Steps you take this year could mean a lower income tax bill next year
By Olev Edur
Once you’ve got your income taxes done and the subject is fresh in your mind, you might want to give some thought to what you can do to reduce your tax bill next year.
While our tax laws incorporate numerous anti-avoidance and attribution rules that limit how far you can legitimately go, there still may be things you can do before December 31 to lower your annual tithe to Ottawa. Still other actions you could take may not have a big immediate impact, but they could significantly reduce your tax bills in years to come.
Because of our graduated tax regime, for example, one fundamental financial planning tenet is to “smooth out” your income so it tops out at the same tax bracket every year. Sometimes by moving high income into lower-income years, the results can be significant.
You cannot, however, simply move income from one year to another or hand it off to someone else—apart from specific exceptions in the Income Tax Act (ITA), all your income must be declared by you in the year you receive it, or in which it’s credited to you from, say, a multi-year GIC.
One common exception is the RRSP; with these plans, you effectively take current earnings and move them into future years when your retirement income and taxes will (presumably) be lower. Another is pension splitting; by transferring pension income to a lower-income spouse so that your incomes are closer to equal, you again move otherwise highly taxed earnings into a lower tax bracket.
Yet another exception of sorts relates to capital gains: profits on investments such as company shares or mutual funds can go untaxed until they are realized, even if that happens to be 10 or 20 years later. “You need to pay tax on a capital gain only once the underlying asset has been sold,” says Joseph Pagliaroli, a tax partner with KPMG Enterprise who’s based in Vaughan, ON.
In addition to smoothing your income, there are some other year-end tax items—credit-related expenditures, for example—that could get overlooked or forgotten until 2020 has lapsed. In part, year-end planning means making a list ahead of time, and not just for Santa.
Further strategies may also apply in certain situations. Year-end opportunities will differ depending on circumstances and needs, but the following can each represent areas of potential tax savings for a retiree.
As noted, RRSPs are a dandy way to do some income juggling, and you even get an extra 60 days beyond year-end to contribute to these plans. Not only that—if you have a spouse/common-law partner, you can split income with him or her by contributing to his or her plan rather than your own (subject to a requirement that no withdrawals are made in the current and following two years, or else the withdrawal may be attributed back to you).
Note, however, that anyone who is or will be entitled to Guaranteed Income Supplement (GIS) should avoid RRSPs, because each dollar withdrawn from the plan will result in 50 cents being deducted from benefits. You may even want to go so far as to drain any small (say, $50,000 or less) existing RRSP over a year or two and pay the tax, ideally before turning age 65, in order to maximize your future GIS entitlement. If the cash isn’t required, it could be placed in a Tax-Free Savings Account (TFSA).
Another caveat: While the RRSP contribution deadline is 60 days after year-end, if you turned 71 in 2020, you must close your RRSP before the end of the year. Otherwise the plan proceeds will be added in their entirety to your 2020 income; a five- or six-digit income boost could well end up being taxed at a rate of 40 to 50 per cent (or even more in some provinces).
The alternative to cashing out and paying a lot of tax is rolling the RRSP proceeds into either a RRIF or an annuity (or perhaps both) before year-end. With a RRIF, you have much the same investment choices as with an RRSP, and you must withdraw a minimum amount each year but can withdraw more whenever you want. Income from an annuity is fixed and guaranteed for life or until age 90 (depending on annuity type)—you have no further decisions to make. Income for both options is eligible for the annual pension income credit of up to $2,000, but there are wrinkles to both of these products, so some professional advice may be in order.
If you turned 71 this year and your RRSP is already maxed out, one strategy for getting a last kick at the savings can involves making an overcontribution in December 2020. A penalty will apply but for only one month; in January 2021, your income for that year can serve to offset the overcontribution. “This assumes that in 2021 you have enough earned income—that is, employment or self-employment income—to create the necessary contribution room,” Pagliaroli says. “And it’s worth noting that RRSP deductions can be claimed at any age, not just until 71.”
If your 2020 income has been abnormally low (not an uncommon occurrence given COVID) and you anticipate better days ahead, bear in mind that RRSP withdrawals are not accorded the same 60 days’ grace as contributions. If you want to take some money from your RRSP to pay off debts or buy necessities, do it before year-end, while your income is low.
The TFSA alternative
As for TFSAs, they’re a far better tax-assisted savings alternative than RRSPs for low-income retirees because, while contributions garner no up-front tax deduction, withdrawals don’t count as income, either. Any amounts you withdraw from a TFSA are not taxable, nor do they have any impact on geared-to-income benefits such as GIS or provincial tax credits. And you can replace whatever you withdraw without affecting your normal contribution limits.
If you want to withdraw some TFSA funds for whatever reason and hope to replace the money shortly afterwards, though, you can’t replace it until January 1 of the following year. It may therefore be wise to make the withdrawal just before year-end so the money can be replaced soon afterwards (if possible) and thus can begin compounding tax-free again quickly.
(For 2020, the TFSA contribution limit is $6,000, but annual contributions are cumulative, meaning, you won’t lose any contribution room if you fail to contribute the full amount in any given year—unused room is simply added to what you can contribute in future years; since TFSAs were introduced in 2009, total TFSA contribution room has grown to $69,500.)
