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.
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.
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% in 2018 to 9% in 2019, and the gross-up and dividend tax credit will be reduced to match. (But the 2019 changes to the gross-up and credit will apply to all dividends, even if the corporation originally paid tax at a rate higher than 9%.)
This means that the effective personal tax rate on “non-eligible” dividends from private corporations will increase for 2019. For example, if you are in the top bracket in Ontario, the rate will increase from 46.84% to 47.78%.
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 2018.
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 significant tax credit. If you are in the top federal tax bracket (over $210,371 of taxable income after all deductions), the federal credit is 33% of the lesser of your donations over $200 and the amount of your taxable income in the top bracket. If you are not in the top bracket, the federal credit is 29%. As well, there is a provincial credit that typically increases the total credit to something in the range of 40-50%, or even higher.
If you are not in the top tax bracket, you can benefit by receiving income and donating it back to a charity. This may be possible if you volunteer for a charity. If the charity pays you for your volunteer work, and you donate the money back to the charity, you will come out ahead.
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 by province). The net is a saving of about $1,500 after tax.
Of course, the income must represent real work you do for the charity, and your donation must be voluntary. You and the charity also need to determine whether you are an employee or an independent contractor. If you are an employee, the charity must issue you a T4 and might 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 even more tax savings; and if your total business revenues for the year exceed $30,000 you may need to charge GST or HST.
An even simpler technique is to have the charity reimburse you for actual expenses you have incurred 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.
Overall, 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 every case, make sure to get a tax receipt from the charity that meets all of the conditions specified in section 3501 of the Income Tax Regulations, or you will not be entitled to the credit.
Note that donations of property will be 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. Note also that the CRA carefully audits donations of property to check whether the value that is provided on the tax receipt is correct.
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 2018 is based on your 2017 “earned income” as well as your pension adjustment (reflecting future pension credited to you in 2017 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 2017 return in the spring of 2018. Your maximum contribution room for 2018 is:
18% of your 2017 earned income
(maximum $26,230 if your 2017 earned income exceeded $145,722)
your pension adjustment
any contribution room from earlier years since 1991 that you have not yet used up.
Your deadline for contributions for 2018 is March 1, 2019. However, if you have excess cash, you should also consider making your 2019 contribution early in 2019. You can make that contribution any time from January 1, 2019 through February 29, 2020. Putting funds into an RRSP will allow them to grow tax-free, rather than you having to pay tax on any interest 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 will not be taxable. As of 2018, your lifetime TFSA contribution limit is $57,500 if you were born before 1992, and will likely be $63,000 as of 2019.)
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.
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 sell order goes in by December 27, in time for the sale to “settle” before the end of the year. The settlement date for most stock trades in Canada is now two business days, and December 29-30 are Saturday and Sunday.
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.
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 non-deductible 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. Overpaid 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.