Year End Tax Planning

As the end of the calendar year approaches, many people turn their attention to income tax planning. Individuals are taxed on a calendar year basis, so December 31 represents the last date for transactions that affect that year's taxes. There are other tax deadlines that fall around this time or early in the new year, such as the RRSP contribution deadline. Therefore, the calendar year-end is generally a good time to take stock of your income and deductions, and to make decisions about your overall tax position for the current and next calendar year.

Ideally, tax planning should be considered on an ongoing basis throughout the year, as part of an overall financial plan. All taxpayers should review their particular situation regularly to ensure that they’ve structured their financial affairs to minimize tax as much as possible. In particular, any major transactions should be examined in advance to ensure that tax considerations are taken into account. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

However, even if you haven’t actively monitored your tax situation throughout the year, there are still a number of steps you can take before year-end to minimize your taxes for that year. 

Employment Situations

1. If you had a low-interest loan from your employer during any part of the year, you’re deemed to have received a taxable employment benefit. This is calculated as interest at the Canada Revenue Agency’s (CRA’s) prescribed rates (Click HERE for more) for the period during which the loan was outstanding. The amount of the benefit is reduced by any interest you actually paid on the loan. However, the interest must be paid within 30 days of the end of the calendar year.

2. Review your personal use of employer-provided automobiles. The use of these automobiles could result in a taxable benefit. Click HERE for more.

3. Purchase assets eligible for CCA before year-end. Employees are entitled to claim tax depreciation (called Capital Cost Allowance—CCA) on only three types of assets—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.

Business Situations

1. Maintain your calendar year reserve. Under changes which came into effect in 1995, unincorporated businesses are required to report business income on a calendar year basis. The income reported arises from an actual calendar year-end or, in some cases, from estimated calendar year income under the alternative method. Given that more than 12 months worth of income would have to be reported in 1995, a reserve mechanism was introduced which allows the extra income to be taxed over 10 years. If you’re considering winding up your business operations, you may want to wait until early in the calendar year so that the remaining portion of your reserve won’t be taxed until the following year.

2. Pay salaries to family members before year-end. If your spouse or children work for you, consider paying them salaries. Salaries paid reduce your income and are taxed in their hands, possibly at lower marginal tax rates than if the income had been paid to you. They also provide family members with earned income for RRSP contributions. Any salary paid must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party. A record should be kept of the time actually spent and the services actually performed. Also, whenever you pay salaries to your spouse or children, ensure that withholdings for income tax, Canada/Québec Pension Plan (CPP/QPP), Employment Insurance (EI) and any applicable provincial payroll taxes are remitted as required.   

3. Purchase capital assets before year-end. If you’re planning to purchase capital assets in the near future, consider doing so before the end of your fiscal year. If the assets are acquired and in use before year-end, you can claim one-half the usual CCA rate. Even if you’re in a loss position this year, purchasing the asset now will allow a full year’s CCA claim next year. Bear in mind that title to the asset must be acquired and it must be available for use in order to claim CCA.

Owner-Manager Situations

1. Consider paying yourself dividends from your corporation. In certain situations, a corporation can be used to split income with family members. For instance, if your spouse or children, who are 18 years of age and older, subscribe for shares of your corporation at fair market value using their own funds, they can receive dividends from the corporation out of its after-tax profits and you can split income. In most provinces, an individual with no other income can receive about $25,000 of dividends without paying tax. Also, dividends paid by the corporation before its year-end could generate a tax refund on its corporate tax return, if it has previously earned investment income on which it paid tax. There could be a problem with this type of planning if you’ve loaned or transferred property to the corporation. Click HERE for more. 

2. Review your salary/dividend mix from the corporation. If you draw funds from your corporation throughout the year for personal expenses, you should determine whether the amounts will be characterized as salary or dividends before year-end. Otherwise, the funds withdrawn could be treated as a shareholder loan unless certain conditions are met. A shareholder loan would be included in your income without benefit of the dividend tax credit, and without being deductible to the corporation as salary. Also, it would not be considered earned income to you for RRSP purposes. In general terms, if your company earns less than $200,000 of active business income, it’s usually better to declare dividends, the payment of which can offset the shareholder loan. If active income exceeds $200,000, you should generally have the corporation pay you a salary or bonus to reduce its income to $200,000. For further details, see our bulletin Incorporating Your Business. Of course, as is almost always the case with general rules, there are exceptions. Drawing dividends alone will not provide you with earned income for RRSP purposes. Also, if you have no other sources of earned income and your spouse works and earns more than you, neither one of you will be eligible to claim child care expenses. Child care expense deductions are limited to 2/3rds of the earned income of the lower income spouse. Therefore, you should ensure that you receive enough salary to allow a maximum RRSP contribution and a claim for child care expenses.

