Effective Tax Strategies Minimize the Amount of Tax You Pay

Acquire tax smarts

Contrary to popular belief, the Canada Revenue Agency, or the CRA, does not create tax law, nor are they the final and absolute word when it comes to the interpretation of any given tax statute.  Rather the Income Tax Act is the primary source of income tax law.  These laws are created by the Department of Finance based on what is legislated in Parliament. 

The Canada Revenue Agency is a government agency, formed in 1999, to administer the tax law.  In the vast majority of cases for the average individual taxpayer in Canada, there is little dispute over the interpretation of any particular tax law.  Therefore, whatever the CRA publishes on their website or state in their position on a Notice of Assessment, can be relied upon in the majority of cases.  However, by understanding that the CRA is not the author of tax law, but the administrators of it, there may be differences in how a particular tax statute is interpreted between the CRA and the taxpayer, especially for more complex and ambiguous matters.

Tax law changes all the time.  Motivations for the government to make changes include meeting fiscal objectives, political objectives, or a shift in government policies.  While changes can be tabled in Parliament at anytime, traditionally the majority of proposed changes to the Income Tax Act is done through annual budgets, typically released around March each year. 

Make sure to review highlights after a Federal or Provincial Budget is announced because often new exemptions or credits will be put into effect then. Also, changes will be listed on the CRA website.  Pay particular attention to the effective dates of these changes as some are retrospective and some are set for a future date.  Alternatively, check back here for our budget updates.

In Canada, we have a Taxpayer Bill of Rights. This is a set of sixteen rights confirming that the Canada Revenue Agency (CRA) will serve taxpayers with a high degree of accuracy, professionalism, courteousness and fairness. The Taxpayer Bill of Rights helps you understand what you can expect in your dealings with CRA.  For example, your right to privacy and confidentiality and the right to a formal review and appeal.

There is also a Taxpayers’ Ombudsman.  The Taxpayers’ Ombudsman is responsible for ensuring that the Canada Revenue Agency (CRA) respects service rights outlined in the Taxpayers Bill of Rights.

In addition to understanding your rights, if a taxpayer feels that they did not receive the level of service expected (e.g., undue delays, poor or misleading information, or inappropriate staff behavior), a complaint can be launched through the CRA’s Service Complaints Program.  The objective of this program is to create public awareness about how to file a complaint with the CRA, for the CRA to track and gather information throughout the process and to allow them to analyze trends and identify any systemic issues. 

The CRA website has a wealth of information on income taxes and is a great place to start to familiarize yourself with the most current tax law. 

Staying organized throughout the year not only makes tax time easier for you or your accountant but also allows you to access all of your organized information easily so that you can focus on planning your tax strategies instead of focusing on collecting and gathering all of your information.

If you choose to prepare your own taxes, choose a tax preparation package that suits your circumstances. For more complicated tax issues, you may want to consider purchasing a more robust software package or working with a tax professional.  Choose carefully when hiring an individual or firm to prepare your personal tax returns. Make sure they have the relevant qualifications and experience.

Types of tax savings

The goal of tax planning is to minimize your tax liability – the amount you owe to the government.  It’s very important to plan ahead, do your research and lay out your plan for lowering your tax liability in advance. Reacting to tax issues as they arise or after the fact is not effective and doesn’t give you time to put a solution in place or you might have missed the deadline to make a difference.

Always consider your future income projection and marginal income tax rate when it comes to analyzing your tax exposure.  Remember to consider both your provincial tax rate and your federal tax rate.  Each province has its own tax rates and tax brackets.

There are only two types of tax savings:
1. Absolute: Taxes are saved or avoided entirely

2.  Deferred: Taxes are not immediately payable in the current year, but pushed out to some other future year (increase current cash flow and time value of money)

There are many ways to take advantage of these two types of savings.

A great way to realize absolute savings in tax is through a Tax-Free Savings Account or TFSA.  Although contributions are made with after-tax dollars, you don’t pay tax on the income that is earned from qualified investments in a TFSA.  The available amount that you can contribute to a TFSA is based on the following formula: Annual contribution limit ($6,000) + Cumulative Unused TFSA Contribution Room from Prior Years + Total Withdrawals from the Previous Year.  Any contributions over and above this total available contribution room will be subject to penalties.

