The beginning of March officially kicks off the tax season. This time of year is enough to cause temporary insanity for any accountant as clients demand tax savings. I think of the accounting professor from George Washington University who was honoured at a basketball game last year at this time for being a very large donor to the school. Moments after receiving the honour he was ejected from the stands for causing a ruckus by harassing a referee about a missed call. True story. I'm telling you – tax season does that.
Today, I want to share an approach to tax planning that can take the stress out of this time of year. It involves using five pillars of planning to create tax savings.
The five pillars
1. Deducting: This involves claiming deductions or credits to reduce a tax liability.
2. Deferring: This entails pushing a tax bill from the current year to a future year. The benefit, of course, is that you're able to use those dollars in the meantime.
3. Dividing: This involves moving income to the hands of another family member who may pay tax at a lower rate than you. This is also referred to as income splitting.
4. Disguising: This is the concept of disguising one type of income that is taxed at higher rates as another type that is taxed at lower rates. That is, converting from one type to another to save tax.
5. Dodging: This entails structuring your affairs so that certain income is not taxable at all.
Okay – let's get practical here. Let me share some specific strategies that you should consider implementing today to save tax in the future.
Creating tax deductions and credits can be as easy as rearranging how you are doing certain things. Consider these ideas:
- Work from home. Create a deduction for certain home-related costs that you're paying for anyway. If your employer requires you to work from home and your home office is your primary place of work, or where you have a designated area of your home set aside to regularly meet clients or customers, you may be entitled to deduct a number of costs. So, negotiate this requirement with your employer.
- Swap your debt. Create an interest deduction by transforming your non-deductible debt into deductible. How? Consider selling some investments (count the tax cost first), paying down your non-deductible debt, then re-borrowing to replace your investments. If you're borrowing to produce income, your interest generally will be deductible.
- Realize some losses. Now is a good time of year to trigger losses on investments that have declined in value. So, consider selling some of your losers. If you've got investments that are no longer trading because of bankruptcy or insolvency, you may be able to claim a loss without disposing of the security. Subsection 50(1) of Canadian tax law will allow you make an election that will deem you to have sold that security for nil proceeds if the company meets certain criteria.
Pushing a tax bill to a future year can be done in these ways, among others:
- Contribute to registered plans. Contributing money to your registered retirement savings plan (RRSP), a spousal RRSP, or a registered education savings plan will allow the assets in the plan to grow on a tax-deferred basis. An RRSP also creates a tax deduction today, resulting in a deferral of tax on the amount contributed.
- Negotiate a leave or sabbatical. Your employer can set up a deferred salary leave plan, which will allow you to contribute up to one-third of your salary each year to this plan, for up to six years. You won't face tax on the deferred salary until you take your leave or sabbatical, which will have to begin no later than six years after the deferral begins.
- Revise your estate planning. You can defer tax for many years by doing a couple of things as part of your estate planning: Any assets that have appreciated in value should be left to your spouse (or a spousal trust) upon your death to defer tax until your spouse dies. In addition, consider an estate freeze (I wrote about this in ) to push tax off for potentially a generation.
I'll finish this topic next time.