It’s December, and time to think of some tax planning ideas. If you wait until your tax return is due next April or June, it will generally be too late to change your tax situation for this year.
1. Private Companies — Pay out Dividends before the Tax Cost Goes Up
The so-called “gross-up” and dividend tax credit apply when you receive dividends from a Canadian corporation. The purpose of these rules is to put you in the same position as you would be if you earned directly the income earned by the corporation — taking into account that the corporation has already paid corporate income tax. The “gross-up” brings into your income an amount that theoretically reflects the pre-tax income earned by the corporation to pay you the dividend, and the dividend tax credit then gives you a credit for the corporate tax that the corporation theoretically paid on that income. This so-called “integration” is often not exact, especially when varying provincial tax rates are taken into account.
As noted above in “A Wild October”, the federal corporate tax rate on small business active business income (up to $500,000 per year for most Canadian-controlled private corporations) will drop from 10.5% to 10% in 2018 and 9% in 2019, and the gross-up and dividend tax credit will be reduced to match.
This means that the effective personal tax rate on dividends from private corporations will increase a little bit for 2018 and again for 2019.
Other things being equal, if you are planning to have your corporation pay out dividends in the near future, do it before the end of 2017. Your personal income tax on the dividend will be a little lower than in 2018. The top federal rate on dividends will increase from 26.3% to 26.64% in 2018 and 27.57% in 2019. The effect of provincial tax will add to the amount you save.
Of course, this is not a very large saving, and you need to take other factors into account as well. For example, if your personal income will be lower in 2018 so that you will be in a lower tax bracket than in 2017, it will be much better to postpone the dividend until 2018.
2. Income Sprinkling
The new rules for income sprinkling (see “A Wild October” above) may take effect in 2018, although the details are not yet known. If you have the option of having your corporation pay dividends to family members who are not involved in the business, and who have not contributed significantly to the business, consider paying those dividends before year-end for income-splitting purposes. Starting 2018, such dividends may be taxed at the highest rate that can apply, if the “tax on split income” applies.
Of course, if the shareholders are children under 18, this “tax on split income” already applies to them, until the year in which they turn 18.
3. Charitable Donations
Charitable donations must be made by December 31 to be counted for this year.
Charitable donations receive special tax assistance. Donations that exceed $200 per year give you a tax credit calculated at the highest marginal rate. If your taxable income for 2017 (after all deductions) exceeds $142,353, the charitable donation credit is generally worth the same as a deduction (sometimes a little less, depending on the province). If your taxable income is lower, then the donation credit is better than a deduction, usually around 45%. (In Alberta and Nova Scotia, a special high credit for donations brings the value of the donation up to 50-54%.)
In fact, if you are not in the top tax bracket, you can benefit by receiving income and donating the excess to a charity. This may be possible if you already volunteer for a charity. If the charity pays you for your volunteer work, and you donate the income back to the charity, your tax bill will go down.
For example, suppose you are in a 30% tax bracket (including provincial tax), and you have already made over $200 in donations this year. If the charity pays you $10,000 for work you have done for it, your tax bill will go up $3,000 (maybe a bit higher, if you move up to the next bracket). If you donate the same $10,000 back to the charity, your tax bill will go down about $4,500 (varying slightly by province). The net is a saving of about $1,500 after tax.
Of course, the income has to represent real work you have done for the charity, and your donation must be voluntary. The charity also has to determine whether you are an employee or an independent contractor. If you are an employee, the charity must issue you a T4 and may have to withhold some tax at source. If you are an independent contractor, you may be able to deduct expenses from your “business income”, providing you with further tax savings; and if your total business revenues for the year exceed $30,000 you may need to charge GST or HST. Professional advice may be useful in addressing these issues.
An even simpler technique is to have the charity reimburse you for expenses you have incurred this year as a volunteer (e.g., travel and parking costs). Such reimbursements, provided they are reasonable, are not taxable to you. You can then donate the reimbursed amount back to the charity and get a tax credit.
Another idea to consider is donating publicly-traded shares or mutual fund units to a charity. If you do this, you do not pay tax on any capital gain on the securities, but the donation is valued for tax purposes at its current fair market value. If you are considering making a donation to a charity, and you have some securities that have gone up in value, donating the securities will be very tax effective.
You can claim charitable donations up to 75% of your “net income” for tax purposes. Net income is basically your income after most deductions, but before claiming the capital gains deduction (capital gains exemption) or any loss carryovers from other years.
In cases, make sure to get a tax receipt from the charity that meets all of the conditions specified in the Income Tax Regulations, or you will not be entitled to the credit.
Note that donations of property are valued at your cost of the property, if you acquired the property within the past 3 years or if you acquired it for the purpose of donating it. (This rule does not apply to publicly-traded securities or certain other property.) This prevents the so-called “gifting” schemes which used to attract many taxpayers, who would purchase art or other goods for less than their appraised value and then donate the art to a charity for a high-value tax receipt.
