As year end is fast approaching, taking some time to review your financial affairs may yield significant tax savings. To keep more money in your pocket, we have summarized some common year end personal tax planning tips for you.
Year end expenses
You can deduct certain expenses you paid in the year on your personal income tax return. These include investment management fees, tuition fees, deductible accounting and legal fees, childcare expenses, alimony, and medical expenses. Remember to pay them by December 31 if your intention is to deduct them on your current year tax return.
Planning for year end bonus
Receiving a bonus prior to year end creates additional RRSP contribution room for next year if you have not yet reached the next year’s maximum RRSP limit. Conversely if you expect to be in a lower tax bracket next year, consider deferring the receipt of your bonus to early next year.
Tax loss selling
If you have realized capital gains during the year and you are holding investments with unrealized losses, consider selling the investments to realize the losses. This strategy of selling investments at a loss to offset capital gains realized during the year is a year end personal tax planning technique known as tax loss selling. Review your portfolio to determine if any investments are in a loss position and no longer meet your investment objectives. If the investment still has strong fundamentals and meets your investment needs, consider all potential costs and tax benefits.
When using the tax loss selling strategy, you must be aware of the superficial loss rules. It occurs if you acquire an identical investment that was sold at a loss within a period of 30 days before and 30 days after the settlement date. If you violate the superficial loss rules, the capital loss will be denied.
Also, for any capital loss realized in excess of the current year’s capital gains, the balance of the loss can be carried back three years. When you carry back a capital loss to offset the previous year’s capital gain, it reduces your taxable income for that previous year and may result in additional tax refund.
Deferral of capital gains
On the flip side, if you currently have unrealized capital gains, you should consider deferring the realization of capital gains until next year if you anticipate a lower tax rate next year.
In addition, realizing capital gains at the end of this year means that any tax payable associated with the gains must be to be remitted to the CRA by the next few months (April 30). Realizing capital gains at the beginning of next year means delaying taxes payable until the following year (unless you are required to make tax instalment).
If you are required to make quarterly tax instalment payments to the CRA, remember to make your final payment by December 15 to avoid late interest charges. If you missed an earlier instalment payment deadline, consider making a larger final instalment payment or making the final instalment payment earlier than December 15 to minimize late interest charges.
Making a charitable donation is another way to reduce your personal tax. The final day to make donations to a registered charity is December 31. Remember to ask for a donation tax receipt so you can claim it on this year’s personal tax return.
If you haven’t done it already, make a TFSA contribution for this year and catch up on any unused contribution room since 2009. Check your TFSA contribution room first to avoid over-contribution penalty.
Also, if you are thinking of making a withdrawal from your TFSA in the near future, consider doing so before December 31. This will allow you to recontribute the amount withdrawn as early as January 1 rather than having to wait for another year.
Low tax bracket year
If you are in a low tax bracket this year and expect to be in a much higher tax bracket during retirement, you should consider making an early withdrawal from your RRSP before year end. The advantage of this strategy is to avoid a higher tax rate on RRSP withdrawal in the future when your tax rate may be higher.
If you reinvest RRSP funds in your TFSA, you are not required to pay any future tax on the income earned or capital gains realized. The drawback of this year end personal tax planning strategy is a prepayment of income tax and lost tax deferral on the growth of the RRSP funds withdrawn.
Registered Education Savings Plan (RESP) is a way to save for a child’s or grandchild’s post-secondary education and can be used as an income splitting vehicle. The lifetime contribution limit is $50,000 per beneficiary and there is no annual contribution limit.
By making RESP contributions, you are also eligible to receive the Canada Education Savings Grant (CESG). The government will match 20% of the first $2,500 in annual contributions to a maximum grant of $500 ($2,500 x 20%) per beneficiary each year. Each beneficiary can receive a lifetime maximum CESG of $7,200. Therefore, consider making a RESP contribution by December 31 if you haven’t maximized your contributions to take advantage of CESG and tax-deferred growth in the RESP.
The income earned on CESG and contributions in the RESP will be taxed in your child’s or grandchild’s hands, who likely has a lower tax rate than you.
Interest on family loan
If you set up a spousal loan at a prescribed rate, remember to pay the interest owing by January 30 of next year. The borrower may be able to claim a deduction for the interest paid on their tax return. The lender will have an income inclusion on their tax return. The timing of the income deduction and inclusion depends on the year the interest relates to, when the interest is paid, and the method you regularly use in computing your income.
Buying mutual fund
When you buy a mutual fund part way through the year, you are buying the fund at its net asset value, which includes any accumulated income and gains that have not yet been distributed. When the fund makes a distribution, it includes all accumulated earnings and the distribution is fully taxable.
There are 2 ways to avoid the distribution. For new purchases, you could simply buy the fund after the distribution date. By doing so, the fund is purchased without any accumulated income and gains.
If you have already bought the fund, consider selling it prior to the distribution date. Before selling, review the size of the potential distribution and the resulting tax liability. It is critical to determine how much you will save by avoiding the receipt of this distribution in comparison to the costs that a sale could trigger.