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Oct. 19, 2012
Strategies for reducing taxes
There are at least five ways in which you can pay less to CRA.
SAM SHAMASH
When you work for your investment income, the last thing you want to do is see your returns eroded by taxes. But at least you can do something to protect the money you do make. Following are several strategies that can help you reduce your family’s tax bill. Please note that this article is for information purposes only and you should consult with a professional advisor before taking any action based on the information provided.
An historic opportunity right now: the spousal loan strategy
If you pay taxes at the highest rate, you know just how punishing Canada’s marginal tax system can be. But, if your spouse earns little or no taxable income, you currently have an opportunity to reduce your family’s overall tax bill using the spousal loan strategy. Here’s how it works. First, you make a loan to your spouse, which is backed by a simple promissory note setting out the terms of the loan. Then, your spouse invests the entire loan amount in their own name. This way, the investment income is taxed at your spouse’s lower marginal rate – reducing your family’s overall taxes.
To ensure that the income is taxed in your spouse’s hands – and not yours – your spouse must pay you interest at a certain rate, which is set by the Canada Revenue Agency (CRA). Currently, the CRA-prescribed interest rate on spousal loans is one percent, creating an unprecedented opportunity to maximize this proven yet often overlooked strategy. Bear in mind the rate is reviewed every quarter by CRA and may be different after Dec. 31, 2012.
Helping your family while reducing taxes: the family trust
You could be looking at some large capital gains over the next few years as the stock markets recover. One way you can reduce these taxes is through a family trust. With a family trust, you can effectively transfer the tax obligation for the taxable income generated in the trust to your children or grandchildren. Because of the basic personal amount they can claim on their tax returns, they can each earn up to approximately $50,000 in tax-free income, depending on the income mix generated in the trust (varies by province of residence).
To qualify for the tax break, the income generated in the trust must be used for the benefit of, or be made payable to, the beneficiaries of the family trust. If you are currently paying for things like your children’s education costs from your after-tax income, the family trust can make a lot of sense. When properly structured, you don’t pay taxes on the capital gains earned within the trust, so your dollar goes a lot further in covering this sort of cost.
Earn tax-free investment income
The tax-free savings account (TFSA) is a no-brainer for anyone looking to reduce taxes. With the TFSA, you can earn tax-free investment income and make tax-free withdrawals any time you want for any reason. You can contribute up to $5,000 annually and, while this may seem like a small amount now, over time, it can make a big difference, especially with the effect of tax-free compound growth.
Charitable donations
In addition to registered retirement savings plan contributions and investment tax shelters, making a charitable donation is one of the few remaining ways that you can significantly reduce the personal tax you pay. The final day to make contributions to a registered charity in order to claim the donation tax receipt on your 2012 income tax return is Dec. 31, 2012. Due to the calculation of the donation tax credit, donations above $200 can result in a tax savings equal to the top marginal tax rate in your province of residence (except Alberta, where the donation tax credit is equal to 50 percent). For example, a donation of $10,000 can result in tax savings of approximately $4,300 for residents of British Columbia.
As an alternative to cash, you can also donate publicly listed securities in-kind to qualified charities without being subject to tax on the capital gain. You will receive a donation tax receipt equal to the fair market value of the security at the time of the donation, which can help reduce your income tax on your other income.
RESP contributions
Registered education savings plans (RESPs) are not only an excellent way to save for a child’s post-secondary educations costs – they are also a good income-splitting strategy. Since 2007, RESPs offer even more flexibility to families who want to save money for education. The annual contribution limit was eliminated and the lifetime contribution limit was increased to $50,000. Since the maximum annual RESP contribution qualifying for the 20 percent Canada Education Savings Grant (CESG) has increased to $2,500 from $2,000, you’ll want to have contributed at least that amount by Dec. 31, 2012. You do not have 60 days after the end of the tax year to contribute to an RESP like you normally do for RRSP contributions. Though the official deadline to contribute to an RESP for the 2012 tax year is Dec. 31, 2012, any unused government grant room (i.e., CESG) can be carried forward until the year the child turns age 17, subject to annual maximums.
Sam Shamash, CA, CBV, CFP, FCSI, is vice-president, director and portfolio manager at RBC Dominion Securities. He can be reached at [email protected]. For more information about the above, and other, tax-reducing strategies, call 604-718-3135 and visit dir.rbcinvestments.com/sam.shamash.
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