If you’re 65 or older and have no pension income other than CPP but do have an RRSP, consider rolling some of it into a RRIF and then withdrawing up to $2,000 before year-end—after you reach age 65, RRIF withdrawals are eligible for the annual $2,000 pension income credit. “CPP benefits don’t qualify for this credit, but each spouse aged 65 and older can claim it on eligible income, including pension income you split with your spouse,” Pagliaroli says.
(If you’re receiving pension income from an RPP, RRSP, or RRIF, you can allocate up to half of this income to your spouse/common-law partner, although this is an option that can be exercised when you do your tax return next April, rather than being a year-end requirement.)
Although it’s a monthly rather than specifically year-end consideration, you should think about the timing of your CPP and OAS benefits. You can start collecting CPP as early as age 60, and OAS as early as age 65, but both can be deferred as late as age 70, with the benefits of both plans increasing each month that you delay start-up. If you’re still working, for example, you may want to wait until you’re no longer doing so, because the benefits may be taxed at a higher rate when added to your work income than would be the case later on.
(CPP benefits increase 0.6 per cent each month from age 60 to 65, and 0.7 per cent each month from 65 to 70; OAS increases 0.6 per cent monthly from 65 until 70. Beyond age 70, there are no further increases other than annual inflation adjustments.)
Most retirees don’t own businesses for which they can juggle income and expenses (see page 37), but many do have investments, and managing these constitutes a business in itself. As far as the year-end goes, if you have some investment losers you’ve been thinking of unloading, and you also have some capital gains to declare for 2020, you can sell the losers before year-end to help offset those gains. If you’re planning to sell some winners, consider whether the taxes might be higher this year or next year before executing the trade.
However, if you’re hoping to sell a loser for the tax deduction and then buy it back because it still has future potential, you need to be careful. “If you sell an investment to trigger a capital loss, and you or your spouse or a corporation controlled by either of you acquires identical investments within 30 days, the capital loss will be deemed a ‘superficial loss’ and will be ignored for tax purposes,” Pagliaroli cautions.
Bear in mind, too, that profit/loss considerations should always trump taxes when contemplating any investment purchase or sale. “Never let the tax tail wag the investment dog” is a common industry saying.
Grants and tax credits
Various tax credits and grants are available from the federal government, and for the most part, they are based on actions taken before year-end.
Charitable donations must be made before year-end to count on your 2020 tax return, but in some cases, it may be advantageous to save a few years’ worth (the limit is five years) and contribute them all in a single year. That’s because the first $200 you donate each year is accorded a
15 per cent federal tax credit (plus a provincial/territorial credit), whereas any additional amounts are accorded a
29 per cent federal credit (or 33 per cent, to the extent that you are wealthy enough to have paid 33 per cent federal tax on income over $214,368 for 2020). By bunching donations together into a single year, you can maximize the amount that is accorded the higher rate.
Medical expenses can be calculated on the basis of any 12-month period ending in 2020, rather than needing to be based on the calendar year. “But if you do use a December end for the 12-month period and you have pending expenses that are due early in the new year, you might consider prepaying them so that you can claim them this year rather than next,” Pagliaroli suggests.
The federal home accessibility tax credit (HATC) also must be claimed before year-end; it provides a credit of 15 per cent on up to $10,000 of eligible renovations to a qualified dwelling in which a person 65 years or older, or a person eligible for the disability tax credit, lives during the year; similar credits are available in some provinces. “If these alterations were prescribed by a doctor for medical reasons, you may be able to claim the same expenses as medical expenses, as well,” Pagliaroli says.
“In addition, there may be other credits that seniors may claim on their returns, such as the disability tax credit and the caregiver credit, depending on their personal medical situation,” Pagliaroli says. “The disability credit would require a certificate completed by a qualifying medical practitioner.”
As noted earlier, business owners (and the self-employed) may have more leeway in the timing of expenses and deductions, for example, by choosing whether to buy equipment or supplies before or after the year-end. They can also choose whether or not to claim capital cost allowance (CCA, indicating depreciation) in any given year. And until 2027, CCA claims may be enhanced considerably under the Accelerated Investment Incentive (AII), a provision that lets an investor write off a larger share of new capital assets in the year they’re acquired.
“In general, expenses are deductible if they are laid out to earn income from the business and are in reasonable amounts,” Pagliaroli says. “There are exceptions, too, but it can get very complicated. If you have a business, you should definitely seek guidance from a tax professional familiar with business and corporate tax legislation.”
Foreign tax issues
Many retired snowbirds own property in the United States or other southern climes, and this may give rise to year-end tax-filing considerations in that country.
“If you spend a substantial portion of the year in the United States, for example, you become a US resident for tax purposes,” Pagliaroli says. “If this happens, you may be required to file US tax returns and pay US tax on your income from all sources, including Canada, except to the extent that you can claim foreign tax credits or be deemed resident in Canada under the Canada-US tax treaty. Snowbirds should consult with a US tax advisor to determine if they have any US tax filing requirements as a result of their frequent travel to the States.”
Finally, while year-end planning can be important, it should always be considered within the context of your longer-term financial plan. In this regard, independent financial advice is generally recommended, especially as you approach retirement and many financial changes and considerations arise.