My son Michael loves to play hide and seek. I've tried everything to avoid being found – including draping myself in a tarp and posing as a piece of lawn furniture in the garage.
Tax planning is a lot like hide and seek. The government is seeking to find taxable income, and I'm trying to hide it. Don't get me wrong. I'm not doing anything wrong. I'm just structuring my affairs to pay the least amount of tax possible under the law.
I've been writing in recent columns about the five pillars of tax planning: Deducting, deferring, dividing, disguising and dodging. Today, I want to finish the discussion by talking about the final two pillars: Disguising, and dodging (sounds like hide and seek, doesn't it?).
"Disguising" income is simply the idea of converting your income from one type that will be taxed at a higher rate to another that will be taxed at a lower rate. There are above-board ways to do this. Here are some ideas:
-Consider a prescribed annuity. If you rely on GICs or other interest-bearing investments for income, you're paying a lot of tax on what little interest you're earning. Consider using all or some of the cash invested in that GIC or other interest-bearing investment to buy a life annuity, which could provide more after-tax cash flow than your current investment because each annuity payment is partly a return of your original capital, which is not taxable. To replace the capital that you used to buy the annuity, so that there's something left for your heirs, consider using some of the additional cash flow annually to buy a life insurance policy that will pay out on your death. In most cases you'll still be left with more in your hands after taxes than the GIC or similar investment could provide.
-Take back your "paid up capital." If you own shares in a private corporation and you have what is known as paid up capital (PUC) in your shares, consider taking some of the PUC as a tax-free return of capital to you rather than taking taxable dividends or salary. PUC is a cousin to your adjusted cost base (ACB) and generally represents the amount of capital you may have invested in the shares of your company. Speak to a tax pro about how to take back PUC.
-Make the Canadian securities election. It's possible to elect to have any profits on the sale of your Canadian securities treated as capital gains rather than business income. You might be afforded this treatment even without the election, but where you make a significant number of trades in a year the taxman might consider your activities to be an "adventure in the nature of trade," and may try to tax your profits as business income, not capital gains. This election can fix that problem, but it's irrevocable and will apply to all future years, so speak to a tax pro first.
When I talk about "dodging" I'm simply talking about structuring your affairs so that all or some of the income you earn is not required to be reported on your tax return at all. So, in a real sense you're dodging the taxman – legally. Consider these ideas:
-Negotiate non-taxable benefits. There are a number of benefits that your employer could provide that could be tax-free to you, including personal counselling, discounts on merchandise, club membership dues, and education costs, to name a few. See my article from Dec. 8, 2011 for more ideas.
-Consider exempt life insurance. A universal or whole life insurance policy can allow you to accumulate investments inside the policy on a tax-sheltered basis. This makes good sense particularly for your fixed income investments that earn highly taxed interest income. Further, some of the returns inside certain whole life policies have been particularly stable over time.
-Give up residency. Sure, this may seem extreme, but you may be able to escape the Canadian tax net entirely by leaving Canada and giving up residency for tax purposes. There are a number of steps to ensure you've done this properly (simply leaving Canada may not be enough), so speak to a tax pro about it.
Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.