Due to the tax-free compounding of earnings within a TFSA, it is best to make contributions to your TFSA as early as possible in the year. Assuming you have used up your annual $6,000 contribution room, you cannot withdraw an amount from your TFSA and repay it in the same year; you could face an excess contribution penalty (1% per month on excess) if this were the case.

One good way to use the TFSA is to save for emergencies or a large purchase.  Unlike an RRSP, a unique feature is that any withdrawals are not taxed.

You can give your  spouse or common-law partner funds to contribute to their TFSA. Making such contributions will not affect your TFSA contribution room and allows your spouse or common-law partner to maximize the amount of tax-free savings. You might even consider opening an account for your children (they can start at 18 years of age).

Consider holding investments that pay interest in your TFSA. Since interest is taxed higher than dividends and capital gains, it may be an advantage to hold investments that pay interest such as GICs and bonds inside a TFSA.

Remember, if you change institutions, you must make a direct transfer instead of an ordinary withdrawal and re-contribution in the same year.

One of the most common and best strategies used by taxpayers to reduce taxable income is to contribute money to an RRSP (Registered Retirement Savings Plan).  Contributing to an RRSP means you are both saving for retirement and getting a tax break. Any income earned is usually exempt from tax as long as funds remain in the plan. It’s ideal if you can set up automatic monthly contributions to receive the best return – better than putting in a lump sum at the end of the year because you collect interest/dividends all year long.

Note that even if you don’t owe tax, you should still file a tax return when you earn income to help you build up RRSP contribution room.  And you don’t have to claim a deduction in the year the contribution is made – save for next year if a higher income bracket is expected.

You may also want to consider contributing to a spousal RRSP, especially if your spouse’s projected income on retirement will be lower.  The Income Tax Act allows for an individual to contribute and claim the deduction yourself.

As well, under the Income Tax Act, an RRSP must terminate in the year that the person turns 71.  Ordinarily, this would constitute a lump-sum withdrawal from the RRSP and the entire amount would be taxable in the year of withdrawal.  Thankfully, and in most cases, the Income Tax Act allows for an individual to rollover the RRSP into a Registered Retirement Income Fund, or RRIF.

If you’re wanting to buy or build your first home, you can borrow up to $35,000 tax free from your RRSP.

The Lifelong Learning Plan allows individuals to withdraw funds from their RRSP to finance training or education for themselves or their spouse or common-law partner. Amounts must be repaid over 10 years or they will be included in the income of the person who made the withdrawal. You can withdraw up to a total of $20,000 from your RRSPs.

• Up to $10,000 in a calendar year
  • Up to $20,000 in total.

File tax returns even when you have no tax liability in order to build up RRSP contribution room, this is especially important for teenagers earning an income.

Registered Education Savings Plans (RESPs) are a great way to save for a child’s future education and also a way to defer tax and split income with the beneficiary of the plan.  An RESP is a registered plan that allows for the tax deferral on accumulated income earned on contributions from an individual and, if applicable, from government and/or provincial grants with the intent that the accumulated plan funds will be used to pay for the post-secondary education of a beneficiary.

The tax deferral in an RESP happens because all of the income that is earned in an RESP is neither taxable within the RESP nor in the hands of the subscriber.  Rather any earnings that are eventually paid out to the beneficiary by the promotor for post-secondary education, is taxed in the hands of the beneficiary, who would, presumably, be in a lower tax bracket.  Unlike an RRSP, contributions by the subscriber are NOT tax-deductible in calculating the subscriber’s income for the year. 

Earnings can grow tax-free (like earnings in an RRSP) for up to 35 years or until funds are withdrawn (contributions cannot be made after 31 years). For specified plans (i.e., for plans set up for beneficiaries qualifying for the disability tax credit), earnings can grow tax-free for 35 years and 40 years, respectively.

Lifetime contribution maximum for each beneficiary: $50,000.

The federal government, under the Canada Education Savings Grant program, provides a grant of up to 20% of the first $2,500 of annual contributions up to a lifetime maximum of $7,200.

Grant can be higher for low- and middle-income families.

Tax planning

The goal of tax planning is to minimize your tax liability – and every taxpayer in Canada has the right to arrange their affairs in such way as to minimize their tax liability long as it is within the bounds of the Income Tax Act.

