Janna Krieger, Toronto
December is a hectic month for many people. But take some time out of your busy schedule to review these year-end tax tips — they could help you save tax dollars for 2012 and years to come.
Contribute to a tax-free savings account: Make your $5,000 tax-free savings account (TFSA) contributions for 2012. If you haven’t contributed before, you can contribute up to $20,000 before the end of the year. Also, in order to maximize tax-free earnings, consider making your 2013 contribution in January. In fact, the government has just announced that 2013 will be the first year in which the TFSA annual contribution limit will be indexed to inflation, and raised to $5,500. Remember that you can also fund your spouse’s/partner’s contributions without attracting the attribution rules.
If you’ve withdrawn funds from your TFSA in 2012, keep in mind that the contribution room created by the withdrawal is not available until 2013.
Contribute to education: Remember to make registered education savings plan (RESP) contributions for your child or grandchild before the end of the year. With a contribution of $2,500 per child under age 18, the federal government will contribute a Canada Education Savings Grant (CESG) of $500. If you have prior non-contributory years, the annual grant can be as much as $1,000 (in respect of a $5,000 contribution). If you have a child who is 15 this year, but you have never contributed to an RESP on his or her behalf, 31 December is your last chance to make a contribution and earn a CESG for that child.
Contribute to a registered retirement savings plan: The deadline for making deductible 2012 registered retirement savings plan (RRSP) contributions is 1 March 2013. The earlier you contribute, the more time your investments have to grow, so consider making your 2013 contribution in January 2013 to maximize the tax-deferred growth. If your income is low in 2012, but you expect to be in a higher bracket in 2013 or beyond, consider contributing to your RRSP as early as possible but holding off on taking the deduction until a future year when you are in a higher tax bracket.
If you are 71 years old at the end of the year, you must make your final RRSP contribution no later than 31 December (not 60 days after the end of the year), and you must select an RRSP maturity option by the end of the year. If your spouse is under 71, consider making deductible spousal RRSP contributions if you have earned income or unused contribution room.
Pay tax-deductible or tax-creditable expenses in 2012: A variety of expenses can only be claimed as deductions in a tax return if the amounts are paid by the end of the calendar year. Some of these expenses include interest, investment counsel/management fees, safety deposit box fees, professional dues, spousal support and child-care costs. In addition, expenditures that give rise to tax credits, such as charitable donations, political contributions, medical expenses, children’s fitness program costs, children’s arts program costs, tuition fees and transit pass costs, must be paid in the year in order to be creditable.
If these amounts would otherwise be paid early in 2013, consider paying them by the end of this year to get the benefit of the tax deduction or credit in your 2012 return.
And remember to keep receipts! Although you aren’t required to include most receipts when filing, the Canada Revenue Agency (CRA) randomly requests receipts as part of its post-assessment review.
Reduce or eliminate non-deductible interest: Interest on funds borrowed for personal purposes is not deductible. Where possible, consider using available cash to repay personal debt before repaying loans for investment or business purposes on which interest may be deductible.
Reduce automobile taxable benefit: If you’re an employee who uses an employer-provided car primarily for business, you may be eligible for a reduced standby charge (in respect of the availability of the car) and a lower alternate operating benefit, computed as one-half of the standby charge. Update your travel log now to determine if you’re within the thresholds for reduced benefits, and advise your employer in writing before year end in order to have the alternate operating benefit apply.
Request reduced source deductions: If you regularly receive tax refunds because of deductible RRSP contributions, child-care costs or spousal support payments, consider requesting CRA authorization to allow your employer to reduce the tax withheld from your salary (Form T1213). Although it won’t help for 2012 taxes, in 2013 you’ll receive the tax benefit of those deductions all year instead of waiting until after your 2013 tax return is filed.
Consider income-splitting loans: The prescribed interest rate applicable to the exemption from income attribution on intra-family loans is still 1% for the final quarter of 2012. That means income-splitting loans are still an excellent tax-saving opportunity if you have liquid or certain other assets, and are interested in income splitting with your spouse/partner and/or children or grandchildren.
If you have outstanding income splitting loans, keep in mind that you must pay interest by 30 January 2013 to avoid income attribution.
