As 2016 winds down, many Canadians will start to look ahead to the new year, identifying goals, plans and hopes, financially speaking and beyond. But before switching out the calendar and starting fresh for 2017, an important year-end step for individuals is taking the time to review their financial affairs. And though some individuals have negative perceptions about tax season overall, this often arises from an unfamiliarity with the ins and outs of tax. In fact, it was shown in a study conducted by Leger Marketing that among survey respondents, less than 25 percent have a good understanding as to what can be claimed on their tax returns.1 Combine that with the range of personal changes and life events people experience, and it becomes understandable why tax planning may seem complicated and confusing. Building some general knowledge, however, can go a long way in helping individuals successfully and accurately plan for year-end.
If you sold assets and realized capital gains during the year and you’re holding securities with unrealized losses, you may want to consider selling some of them. Tax-loss selling is a technique that involves selling securities at a loss to offset capital gains realized during the year. Before using this strategy, part of your portfolio review should also include determining if the securities no longer meet your objectives.
One key consideration to be aware of, however, to ensure a capital loss can be claimed, is the superficial loss rules. A superficial loss occurs when a security is sold at a loss and the individual, or someone “affiliated” with them (i.e. your spouse, a company controlled by you and/or your spouse, or a trust in which you and/or your spouse are a majority interest beneficiary), acquires the identical property that was sold within the period that begins 30 days before and ends 30 days after the settlement date of the disposition. If, on the 30th day after the settlement date, that same individual or a person “affiliated” with them owns or has a right to acquire the identical property, the superficial loss rules may apply, and the capital loss may therefore not be useable. Instead the capital loss that is considered a superficial loss is added to the adjusted cost base of the newly acquired security. Here, it’s important to recognize that these are complex rules and it’s crucial to consult a tax professional for advice before proceeding.
What if capital loss can’t be used all in one year?
The rules behind this strategy dictate that those who realize a capital loss must apply it first against capital gains realized in the current tax year. Then, when the current year’s capital gains have been offset, any balance of the loss can be carried back three years or forward indefinitely to offset capital gains in those years. Note that if you apply a net capital loss against a previous year’s taxable capital gain, it reduces your taxable income for that previous year. Therefore your refund depends on your marginal tax rate for that previous year. However, this won’t change your net income for that year, which is used to calculate certain credits and benefits to which you may be entitled.
A related consideration here is deferring the realization of capital gains until the next tax year. This approach may be prudent if you anticipate being in a lower marginal tax bracket next year. Also keep in mind that if you realize capital gains in the current tax year, you must remit any tax payable as a result of those gains to the Canada Revenue Agency (“CRA”) by the tax due date in the next calendar year. With these details in mind, what it comes down to is always considering the investment merits of deferring the sale of a security before assessing the tax benefit. For more specific information on the concept of tax-loss selling, please view “Tax-loss selling – Building a better understanding”.
Planning for a bonus
Informed tax planning for bonuses is another area that may prove advantageous for some. If an individual’s maximum RRSP contribution limit hasn’t been reached, a bonus creates additional RRSP deduction room for the following year. Additionally, a bonus may allow greater pension and/or employee profit-sharing plan contributions for the year. It’s also important to consider your tax bracket, as it may prove worthwhile to consider deferring receipt of a bonus to early next year, if you expect to be in a lower tax bracket. Furthermore, some individuals may be able to avoid withholding taxes if their employer will transfer the bonus directly to their RRSP; the only caveat to this is having unused RRSP deduction room.
While people often associate year-end only to the current year, it’s also valuable to think ahead to anticipated tax brackets in future years. If an individual expects to be in a higher marginal tax bracket when they retire, it’s worthwhile to consider withdrawing funds from an RRSP before year-end. This also applies to growth investors who are nearing retirement, as withdrawing funds now may avoid higher taxation. Then, by reinvesting in a non-registered account, individuals can benefit from the preferred income tax treatment for capital gains, Canadian dividends and return of capital. One consideration to take into account is that this strategy involves paying tax earlier at a lower rate, but you may lose tax-deferred growth potential on the funds withdrawn.
For those who have charitable intent, donations must be made by December 31 in order to claim the donation tax credit for the current year. What some individuals may not be aware of is that you can also donate publicly listed securities in-kind to qualified charities without paying tax on any capital gain realized. The potential advantage here is that you’ll receive a donation tax receipt equal to the fair market value of the security at the time of donation, which can then help reduce your tax bill because of the donation tax credit. If you’re considering this type of approach, it’s important to first talk to your qualified tax advisor about the merits of donating securities in-kind.
Making timely RRSP and TFSA contributions
The basic consideration to understand here is that timing may make a difference. While you can contribute to an RRSP for the first 60 days of the new year and deduct the amount on the previous year’s tax return, if you instead contribute before December 31, you’ll benefit from two extra months’ tax-deferred growth, which can increase your retirement savings.
A Tax-Free Savings Account (TFSA) allows you to earn tax-free investment returns, resulting in potentially greater growth than a regular taxable account. If you need cash before the year-end, you may withdraw from your TFSA by December 31. The same amount can be re-contributed to your TFSA, plus the new annual contribution room starting on the next January 1. Keep in mind that recontributing in the same calendar year requires the necessary contribution room.
