Personal Tax Planning. July 21, 2014

Transcription

1 Personal Tax Planning July 21, 2014

2 Tax Deductions and Credits Tax planning begins with the effective use and application of available tax deductions, and non-refundable tax credits With a progressive tax system, personal tax planning often focuses on shifting income to the lower income spouse, and tax deductions / credits to the higher income spouse to reduce the overall tax burden; Tax planning, like financial planning, typically focuses on the family s tax position. Spouse = married / common law / same sex; Spouses file separate T1s, but can share, transfer or choose who claims certain income / deductions / tax credits;

3 Spouses / Dependants Children, parents, grandparents, etc. may qualify as dependants for tax purposes under various circumstances; Various tax credits can be claimed by a taxpayer for his / her dependents to reduce the overall tax burden: Amount for Eligible Dependant (in place of spouse); Caregiver Amount Disability Amount Transfer Tuition / Education Amount Transfer Medical Expenses Tax planning should identify opportunities to transfer / share applicable tax credits that are not otherwise required by the dependent to reduce the overall tax burden:

4 Income Deferral / RRSPs Tax deferral strategies delay the recognition of income in order to match it against future consumption, at a potentially lower marginal tax rate; Registered pension plans / RRSPs are the most common vehicles for tax deferral; Contributions to these plans are a tax deduction claimed in the calculation of taxable income in the year in which they are made, and therefore provide savings at the marginal tax rate; Withdrawals from these plans are taxed as income at some point in the future, typically when the marginal tax rate may be lower.

5 Income Deferral / RRSPs In 2013, RRSP contributions are subject to annual contribution limit: 18% of previous year s (2012) earned income to max. of $23,820; less any 2012 Pension Adjustment as reported by employer (if you also contribute to RPP), plus all unused contribution room accumulated and carriedforward from previous years; Unused RRSP contribution room carries forward & accumulates; It is possible to contribute more than the $23,820 annual RRSP limit in a 2013 if you have unused contribution room from previous years;

6 Income Deferral / RRSPs RRSP contributions can be made up to 60 days after the end of the taxation year (Mar 03, 2014), yet could still be deducted when determining 2013 taxable income; Investment earnings and capital gains earned on funds held within the RRSP are not taxable; These accumulate tax free until funds are withdrawn; Contributions can be made to the taxpayer s own RRSP or to a spousal RRSP; Spousal RRSP s provide the contributor with the tax deduction, yet retirement assets accumulate in the name of the recipient. Funds withdrawn from an RRSP at any time are included in taxable income and subject to a withholding tax; RRSP contributions can be made up to age 71.

7 Income Deferral / RRSPs Consider contributing to your RRSP at beginning of year to take advantage of tax-free compounding of the investment, Consider contributing to a spousal RRSP: Contributor claims the tax deduction, while spouse eventually withdraws funds / reports the retirement income; Consider transferring non-registered investments to a RRSP to avoid future taxation of investment earnings. (Caution: Transfer to RRSP may trigger capital gain based on FMV of assets at the time of transfer). Consider borrowing to make RRSP contributions, using the result tax refund to pay off the debt. Note: the interest paid on money borrowed to make RRSP contributions is not tax deductible.

8 RRSPs Home Buyers Plan The Home Buyers' Plan (HBP) is a program that allows taxpayers to withdraw funds from a registered retirement savings plan (RRSPs) to buy or build a home; Can withdraw up to $25,000 in a calendar year. RRSP contributions must remain in the RRSP for at least 90 days before withdrawal under the HBP, or they may not be deductible for any year. Must repay all withdrawals to RRSPs within a period of no more than 15 years. Must repay a minimum amount to the RRSP each year until HBP balance is zero. If you do not repay the amount due for a year, it will have to be included in your income for that year.