3. Consider paying interest on shareholder loans. If you’ve paid yourself sufficient salary to maximize your RRSP and family’s child care deduction claim, and your corporation still has active business income that is too high and is no longer subject to the small business deduction (click HERE for more), you should consider charging interest on any loans you’ve made to the company. The interest would be deductible to the corporation and would not be subject to provincial payroll taxes. To be deductible to the corporation, the interest must be charged at a reasonable rate. Also, there must be a legal obligation to pay interest established in advance. Therefore, if you intend to charge interest on your loans to the corporation, you should establish the terms at the beginning of the year.

4. Consider planning techniques to reduce your corporation’s taxable capital before year-end. Depending on their size, corporations can be subject to provincial capital taxes and federal Large Corporations Tax. The jurisdictions vary in how they calculate taxable capital and the rate at which the tax is charged. Taxable capital usually includes share capital and debt, and may require some tax-based adjustments. All jurisdictions provide an allowance which reduces taxable capital for certain specified investments. There are a number of very simple steps that can be taken prior to year-end to reduce capital tax. For instance, using excess cash to pay off some debts may reduce your taxable capital.

5. Purchase older automobiles from your corporation. If you use an older corporate-owned automobile for personal use, you may want to purchase it at fair market value. Buying the older automobile now will ensure that you won’t be taxed on a large automobile benefit next year. Click HERE for more.

Investment Situations

1. Review the mix of investments in your portfolio. Each type of investment income is taxed differently. Most interest must be accrued annually and is fully taxed. Dividends are only taxed as received and are eligible for the dividend tax credit. Capital gains are taxed when realized. Because of the dividend tax credit, a dividend is roughly equivalent to 1.3 times the same amount of interest. That is, a share yielding a 6% dividend produces approximately the same after-tax return as a bond with interest at 8%. However, you must also take into account other factors, such as risk, liquidity and opportunity for capital appreciation. Year-end is an excellent time to review the mix of investments in your portfolio to ensure that you’re getting the best returns on an after-tax basis.

2. Consider the timing of the taxation of interest-earning investments. Interest on investments purchased after 1990 must be accrued annually on the anniversary date of the investment, unless you receive the interest more frequently. This applies even if you have not yet received the interest. Also, some investment products pay interest at increasing rates over the term of the investment. For tax purposes, you may find that you must report the interest at an “average rate,” with higher income recognized in the earlier years, when the actual interest received is lower. Be sure to take into consideration the timing of the receipt of income and the tax consequences, when investing. Also, if you’re thinking of purchasing a Guaranteed Investment Certificate towards the end of a calendar year, you may want to consider delaying the purchase to the next calendar year to defer the recognition of the income to the second calendar year.

3. Review your outstanding debt to ensure that you make your interest expense deductible to the maximum extent possible. To be deductible, interest expense must relate to debt incurred to earn business or investment income. Interest on personal debts such as mortgages or car loans and interest incurred to make RRSP contributions are not generally deductible. Review your loans outstanding at year-end and your overall cash position. Where possible, pay off non-deductible debt as quickly as possible. Avoid using excess funds to pay off business or investment loans, if you know you will have to make large personal expenditures in the near future. Where you have a choice, always borrow for investment or business purposes over personal uses. Also, note that where you’ve sold an investment at a loss after 1993 and continue to carry debt incurred to purchase the investment, you should leave these loans outstanding as long as you have other non-deductible debt that could be paid off first. Interest from debts relating to the loss on an investment (other than real estate or depreciable property) continues to be deductible as long as those debts remain outstanding.

4. Consider delaying mutual fund purchases. If you’re considering purchasing units of a mutual fund, you may want to defer the purchase until early the next calendar year. Many mutual funds (and most equity funds) distribute income and capital gains once a year, during December. Consequently, if you purchase units of a fund just prior to a distribution, you will be allocated a full share of the mutual fund’s income and gains for that year. Deferring the purchase until early January will ensure that you won’t be allocated taxable income for the current year.

Capital Gains Situations

Click HERE for tax rates on capital gains. Capital losses can generally only be deducted to the extent you have realized capital gains in the year. Capital losses may also be carried back three years or forward indefinitely to offset taxable capital gains that have been realized in other years. Review your asset sales for the year to determine your net capital gain/loss position, and consider the following planning points.

1. Utilize your capital gains exemption for qualified small business corporation shares and qualified farm property. A $500,000 capital gains exemption is available for capital gains from qualified small business shares and qualified farm property. If you own such assets with accrued gains, you can trigger the gain by means of an actual sale to a third party, or by transferring the asset to your spouse (if you elect to transact at fair market value), or to a corporation you control.

2. Consider selling investments with accrued losses before the end of the year. If you’ve realized capital gains in the year, consider selling assets with an accrued loss to offset the gain. You may also want to realize the loss if you’ve had capital gains in the last three years that weren’t offset by your capital gains exemption.

3. Consider carryback of capital losses realized in the current year. Where you have realized a capital loss in the current year and have taxable capital gains that you realized in a prior year (going back 3 years), you could offset the loss against that gain and get a tax refund.

