A tax perspective on year-end

At the end of every year, many Canadians will start to look ahead to the new year, identifying goals, plans and hopes, financially speaking and beyond. Before switching the calendar and starting fresh for a new year, an important year-end step is taking the time to review your financial affairs. And though some may have negative perceptions about tax season overall, that feeling can sometimes arise from an unfamiliarity with the ins and outs of tax planning or what can be claimed on a tax return. Combine that with the range of personal changes and life events people experience, and it’s understandable why tax planning may seem complicated and confusing.

Here’s an overview of some areas to consider to help successfully and accurately plan for year-end from a tax perspective.

Tax-loss selling

If you sold assets and realized capital gains during the year and you’re also 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 include determining if the securities no longer meet your objectives.

Another key consideration 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. As these rules are complex, it’s crucial to consult a qualified tax professional for advice before proceeding.

What if a capital loss can’t be used all in one year?

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. So, 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 you may be entitled to.

A related consideration 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, you should always consider the investment merits of deferring the sale of a security before assessing the tax benefit.

Find out more about the concept of tax-loss selling.

Planning for a bonus

If your 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 the following year, if you expect to be in a lower tax bracket. Furthermore, some may be able to avoid withholding taxes if their employer will transfer the bonus directly to their RRSP; the only caveat is having unused RRSP deduction room.

Low-income year

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 you expect to be in a higher marginal tax bracket when you retire, it may be 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 may benefit from the preferred income tax treatment for capital gains, Canadian dividends and return of capital. Keep in mind that this strategy involves paying tax earlier at a lower rate, but you may lose tax-deferred growth potential on the funds withdrawn.

Charitable donations

For those who are charitably inclined, donations must be made by Dec. 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

With these contributions, timing may make a difference. While you can contribute to a registered retirement savings plan (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 Dec. 31, you may benefit from two extra months of 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 year-end, you may withdraw from your TFSA by Dec. 31. The same amount can be re-contributed to your TFSA, plus the new annual contribution room starting on the next Jan. 1. Keep in mind that recontributing in the same calendar year requires the necessary contribution room.

Saving for a child’s education

If you have children or grandchildren and are keen on saving for their future post-secondary education, an option to consider is a registered education savings plan (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.

Capital gains in a trust

Individuals, including minor children, with no other taxable income, can realize a certain amount 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 important to speak with your qualified tax professional about the benefits of this strategy and any additional tax return preparation fees that may result.

Find out more about year-end planning 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 Dec. 31. Marginal tax rates vary by province and territory, so if you plan 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 Jan. 30, annually. Doing so prevents the attribution rules from applying. If the interest payment is not made by Jan. 30, even on one occasion, the effectiveness of this strategy is at risk. You can lose the benefit of the prescribed rate loan for the year in question and all subsequent years. If you miss the Jan. 30 payment date, talk to your qualified 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 an annuity) or deregistering an RRSP by Dec. 31. Any final RRSP contributions made by Dec. 31 can be claimed on the current year’s tax return.

If you’ve earned income in the year you turn 71, consider making an RRSP contribution by Dec. 31. You won’t have new contribution room, generated by this year’s earned income, until the next Jan. 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 one percent penalty per month, but on Jan. 1 you’ll have new contribution room and won’t be over-contributed. This means the penalty will only apply for one month. The tax savings from deducting your contribution may outweigh the one 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 Dec. 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.

There are a wide range of year-end planning techniques that may provide you and your family with tax savings. While this article offers an overview of the factors and options that exist in the Canadian tax system, it’s crucial to review tax-planning strategies with your qualified 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.