December 2007

Decision Time

pointNot much time left before 2008 rolls around. So, in the list below, you'll find some of the items you mustn't forget at this time of year. Print and read it at your leisure to help optimize your financial plan with regards to taxes.

Careful with increased income
When your income increases, in addition to paying more taxes, you lose your entitlement to all sorts of tax credits and government payments. If you find yourself in this situation, start preparing now because the income taxes you pay or the reimbursements you receive in a few months might very well be affected.

Instalment payments: Be aware!
Revenue Canada charges interest as high as 13.5% for late payments. And the provinces also have interest charges. If you make instalment payments, you should always make them on time, even if you have to borrow the money from a financial institution at a better rate. As well, you should contribute the allowable maximum to your RRSP and, as a result, lower your taxable income and help make future instalment payments a little easier to handle. Another solution is to ask your employer to substantially increase the deductions at source on your salary.

At retirement, split your pension income
Canadian residents who receive a fixed pension income can now allocate up to half of this income to their spouse. This is especially interesting for couples where one of the spouses receives a high pension income and the other a more modest sum. Note that Canada Pension payments can also be split.

RRSP: max out your contribution and be creative
RRSP contributions ensure sizeable tax savings. Because such contributions reduce your taxable income, they also provide greater access to some tax credits and government payments, which means that the actual cost of the RRSP contribution is greatly reduced. As well, an RRSP is a financial cushion that can prove very useful not only at retirement but also in a number of circumstances:

  • When you return to school full time, the Lifelong Learning Plan provides for non-taxable withdrawals.
  • When you purchase a home, the Home Buyers' Plan provides for non-taxable withdrawals of up to $20,000 if you're a first-time buyer.
  • When you leave your job or you lose it, you can avoid immediately having to pay taxes on severance pay or a retirement allowance by transferring it to your RRSP account.
  • As well, an RRSP can also be used to inject funds into a small business, but very precise rules and limitations apply.

Other possibilities

  • Making contributions to a spousal RRSP allows you to set up an income splitting strategy with your spouse, both before and at retirement.
  • The federal budget tabled on March 19, 2007 moved the age limit for converting an RRSP into a RIFF from 69 to 71. If you turned 70 or 71 in 2007, you won't have to make a minimum withdrawal from your RRIF in 2007. You can even put any minimum withdrawal you made during the year back into your RRIF (or RRSP), thereby reducing your taxes.
  • The deadline for 2007 RRSP contribution is February 29, 2008.

RESP: An immediate 20% return
Thanks to the Canada Education Savings Grant (CESG), the federal government pays your RESP an amount equal to 20% of your annual contribution, up to a maximum of $500 per year. Also, low-income families are entitled to the Canada Learning Bond. Note that, to take advantage of the CESG, the child's social insurance number absolutely must be provided. If the child doesn't yet have a social insurance number, you should request one immediately.

Capital loss: He who loses wins
Year-end is the ideal time to sell investments that will generate capital losses and, as a result, remove or reduce potential taxes on any capital gains realized in 2007 or other years (more precisely: during the three previous years or all future years). However, this must be done before December 24, 2007. It is important to note that, if you have a loss for a given year, you must first be applied to the same year's capital gains. If you want to defer the loss, try to avoid having large capital gains during that same year. Also, be aware of the rules that apply to "superficial losses" and consult a specialist before moving ahead. Also interesting is the fact that, because of the strong Canadian dollar, you can realize a capital loss simply by converting certain U.S. dollar investments into Canadian dollars.

Charitable donations: consider securities
Donations to charitable institutions entitle individual taxpayers to a tax credit for charitable donations or companies to a deduction. But, there's something even better. If the donation is in the form of securities, the transfer is made with no tax payable on the capital gains that are realized in the process. In other words, a donation of eligible securities lets you save the equivalent in taxes on the capital gain while benefiting from a generous tax credit.