Saving for a child’s education
Individuals with children or grandchildren who are keen on saving for that family member’s future post-secondary education will want to consider an RESP. The lifetime contribution limit is $50,000 per beneficiary and beneficiaries may qualify for the Canada Education Savings Grant (CESG) to a lifetime maximum of $7,200. More specifically, if your beneficiary turned 15 this year and hasn’t yet benefitted from an RESP, consider making a minimum contribution of $2,000 by December 31. Your beneficiary may qualify for CESG this year and the next two years. Otherwise, CESG may not be available for the years the child turns 16 and 17.
Capital gains in a trust
Individuals, including minor children, with no other taxable income, can realize approximately $22,000 of capital gains tax-free each year (the amount varies by province and territory) due to their basic personal exemption. Capital gains realized by a properly structured trust may be allocated to and taxed in the hands of a beneficiary with little or no taxes payable. Here again, it’s valuable to speak with your tax professional about the benefits of this strategy and any additional tax return preparation fees that may result. For additional information relating to trusts, please view “Year-end planning checklist for trusts”.
Timing mutual fund purchases
If an individual purchases mutual funds near year-end in a taxable account, and the mutual fund distributes taxable income and capital gains late in the calendar year, the distribution is paid to all unit holders — even if the individual only recently purchased units — and may create a tax liability. As such, it’s necessary to check the fund’s history of distributions and then consider delaying a mutual fund purchase until after a distribution. Funds that make regular monthly or quarterly distributions are less likely to have large year-end distributions. If that’s the case, a year-end purchase may not result in a big tax burden.
Considerations when moving within Canada
Provincial and territorial taxes differ across Canada, and residents therefore pay those taxes based on the province or territory where they live on December 31. Marginal tax rates vary by province and territory, so if an individual plans to move to a lower-taxed province or territory, it may prove advantageous to do so before year-end. Alternatively, if the new residence is in a higher-taxed province or territory, delaying the move until the New Year may be beneficial from a tax standpoint.
Make interest payments on time and check deductible expenses
Those with a spousal loan, or a family trust with a prescribed rate loan, should make the interest payment by January 30, annually. By doing so, they can prevent the attribution rules from applying. Those who don’t make the interest payment by January 30, even on one occasion, put the entire strategy at risk. They can lose the benefit of the prescribed rate loan for the year in question and all subsequent years. If you miss the January 30 payment date, talk to your tax professional.
The borrower may be able to deduct the interest paid while the lender includes the interest received in their income. The timing of the income deduction and inclusion depends on the year to which the interest relates, when the interest is paid, and the accounting method used in computing income.
Strategies to consider when turning 71
Some tax-planning strategies apply specifically in the year individuals turn 71. These include choosing registered plan maturity options (i.e. a RRIF or annuity) or deregistering an RRSP by December 31. Any final RRSP contributions made by December 31 can be claimed on the current year’s tax return.
If you have earned income in the year you’re 71, consider making an RRSP contribution by December 31. You won’t have new contribution room, generated by this year’s earned income, until the next January 1. By then your RRSP will have been converted to a RRIF, so you will no longer have your RRSP to contribute to. This so-called “forgotten RRSP contribution” allows you to claim the deduction on your next year’s tax return or thereafter. If you have no contribution room, you’ll pay a 1 percent per month penalty, but on January 1 you’ll have new contribution room and won’t be over-contributed. This means that the penalty will only apply for one month. The tax savings from deducting your contribution may outweigh the 1 percent penalty.
If you’re over 71 and can’t contribute to your own RRSP, you can make a contribution to a spousal RRSP until your spouse turns 71, provided you have a younger spouse and you have unused contribution room or earned income from the year. The benefit here is receiving the contribution deduction on your tax return but withdrawals will, in most cases, be taxed at your spouse’s marginal tax rate, which may achieve family income splitting for those with a lower-income spouse.
In the year an individual turns 71, final RRSP contributions must be made by December 31. However, some may wish to deduct this contribution in a future, higher-income year, to reduce their taxable income. If you over-contributed by $2,000 in the past, it may be worthwhile to reduce your final contribution by $2,000 and deduct this now to avoid potential double taxation.
From non-registered and registered investments to bonuses and charitable donations, trusts and mutual funds to provincial and age considerations, there are a wide range of year-end planning techniques that may provide individuals with significant tax savings. And while the information presented offers an overview of the factors and options that exist in the Canadian tax system, the best course of action is always reviewing tax-planning strategies with your tax professional. Doing so will help ensure the decisions are appropriate for your circumstances and will help you meet your planning objectives for this year, next year and into the future.
Proposed enhancements to the Canada Pension Plan (CPP)
Canada’s Finance Ministers (excluding Quebec) have reached an agreement on proposed enhancements to the Canada Pension Plan (CPP). The proposed changes, intended to improve the retirement security of Canadians, will increase the income replacement provided by CPP from one-quarter to one-third of pensionable earnings. The changes, expected to include a 14-percent increase in the amount of income subject to CPP, will be gradually implemented over a seven-year period beginning January 2019.