Year End Tax Planning Tips
As we approach the end of 2008, it’s a good time to review your financial picture and explore any year-end tax-saving opportunities. If you are thinking more about Christmas, fine - just bear in mind that after December 31 very little could be done to reduce your taxes and save money. So here is a short list of year-end tax-planning ideas that can be implemented before we enter into 2009.
1. Realize capital losses
Year 2008 was extremely tough for most investors, and speaking of capital losses they have lots of investments (unfortunately) to choose from. The reason is simple – most stocks are sharply down this year. I just want to remind you that when you sell your portfolio dogs you create a capital loss. This loss must be applied against taxable gains realized during the year, but it can also be carried back three years or carried forward indefinitely to apply against future capital gains. Therefore it would be a good idea to check your 2005-2007 tax returns and see if you paid taxes on capital gains for any of those years.
Tax-loss selling must take place by the end of the year; just make sure you do that by December 23 as it takes three business days to settle a trade. Also keep in mind that selling a security should always be done in the context of your overall investment plan. Tax considerations alone should not drive your investment decision. Consult with your Investment Advisor.
If you decide to claim your losses as a business loss (as a professional trader) instead of claiming them as capital loss, consult a Tax practitioner. This aspect of the Tax Game is pretty complicated and you should know the Rules.
One word of wisdom for long-term investors: don’t try to buy “cheap” stocks these days just because they look inexpensive. Lots of them will go much lower, and you will lose money (as smart folks say, “don’t catch the falling knife”). Search instead for quality stocks that either held on, or declined the least compared to their peers. When the market eventually rebounds, those stocks will often be you great winners. As a less risky alternative, buy some “cheap” indices and well-managed mutual funds that lost part of their value. This is absolutely different from buying falling stocks.
2. Claim an allowable business investment loss (ABIL)
If you lent money to a small business venture (or purchased shares in a private company) that subsequently failed, you may be able to claim up to 50% of your investment as an allowable business investment loss. This loss is deductible against any type of income (unlike normal capital loss, which you can claim only against capital gains).
It is important to mention that business loans to FAMILY members can be claimed as ABIL if business later fails but there are 3 conditions that should be met. Otherwise a loss would be deemed to be Nil under the provisions of paragraph 40(2)(g) of the Act.
This whole thing is pretty complicated, and professional advice is required.
3. Deduct all interest expense on investments:
The interest on your investment loan is deductible if you purchase investments that are expected to generate income such as dividends and interest. Most investments fall into this category. Even if you buy “indexes” like QQQQ, it is not a pure “capital gains” play - they still distribute some dividends (although the amount is very insignificant).
4. Contribute to your RRSP.
RRSP is one of the best remaining tax avoidance strategies, and it is perfectly legal. Still, every year thousands of Canadians miss making an RRSP contribution. And far too many people wait until the last minute to contribute. This “last minute” normally falls on March 1st the following year. Considering this huge market drop you might want to put your money to work sooner, as there are lots of bargains around us.
Borrowing to make an RRSP contribution usually makes financial sense, and it sure does this year. If you do your home work and choose your investments carefully, your rate of return will definitely exceed the interest you pay to the bank. But be aware that this interest is not tax deductible. Instead you will deduct your RRSP contributions from your total income for the year.
On the other hand you might want to withdraw some money from your RRSP or RRIF before the end of the year if your 2008 income is low. You may pay little or no tax on the withdrawal. Remember the financial institution must withhold tax when you take money from your RRSP, but you may be eligible for most or all of the tax as a refund when you complete your 2008 tax return.
5. Consider deferring some of your RRSP deduction
If by claiming all of your RRSP deduction you will reduce your taxable income to a lower tax bracket, defer some of your RRSP deduction to next year. This will enable you to generate tax refunds at the highest possible tax rates. This is often overlooked by tax professionals so make sure your accountant does that correctly.
6. Adjust prior errors and omissions
If you find that you missed a tax deduction or credit, you can adjust most federal provisions under CRA’s Fairness Package all the way back to 1998. Many taxpayers often under report eligible deductions, including moving expenses, childcare expenses, employment deductions, and carrying charges. People also tend to forget about such non-refundable tax credits as tuition and education, caregiver, transit passes and children’s fitness amounts.
7. Pay your tax installments on time
If you are required to submit quarterly installments on Mar 15, June 15, September 15 and December 15 do send them in on time. The interest and penalties on late installments could be costly.
8. Combine your medical expenses and charitable donations
In most cases the lower income spouse should claim all medical expenses (if he or she pays any tax at all), and the higher income spouse all of the charitable donations. This will increase the overall tax credits.
9. Make your charitable donations by December 31, 2008
One of the most tax-effective ways to give to a registered charity is to donate publicly listed securities that have appreciated in value. That’s because you do not have to include any part of the capital gain as taxable income on your tax return, yet you are entitled to a donation tax receipt for the full value of these shares or securities.
10. Consider investing in a tax shelter
There are many different tax-shelter plans out there. Certain tax shelters are sanctioned by the Canada Revenue Agency and may be eligible for credits while many others are pure scams. In short, taxpayers should be wary of any arrangement that promises a donation receipt in excess of the cash payment. The tax shelters being promoted by many professionals are very complicated “designs”, so we advise you to speak to a tax practitioner before putting your money into any such shelter.
11. Get your child to file a tax return
If your kids received income from a part-time job get them to file a tax return even if no taxes are payable. They will start earning RRSP contribution room that could be used in the future when they are in a higher tax bracket. If your child is over 19 and not a full-time student he or she may receive up to $500 of WITB refundable tax credit (depending on income, some other conditions apply).
12. Minimize taxes on self-employed earnings
If you run a non-incorporated business the following tips will allow you to maximize your tax savings. First of all, consider writing off obsolete or damaged inventory as it makes no sense from the tax point of view to include them into your year-end inventory. Secondly, if you plan to acquire new assets do this before December 31 – in this case you will be able to start amortizing them in 2008. On the other hand you might want to defer the sale of old assets till next year. This will allow you to claim the maximum CCA (Capital Cost Allowance) for 2008.
Also think about buying office supplies, rewarding special clients or prospects with gifts or paying year-end bonuses to staff. Don’t forget about paying money to your family members if they actually helped you in your business. Everything should be documented. Payments should be regular and reasonable.
In case you have been charged a penalty and/or interest, consider requesting to have them reversed. Canada Revenue Agency will sometimes reverse those charges if you provide the CRA with an exceptional reason why you could not comply with the law. You can find the details on their web site. Another situation where it may be possible to waive penalties and interest is in “severe hardship” case. In other words, you should be able to proof that you have severe difficulties in paying your outstanding taxes.
Last but not least, consider the new Tax-Free Savings Account (TFSA), which will be available starting January 2009. The TFSA is unique because while contributions are not tax-deductible the income earned can be received tax-free. Contributions to a TFSA can be made by Canadian residents aged 18 or over. Up to $5,000 per year can be contributed to a TFSA, with unused contribution room being carried forward.