RRSP Situations

1. Make contribution to your RRSP for the current year. Your prior year Notice of Assessment should include the CRA's calculation of your current year contribution limit. Your contribution must be made on or before February 28 of the following year to be deductible for current year. If you don’t have the necessary funds, consider borrowing to make the contribution. Although interest on an RRSP loan is not deductible, borrowing still makes sense if you can repay the loan within a year. If you receive a tax refund, you can apply it to the loan to reduce the balance outstanding. If you decide not to contribute for the current year, your ability to do so carries forward indefinitely. However, even if you don’t need the deduction for the current year, you should still make the contribution if you have excess funds which would otherwise earn taxable income in your hands. You can claim the deduction in any future year. The income from the funds will accumulate tax-free in your RRSP. If you have excess investment funds, make your RRSP contribution for next year as soon after December 31st as possible, to maximize the deferral of income earned in the plan. You can also make a one-time overcontribution to your RRSP. Penalties do not apply if the amount is less than $2,000 and, as noted above, income from the funds will accumulate tax-free in the RRSP.

2. Withdraw RRSP funds in low income years. If your income is abnormally low, consider withdrawing funds from your RRSP before the end of the year. This alternative would generally only appeal to someone in the lowest tax bracket who would otherwise waste available deductions and credits. Keep in mind that once RRSP funds are withdrawn, the amounts can only be recontributed to the extent you have RRSP contribution room available in the future. Also, income earned on the funds withdrawn will no longer benefit from tax-free accumulation in the RRSP. When you withdraw funds from your RRSP, tax is withheld by the plan administrator. For amounts under $5,000, the rate of withholding is 10%, but increases to 20% for amounts between $5,000 and $15,000, and to 30% for amounts over $15,000. If you’re not subject to withdrawal fees or the fees are nominal, consider keeping each withdrawal to less than $5,000. You’ll receive a T4RSP slip, showing the amount of the withdrawal and the tax withheld. When you file your tax return, include the amount in income, calculate the final tax, and claim the withholdings as a tax payment.

3. Sell non-qualified assets in your RRSP before December 31st. There are specific rules as to the types of assets your RRSP can hold. If you have a self-directed RRSP, you may have purchased assets which don’t qualify. When you purchase a non-qualifying asset, the cost of the asset is included in your income in the year of purchase. You’re allowed a deduction for the amount of the proceeds when the asset is sold, up to the original inclusion. Therefore, if the purchase and sale are in the same year, the deduction may offset a part or all of the income. Make sure the plan sells non-qualifying assets before December 31st.

4. Purchase an annuity to claim the pension income credit. If you’re 65 or over, you’re entitled to claim a tax credit on your first $1,000 of pension income. The credit is equal to the tax that would be paid on the income at the lowest tax bracket. If you don’t currently receive pension income and are in the lowest tax bracket (income less than $30,004), consider using a portion of your RRSP funds to purchase an annuity which pays at least $1,000 per year. The income will effectively be received tax-free. If you’re in a higher bracket, there will be a tax cost, depending on your marginal tax rate.

5. Delay RRSP Home Buyers’ Plan (HBP) withdrawals until after year-end. qualify, you and your spouse can withdraw up to $20,000 tax-free from your RRSP towards the purchase of a principal residence. The home must be purchased by October 1st of the year following the year of withdrawal. Amounts withdrawn must be repaid to RRSPs in 15 equal instalments, starting with the second taxation year following the year of withdrawal. If you’re planning on using the HBP towards year-end, consider deferring your withdrawal until after December 31st. This will extend your time period for purchasing your home and repaying the amounts withdrawn by one year. You’ll also want to delay your HBP withdrawal if you won’t be withdrawing the full amount in the current year. Under the HBP rules, multiple withdrawals are possible, but all withdrawals must be made in the same calendar year. Consequently, if you will be withdrawing funds in the following year, you won’t want to make an HBP withdrawal in the current year.

6. Remember to collapse your RRSP if you will turn 69 this year. You can’t have an RRSP past December 31 of the current year if you’re 69 or older at year-end. Prior to December 31 of the current year you must either collapse your RRSP and pay tax on the fair market value of the plan’s assets, or purchase an annuity or transfer your RRSP assets to a Registered Retirement Income Fund (RRIF). No tax is paid on the purchase of an annuity or the conversion to an RRIF. If you will generate RRSP contribution room for the next year but you have to collapse your RRSP before the end of the current year, consider making an overcontribution to your RRSP in December of the current year, immediately before collapsing it. The amount of the overcontribution should equal $2,000 plus the following year’s contribution limit. A 1% penalty tax on the overcontribution in excess of $2,000 will apply for December of the current year. However, this will end on January 1 of the following year when the new contribution room becomes effective. The basic $2,000 overcontribution will become deductible when you generate additional RRSP room in the future and will never attract the 1% overcontribution penalty tax. If you must collapse your RRSP this year, you can still contribute to your spouse’s RRSP if you have contribution room and your spouse is a year or more younger than you. This is an excellent way to build up your spouse’s RRSP.
   
   

The proper use of these planning techniques can reduce, eliminate, or defer the tax you pay. Careful planning with a Chartered Accountant is warranted. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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