Finally, if you (or perhaps a child of yours who is over 18) have not claimed any donations for years after 2007, a special bonus “super credit” or “stretch credit” of an extra 25% is available for the first $1,000 of donations, significantly reducing the cost of the donation. This year, 2017, is the last year that this bonus credit can be used. It can only be used once, so if you already used it since it was introduced in 2013, you cannot use it again.
4. RRSP contributions
If either you or your spouse are not yet 71 this year, then you can normally make contributions to a registered retirement savings plan (RRSP) and deduct them from your income for tax purposes. Your RRSP contribution limit for 2017 is based on your 2016 “earned income” as well as your pension adjustment (reflecting future pension credited to you in 2016 from your being a member of a company pension plan).
Your available RRSP contribution room should be printed on the Notice of Assessment that you received from the CRA after you filed your 2016 return in the spring of 2017. Your maximum contribution room for 2017 is:
18% of your 2016 earned income
(maximum $26,010 if your 2016 earned income exceeded $144,500)
your pension adjustment
any contribution room from earlier years since 1991 that you have not yet used up.
Your deadline for contributions for 2017 is March 1, 2018. However, if you have excess cash, you should consider making your 2018 contribution early in 2018. You can make that contribution any time from January 1, 2018 through March 1, 2019. Putting funds into an RRSP will allow them to grow tax-free, rather than you having to pay tax on any interest or investment income that you earn during the year. (You can also put money into a tax-free savings account, or TFSA, for which you get no deduction but interest or investment income will not be taxable. As of 2017, your lifetime TFSA contribution limit is $52,000 if you were born before 1992.)
Consider also a contribution to a spousal RRSP. (This also applies to a common-law spouse or same-sex partner who meets the Income Tax Act’s definition of “common-law spouse”, even if you are not legally married.) Your maximum deductible contribution is the same regardless of whether you contribute to your RRSP or your spouse’s, or some combination of the two. If your spouse is likely to have lower income than you in future years, then a spousal RRSP contribution will allow your spouse to take the income out down the road (once the last year during which you make any spousal contributions has passed, plus two more years). Your spouse will then pay tax on that income at a lower rate than you would if you withdrew the funds from your own RRSP.
A spousal RRSP is also useful if you are already over 71 but your spouse is younger. Once you reach the year in which you turn 71, you cannot contribute to your own RRSP and must convert your RRSP to an annuity or a registered retirement income fund (RRIF) from which you draw income every year. However, you can still make contributions to a spousal RRSP if your spouse is under 71 at year-end.
5. Trigger capital losses
Capital gains are half-taxed; that is, half of the gain is included in your income as a taxable capital gain. Capital losses can be claimed only against capital gains (and can be carried back three years and forward indefinitely against such gains).
If you have capital gains this year — for example, from selling some shares for a gain earlier in the year — you may wish to trigger capital losses by selling securities that have gone down in value.
Make sure the transaction is completed by December 27, in time for it to settle before the end of the year. As noted in the article “Change to Market Settlement Rule” above, the settlement date for most stock trades in Canada is now two business days.
You should also ensure that you are not caught by the “superficial loss” rules. If you (or an “affiliated person”, which includes a corporation you control) acquire the same (or identical) securities within 30 days of selling them, then your capital loss will be disallowed.
There are numerous other special rules for capital gains and losses. This is just a general overview.
6. Pay your instalments
If you have instalments to pay for the year, and you have not been paying them as per the notices you receive from the CRA during the year, now would be a good time to catch up. If you wait until next April, you will owe four months’ additional interest, and possibly penalties, on the late instalments.
To avoid interest applying, instalments should be paid on March 15, June 15, September 15 and December 15. Prepaid or “early” instalments earn credit (called “offset interest”) against interest that applies to late instalments for the same year.
You are allowed to calculate instalments based on any of three methods, without interest applying. The instalments can total your tax payable (on income from which tax is not withheld at source) for this year, or for last year, or based on the amounts that the CRA advises you. The CRA’s notice to you for March and June is based on the total taxes you paid two years ago, and then for September and December the suggested instalments are adjusted so that the total for the year equals the amount you paid last year.
If you have not been paying your instalments, you should estimate as best as you can the tax that will be owing for the year on your self-employment and investment income (and other sources from which tax is not withheld), or use the numbers for 2016 (whichever is lower). You should then make a catch-up instalment payment as soon as possible, to reduce interest charges.
Where interest does apply to late instalments, it is calculated at 5% compounded daily, a rate that varies quarterly but has been largely unchanged since 2009. You do not get interest on overpaid instalments, other than as an offset to late instalments for the same year as explained above. But any interest you are required to pay is non-deductible.