternatively, have your employer sell the automobile and repurchase it or lease it back or choosing a less expensive car.
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.