Transferring "latent" capital losses to your spouse: potentially beneficial You can transfer yet unrealized capital losses to your spouse. This might be useful if you haven't realized any capital gains during the year or during the three preceding years, but your spouse has. This also allows you to take advantage of the difference in marginal tax rates between you and your spouse. Finally, this strategy allows you to accelerate the capital loss deduction when you have a spouse whose life expectancy is limited. However, certain precautions must be taken, so make sure to seek advice for your particular case.

Mutual funds: Beware of the distributions
Most mutual funds pay out year-end distributions and, unless the funds are part of a registered plan, these distributions are immediately added to your taxable income. This can be quite a shock if you purchased shares just before the end of the year. To avoid such a situation, buy your shares at the beginning of the year rather than at the end, which will defer the problem for 11 months. As well, in certain cases, you can simply change funds within a same family before the end of the year. Also, if you have fixed-income securities (bonds, GICs, etc.), make sure they come to maturity at the beginning of the year so you can defer the taxes on your interest income for 11 months.

Interest: making it deductible
Various strategies let you convert non-deductible interest bearing loans into loans where the interest is completely deductible. For example, you can sell some non-RRSP investments to pay off debts where the interest is not deductible and re-borrow to finance new investments where the interest is deductible. As well, if you're an unincorporated independent worker, the owner of rental property or a partner in a general partnership, you can use a technique called "cash damming". Here again, make sure you consult a specialist.

Dividends: "Eligible" or "ineligible?"
The dividends paid by companies based in Canada can be either "eligible" or "ineligible." Eligible dividends are taxed at a lower rate than ineligible dividends. Dividends paid by companies listed on the stock exchange are usually eligible dividends, but those paid by private companies depend on the nature of their income. The rules are complicated, so again, if you're trying to reduce your taxes, make sure to get advice from an experienced specialist.

Don't play around with the taxman!
If properly used, the strategies outlined above carry no risks and are recognized by the tax authorities. But every year, questionable "stratagems" drawn up by "innovative experts" make an appearance. Much more often than not, the tax authorities will very quickly challenge these stratagems. So, make sure you avoid any procedure that has not been duly recognized and accepted.

More year-end advice

  • Pay your medical bills, charitable donations and political contributions before the end of the calendar year. Remember that your medical bills and charitable donations can be claimed together on your tax return.
  • Pay your children aged 18 and over for babysitting children 15 and under.
  • If you have children under 6, make sure you register with the Canada Revenue Agency to receive the Universal Child Care Benefit.
  • If you're thinking of withdrawing funds from your RRSP as part of the Home Buyers' Plan, make all your withdrawals in the same calendar year because withdrawals made in subsequent calendar years will, as a general rule, be fully taxable.
  • If you're 71 years of age, convert your RRSP into a RRIF and use your younger spouse's age to determine the minimum annual payment.
  • Use several different income splitting strategies with your spouse, your children and your grandchildren. Draw up a will that provides for such strategies and, at the same time, prepare a mandate in case of incapacity.
  • If you're a shareholder in a small or medium-sized business, determine the salary-dividend (eligible or ineligible) combination that's most beneficial to you. Consider crystallizing your $750,000 capital gain exemption over two calendar years (end of 2007 and beginning of 2008) to minimize the impact of the alternative minimum tax. Avoid generating capital losses during calendar years where you crystallize your exemption. Consider setting up an Individual Pension Plan. Also consider estate freezing through a discretionary family trust.
  • If you're a shareholder in a company that grants advances, reimburse such advances as soon as possible to avoid having them included as part of your income. Consider reimbursing the company by selling it some of your assets (including a life insurance policy).
  • If you've invested in a small incorporated company and the value of your investment has decreased substantially, consider selling it to an arm's length individual so you can realize a business investment loss.
  • If you're a shareholder in a corporation, plan to have the company make eligible investments so it can reduce its capital tax.
  • If you own income property where the value has decreased substantially compared to the purchase price, consider selling it to claim a "terminal loss," which can be applied against the rest of your income.
  • If, in 2007, you exercise your option to buy shares from your employer, you can defer being taxed on the taxable benefit if your employer is a company listed on the stock exchange.

Financial planning is indeed the actions we take on a continuing basis … but there's no better time than year-end to sit down, take stock and make the right decisions!