Planning ahead involves year-end tax planning, so use the last few months of the year to look ahead at your future tax needs. There may be opportunities to plan your income so that it will be taxed at a lower rate and claim deductible expenses in years when you anticipate you will be in a higher income tax bracket.  It may also be advantageous to defer income to a later year and accelerate deductions in the current year. Deferring tax typically results in absolute savings through the time value of money. (The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time.)

For employees, the tax-planning opportunities with respect to employment income are limited. There are opportunities, however, on the personal investment side, such as maximizing RRSP deductions and various tax credits.  The other area for planning is with respect to investment income – and the timing of recognition of capital gains and losses. Be aware that the tax on investment income varies depending on whether it is a capital gain, interest or dividend. *Also know that planning can allow you to ensure that you create tax deductible interest.

Another important consideration when you’re thinking about tax planning is that different types of income attract different rates of taxation.  Income can generally be divided into three different categories.

• Income that is considered a capital gain is income that would result from the disposition of capital property.  Examples of capital property include depreciable property – a car, a rental unit, or equipment purchased for a business.  Capital property can also be non-depreciable, such as shares in a public corporation, mutual funds, etc.  Capital gain income is taxed at 50% of the gain from the disposition of the property.  The gain is the difference between the proceeds you receive on the sale of the property and the original cost that you paid for that same property.
• Income that is interest income (e.g., from a bond, a GIC, or a loan) and other ordinary income (such as salary and wages), is taxed at 100% of the income (unlike capital gains).
• Dividend income is unique in that it represents an after-corporate-tax income that is distributed to the shareholder.  The theory behind the taxation is beyond the scope of this presentation, but understand that there is a “gross-up” and a personal dividend tax credit mechanism involved with the taxation of dividends. The effective tax rate on dividend at the personal tax level is lower than ordinary income.

Define your goals.  Don’t let the tax-tail wag the dog.  As important as tax planning is, saving money on taxes should not be considered in isolation, especially if it hinders or significantly diminishes the value of any other business or personal objectives.  For example, all other things being equal, borrowing large sums of money to invest in a stock portfolio just for the sake of taking an interest deduction to lower your taxable income may not be the wisest reason for incurring a large debt that you have to repay.  Rather consider these: investment return, impact to your net worth, ability to pay off debt, ability to service the debt, investment horizon, risk level, cash flow needs, etc. Are the tax savings really worth it?

Review at year-end and look to ensure all applicable deductions and credits are taken.

When it comes to tax planning – there are two objectives – either defer the income that can be taxed, or accelerate the deductions to lower the total income that can be taxed.

There are many complex rules in the Income Tax Act which address what is and what is not acceptable tax planning. Depending on the type of planning you are considering, you may need to consult a tax professional to determine if it is acceptable.

Achieving tax goals – practiced strategies

There are three fundamental ways to reduce your taxes:

1. lower your gross and taxable income
2. take all allowable deductions, and
3. use all available tax credits.

Deferring income to another year is the same as decreasing your current year’s taxable income.  Consider the timing of capital gains, interest and dividends.   The effect of this can be multiplied if this were also combined with increasing your deductions in the current year, which is the second point.  This is particularly beneficial for those individuals whose income level puts them very close between two tax brackets.  Accelerating deductions and/or deferring income may just be what would push you into the lower the tax bracket.

Finally, maximizing your tax credits will lower your total taxes owing. 

The key to proper planning is to understand the interplay between these 3 fundamental concepts and how they fit within your overarching tax-planning strategies.

When you make an RRSP contribution, it may be affected by your current and expected tax rate. If you expect to be jumping to a higher tax bracket, you may benefit from deferring your RRSP contribution to a later year.

Ensure that you structure your affairs to generate tax deductible interest.  Consider who pays expenses. For example, higher income earners might pay all household expenses so that lower income earners use surplus funds for investment purposes. As such, the investment income will be taxed at a lower bracket. 

Split income if possible.  Unfortunately recent rules on splitting income have made this more difficult.  Talk to a professional before embarking on this tax saving measure. 

Be careful of student debt interest which can be consolidated with non-student deductible debt. The student debt portion will no longer be deductible if combined with another kind of loan. 

Also, when it’s time to  file your tax return, the ideal situation is to come out even –  in other words, you don’t owe the government and the government doesn’t owe you. Even though it is nice to receive a refund , it means you have overpaid, giving the government an interest-free loan and it would be better if you could have been earning interest on that money. To reduce the refund, consider requesting a reduction for income tax deduction at source form (T1213) .

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2023 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services.