Review your investment portfolio: Year end is a good time for an investment portfolio review. You may want to sell loss securities to reduce capital gains realized earlier in the year. If the losses realized exceed gains realized earlier in the year, they can be carried back and claimed against net gains in the preceding three years and you should receive the related tax refund.
- Superficial loss – Keep in mind, if you, your spouse/partner, a corporation that either of you controls, your RRSP or your TFSA acquires the same security that you sell at a loss within 30 days before or after the sale and still owns that security 30 days after the sale, the loss will be denied. Moreover, if an RRSP or TFSA acquires the replacement, any tax benefit from the loss is effectively eliminated. However, if your spouse/partner owns investments that have decreased in value but they cannot use the capital loss, consider taking advantage of the superficial loss rules by purchasing the investments from your spouse/partner at fair market value and electing out of the automatic rollover provisions. On the subsequent sale to an arm’s-length party, you can claim the capital loss.
- Using capital losses – If you have capital loss carryforwards from prior years, you might consider cashing in on some of the winners in your portfolio. By applying unused capital loss carryforwards against 2012 realized gains, the tax cost associated with the gains can be reduced or eliminated.
Or, if you have capital loss carryforwards from previous years, consider transferring qualified securities with accrued gains to your TFSA (up to your contribution limit). The resulting capital gain will be sheltered by available capital losses, and future earnings on these securities can accumulate tax-free.
For further savings if you have capital loss carryforwards from prior years, consider transferring qualified securities with accrued gains to your RRSP. The resulting capital gain will be sheltered by the available capital losses, and you’ll get an RRSP deduction for the value of the securities (up to your contribution limit).
- Settlement date – For security sales, keep in mind that the trade must settle in 2012 to be considered a 2012 disposition. For Canadian exchanges, the final trade date for 2012 settlement is 24 December, and for US exchanges it is 26 December.
- Purchasing investments in December – If you’re considering buying bonds or long-term GICs this month (perhaps from the proceeds of security sales), keep in mind that even if the investment pays no interest in 2013, tax will be payable on the interest that accrues to the first-year anniversary date (December 2013) with your 2013 tax return. By delaying the purchase to January 2013, that tax can be deferred until 2015.
In the case of mutual funds that regularly make distributions near year end, the distribution amount is effectively included in the purchase price and will be taxable in your 2012 return. It might be better to wait until after the distribution to purchase those funds; the cost may be lower and tax would be deferred.
- Canadian-controlled private corporations – If you own shares in certain Canadian small business private corporations, you might want to trigger capital gains to benefit from your remaining capital gains exemption (maximum $750,000 lifetime exemption). However, if such shares have declined in value or are worthless, any related loss is a special class of capital loss (a business investment loss) that can be claimed against any source of income, not just capital gains.
- Donations of securities – If you hold securities whose value has risen and plan to make charitable donations, consider gifting the securities rather than cash to a registered charity. Capital gains realized on a donation of most publicly listed securities to a registered charity are not included in income, and the donation tax credit will reduce your taxes in the same manner as a donation of cash equal to the securities’ full value. Note that there are special rules for donations of flow-through shares, discussed below.
Flow-through shares: If you’re looking for opportunities to reduce a significant tax liability you expect to have for 2012, you might consider a flow-through share investment before year end. Flow-through shares provide for a current tax deduction roughly equal to the amount of the investment, and may also give rise to federal and provincial tax credits, resulting in significant current tax savings.
The deductions and credits reduce the cost base of the investment and, therefore, a capital gain will likely arise when the investment is sold. But before you take the plunge, note that these investments do carry risks and should be assessed on the merits of the operation and not the tax attributes.
Flow-through shares have often been used in tax donation strategies. Keep in mind that the tax-free portion of the capital gain resulting from the donation of flow-through shares is generally limited to the excess of the value of the shares at the time they are donated over the cost of the shares.
Tax shelter gifting arrangements: You should only consider an investment in a tax shelter after obtaining professional advice. The CRA commonly challenges these structures.
In particular, it actively reviews tax shelter gifting arrangements, which are most commonly schemes where a taxpayer receives a charitable donation receipt with a higher value than the actual donation.