9 RRSPs Lifelong Learning Plan The Lifelong Learning Plan (LLP) allows withdrawals from RRSPs to finance full-time training or education for you or your spouse. (You cannot participate in the LLP to finance children's education). Annual withdrawal limit: $10,000 / Total plan limit: $20,000; If withdraw more than the annual LLP limit ($10,000) or total LLP limit ($20,000), the excess will be included in income for the year of the withdrawal. When you withdraw funds from your RRSP under the LLP, have up to 10 years to make repayments to your RRSPs. Usually, each year you have to repay 1/10 of the total amount you withdrew until the full amount is repaid. You do not have to pay any interest on the amounts you withdrew.

10 In Class Problem In Class Problem Ch 7 (Assume Nick is a resident of PEI) Problem # 5 (a) - Nick Orlando (Salary = $90,000) Problem # 5 (b) Nick is concerned about his 2013 tax liability and is considering selling the before the dividend is declared and paid. The current market value of the shares is $10,000, and Nick expects he would incur a $200 brokers commission on the sale. The original cost of the Bell Canada shares was $5,000. What is your advice? Problem # 5 (c) Nick also suggests transferring the shares to his RRSP, as he understands that this would allow him to claim a deduction equivalent to the FMV of the shares. He advises that he has made the maximum RRSP contribution every year and that his 2012 salary was $85,000. He contributes to a company pension plan at Alcan and his 2012 T4 slip reported an Pension Adjustment figure of $4,000.

11 Problem # 7-7 a) Calculate Nick s Total Income: Employment Income $ 90,000 Taxable Cdn Dividend Bell Cda (4,500 x 1.38 Dividend Gross-up) $ 6,210 Total Income $ 96,210 Deductions from Total Income None Net Income / Taxable Income $ 96,210

12 Marginal Tax Rates for PEI 2013 Taxable Income Income (General) Capital Gains Canadian Eligible Dividends first $31, % 12.40% -0.99% over $31,984 up to $43,561 over $ 43,561 up to $63,969 over $63,969 up to $87,123 over $87,123 up to $98,145 over $98,145 up to $135, % 14.40% 4.53% 35.80% 17.90% 14.19% 38.70% 19.35% 18.19% 42.70% 21.35% 23.71% 44.37% 22.19% 24.56% over $135, % 23.69% 28.70% Marginal tax rate f or dividends is a % of actual dividends received.

13 Problem # 7-7 a) Determine whether additional dividend income is to be taxed at a consistent marginal rate: Federal Tax Brackets - Sch 1: (>$87,123 and <= $135,054) Prov l Tax Bracket PE 428: (> $63,969) In both cases, the applicable tax remain consistent for each extra $ of dividend income. Use 2013 marginal tax rate for eligible dividends to calculate the additional tax $4,500 x 23.71% = $ 1, Note: The marginal tax rate is based on actual dividends rec d (not grossed-up amount).

14 Problem # 7-7 Total Income: Taxable Capital Gains (Taxable Amt = ½ x Capital Gain) Capital Gain / Loss = Proceeds from Sale - (Cost Base+ Selling Costs/Outlays) Marginal Tax Rate for Capital Gains = ½ x rate on other income;

15 Problem # 7-7 b) Calculate Nick s Total Income: Employment Income $ 90,000 Taxable Capital Gain Bell Cda ($10,000 5,000 $200)* 1/2 $ 2,400 Total Income $ 92,400 Deductions from Total Income None Net Income / Taxable Income $ 92,400

16 Marginal Tax Rates for PEI 2013 Taxable Income Income (General) Capital Gains Canadian Eligible Dividends first $31, % 12.40% -0.99% over $31,984 up to $43,561 over $ 43,561 up to $63,969 over $63,969 up to $87,123 over $87,123 up to $98,145 over $98,145 up to $135, % 14.40% 4.53% 35.80% 17.90% 14.19% 38.70% 19.35% 18.19% 42.70% 21.35% 23.71% 44.37% 22.19% 24.56% over $135, % 23.69% 28.70% Marginal tax rate f or dividends is a % of actual dividends received.

17 Problem # 7-7 b) Determine whether the taxable capital gain is to be taxed at a consistent marginal rate: Federal Tax Brackets - Sch 1: (>$87,123 and <= $135,054,) Prov l Tax Bracket PE 428: (> $63,969) In both cases, the applicable tax remain consistent for each extra $ of taxable capital gain. Use 2013 marginal tax rate for taxable capital gains (taxtips.ca) to calculate the additional tax $4,800 x 21.35% = $ 1, Note: The marginal tax rate is based on actual capital gain (not the taxable amount).

18 Problem # 7-7 c) Determine Nick s 2013 RRSP Contribution Limit: 2012 Employment Income $ 85,000 Contribution Room based on Earned Income $85,000 x 18% (Max $23,820) $15,300 Less 2012 Pension Adjustment (4,000) Add: Unused Contribution Room C/F 2013 RRSP Contribution Limit $ 11,300 RRSP Contribution Made (FMV shares) $ 10,000 Deduction from Total Income $ 10,000

19 Problem # 7-7 c) Employment Income $ 90,000 Taxable Capital Gain Bell Cda ($10,000 5,000 $200)* 1/2 $ 2,400 Total Income $ 92,400 Deductions from Total Income (RRSP) 10,000 Net Income / Taxable Income $ 82,400

20 Marginal Tax Rates for PEI 2013 Taxable Income Income (General) Capital Gains Canadian Eligible Dividends first $31, % 12.40% -0.99% over $31,984 up to $43,561 over $ 43,561 up to $63,969 over $63,969 up to $87,123 over $87,123 up to $98,145 over $98,145 up to $135, % 14.40% 4.53% 35.80% 17.90% 14.19% 38.70% 19.35% 18.19% 42.70% 21.35% 23.71% 44.37% 22.19% 24.56% over $135, % 23.69% 28.70% Marginal tax rate f or dividends is a % of actual dividends received.

21 Problem # 7-7 c) Determine whether net deduction (taxable capital gain less RRSP deduction) is to be taxed at a consistent marginal rate: Net change in Income = 2,400 TCG 10,000 RRSP ded.n = ($7,600) \ Federal Tax Brackets - Sch 1: (>$87,123 and <= $135,054) (>$43,561 and <+ $87,123) Prov l Tax Bracket PE 428: (>$63,969) In this case, the applicable marginal tax does not remain consistent for the net deduction from total income. Use a combination of 2013 marginal tax rates to calculate tax savings: $90,000 - $87,123 = $ 2,877 x 42.70% = ($1,228.48) $87,123 - $82,400 = 4,723 x 38.70% = ( 1,827.80) = ($3,056.28)

22 Income Deferral / TFSAs Beginning in 2009, Canadians can achieve a permanent tax deferral using the new Tax Free Savings Account (TFSA); Unlike RRSPs, contributions to a TFSA are not deductible for income tax purposes. On the other hand, income generated in such an account (e.g. investment income and capital gains) is tax-free, even when it is withdrawn; The annual TFSA contribution limits for 2009 through 2012 were $5,000. This amount will be indexed to inflation and rounded to the nearest $500 in later years. The limit for 2013 is $5,500. Unused TFSA contribution room can be carried forward to later years; Since TFSA contributions aren t tax deductible, withdrawals of capital are not taxable.

23 Income Deferral / TFSAs Full amount of withdrawals can be put back into the TFSA in future years; TFSAs can accommodate a wide range of investment options, incl mutual funds, Guaranteed Investment Certificates (GICs), bonds; Contributions are not tax-deductible. Neither income earned within a TFSA nor withdrawals from it affect eligibility for federal income-tested benefits and credits, such as OAS / GIC, or the Canada Child Tax Benefit. Funds can be given to a spouse or common-law partner for them to invest in their TFSA. TFSA assets can generally be transferred to a spouse or commonlaw partner upon death.