The CRA has indicated that it audits all of these tax shelter arrangements, and to date has not found any that it believes comply with Canadian tax laws. It has generally succeeded in denying the benefits of tax shelter gifting arrangements before the Tax Court.
In addition, the CRA recently stated that beginning with 2012 returns, it will hold off on assessing any personal returns with claims from gifting tax shelter schemes until the tax shelter is audited, which may take up to two years.
Make capital acquisitions for business: Self-employed individuals and unincorporated business owners expecting to make capital purchases for their business (such as furniture or equipment) in the near future should consider buying before year end to get a depreciation deduction for 2012.
For a 2012 deduction (of a half-year’s depreciation) to be available, the asset must be “available for use” — that is, installed and ready to be used for its intended purpose — by 31 December 2012.
Consider a corporate year-end remuneration strategy: Corporate business owners should make decisions about final remuneration from the company. Changing federal and provincial personal and corporate tax rates have made old rules of thumb in owner-manager remuneration obsolete. These decisions should be re-evaluated each year based on the specific needs of the business owner, particularly given the tax deferral available if funds are left in a corporation.
- In general, if the owner-manager does not need the money, it should be left in the corporation to grow, subject to tax at corporate tax rates, which are less than personal tax rates.
- Keep in mind that leaving earnings in the corporation may affect a Canadian-controlled private corporation’s entitlement to refundable scientific research and experimental development investment tax credits, as well as its status as a qualified small business corporation for the purpose of the shareholder’s capital gains exemption.
- If the owner-manager needs the money, the decision of how and when to take it out will be affected by several factors. For example, the timing of remuneration would be influenced by trends in provincial corporate and personal tax rates. In provinces where personal tax rates are increasing, there may be a benefit to realizing personal income in 2012 instead of 2013.
- If there is a plan to pay salary, remember that bonuses can be accrued and be deductible by the company in 2012, but don’t have to be included in the business owner’s personal income until paid in 2013 (the bonus must be paid within 180 days of the company’s year end). This allows for a deferral of tax on salary.
In determining the preferred form of remuneration, there are also several factors to consider:
- Business owners may want enough salary to create sufficient 2012 earned income to maximize their 2013 RRSP contribution. In order to contribute the maximum of $23,820 for 2013, business owners will need a 2012 salary of at least $132,333. Remember that dividends do not represent earned income for the purpose of creating RRSP contribution room. Earned income is also required for other personal tax deductions, such as child care and moving expenses.
- Paying dividends may be a tax-efficient way of getting funds out of the company. Capital dividends are completely tax free, and eligible dividends are subject to a preferential tax rate. A review of the company’s capital dividend account would determine if capital dividends may be paid.
- A review of the company’s general rate income pool, to determine whether lower-taxed eligible dividends can be paid, could also enhance tax effectiveness.
- Taxable dividends that will generate a dividend refund in the corporation (one-third of the dividend paid), particularly if they are eligible dividends (subject to a preferential tax rate), may generally be paid out with essentially no net tax cost, or even a positive cash flow result between the corporation and its owner(s).
Personal services business: If you operate a personal services business, you should reconsider your decision to do so. For taxation years beginning after 31 October 2011, personal services business income is subject to a federal income tax rate of 28% versus the general federal active business income tax rate of 15% for 2012 and beyond. This means that the tax deferral opportunity from incorporation has been significantly reduced, and the tax cost of earning income in the corporation and later distributing it as dividends has increased. If you have been using a personal services business, consider taking the earnings for 2012 out as a salary.
Employee profit sharing plans: Some businesses have used employee profit sharing plans (EPSPs) as a substitute for salaries or bonuses, often to defer tax and/or avoid the Canada Pension Plan premiums that accompany conventional employment earnings.
The federal government’s 2012 budget introduced significant changes to the taxation of EPSP allocations from closely held employers, generally where the employee either holds at least a 10% interest or does not act at arm’s length to the employer. If you’re a business owner who uses EPSPs, you should consider the implications of these new provisions in your remuneration strategy for 2012 and future years.
For more information on these and other tax-planning and tax-saving ideas, please call your Ernst & Young advisor.
And for more tips and strategies that can help you throughout the year, download our helpful annual guide, Managing Your Personal Taxes 2012–13: a Canadian Perspective.
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