24 Income Deferral / TFSAs Example In March 2009, Jack contributed $5,000 to his TFSA. He did not make any other contributions and he did not withdraw any funds in His unused TFSA contribution room at the end of 2009 was zero. His TFSA contribution room at the beginning of 2010 was $5,000 (his 2010 TFSA dollar limit). On June 15, 2010, Jack made a contribution of $500. On October 26, 2010, he withdrew $4,000. His unused TFSA contribution room at the end of 2010 was $4,500 ($5,000 - $500). Jack makes the following calculation to determine his TFSA contribution room at the beginning of 2011:

25 Income Deferral / TFSAs Example (continued): TFSA contribution room at the beginning of 2010 $5,000 Minus: Contributions made in $500 Unused TFSA contribution room at the end of 2010 $4,500 Plus: Total withdrawal made in 2010 $4,000 Plus: 2011 TFSA dollar limit $5,000 TFSA contribution room at the beginning of 2011 $13,500

26 Income Deferral / TFSAs Consider transferring non-registered investments to a TFSA to avoid future taxation of investment earnings. (Caution: Transfer to RRSP may trigger capital gain based on FMV of assets at the time of transfer). Consider that interest on money borrowed to invest in a TFSA is not tax deductible, whereas carrying charges for investments held outside the TFSA are deductible.

27 Income Splitting In circumstances where different members of the family have (or will have) different marginal tax rates, planning can focus on allocating income from individuals in the higher tax bracket to those in a lower tax bracket to reduce the overall tax burden; Income splitting can take place between spouses or with children;

28 Income Splitting - Spouses Consider splitting the investing and household expense payment functions between spouses based on income levels / marginal tax rates so that the lower income spouse will report the investment income; For pensioners, elect to split up to 50% of pension income earned in the year (i.e. pension income received from registered pension plans or withdrawn from RRSPs) with spouse. The elected split income amount is included in Total Income of the recipient and deducted from Total income of the transferor, even though no cash has changed hands; Contribute to a spousal RRSP future withdrawals will be reported by the recipient spouse;

29 Income Splitting - Children Contribute to an Registered Educations Savings Plan (RESP). Unlike RRSPs, contributions to a RESP are not deductible for income tax purposes. No tax deduction but, upon withdrawal as educational assistance payments, the beneficiary child is taxed on the accumulated investment income; Contributions to RESP provide a 20% Canada Education and Savings Grant (CESG); The maximum annual RESP contribution that will qualify for the 20% CESG is $2,500 or $500 per beneficiary, to a lifetime amount of $7,200; There is no annual RESP contribution limit. The total RESP lifetime contribution limit for each RESP beneficiary is $50,000.

30 Income Splitting - Children Where self-employed, consider paying salaries to spouse and/or children for work in the business; Ensure reasonable $$ for the work performed;

31 Tax Shelters / Capital Gains Principal residence = most common tax shelter. No capital gains reported on disposal of principal residence; Special $500,000 capital gains exemptions for family farm property and qualified small business shares;

32 In Class Problem In Class Problem Ch 8 Problem # 3 (a) Elizabeth and Anita

33 Problem # 8-3 (a) Tax deferral: Elizabeth should save first in an RRSP, and should try to make the maximum contribution every year; Elizabeth should use any available RRSP contribution room carried forward from previous years when she didn t contribute; Elizabeth should consider making RRSP contributions in part or entirely to a spousal RRSP for Anita; Elizabeth should establish a tax-free savings account with 2013 maximum cumulative contribution of $20,000 to achieve permanent tax deferral on investment income

34 Problem # 8-3 (a) Income splitting: Elizabeth should pay the household expenses, whereas Anita should earn investment income. Elizabeth, who pays a high marginal tax rate (47.37%), is earning more and more of the investment income, whereas Anita is paying expenses from her capital. Reversing this situation will result in investment income being taxed at a lower marginal rate in Anita hands and reduce the household tax burden; Currently, Anita is earning nothing in the way of pension credits for retirement, and thus all the household income in retirement will be in Elizabeth s name, at a higher tax rate. Elizabeth needs to make the maximum RRSP savings, and part of them should be in a spousal RRSP to reduce taxes later; Elizabeth should establish and contribute to Registered Education Savings Plans (RESPs)for the two children;