TaxBreaks October 2007, Reduce 2007 taxes, RRSP, eligible dividends, capital gains

Contribute to your RRSP
Donate
Take advantage of the reduced tax rate on eligible dividends
Claim the $750,000 capital gains deduction
Stagger taxation of certain capital gains
Defer tax on certain stock option benefits
Use your capital losses
Offset taxable income with an allowable business investment loss
Repay shareholder loans
Pay a bonus
Check whether interest on your loans is deductible
Make certain disbursements before the end of the year
Contribute to a registered education savings plan
Review your December instalment
Keep your transit passes

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Fall is always a good time to take stock of one’s tax situation. As several weeks remain before the end of the year, now is the time to review your 2007 transactions and make any necessary adjustments. Tax planning is always an issue, whether you work, are retired, operate a business directly or operate a business through a corporation. Here are fifteen ways, among others, to save on taxes for 2007.

1. Contribute to your RRSP
If you haven’t yet contributed to your RRSP for 2007, don’t wait until the end of February 2008 — contribute now. The earlier you contribute to your RRSP, within the allowable limits, the more quickly the capital to finance your retirement will grow, sheltered from tax.

2007 contribution. Your maximum contribution for 2007 is 18% of income earned in 2006, principally from employment or a business, up to a maximum of $19,000 (compared to $18,000 in 2006). The maximum RRSP contribution for 2007 applies to earned income of $105,556 in 2006. If you participate in a pension plan, you should keep the various pension adjustments in mind. To find out the exact amount that you can contribute, look at the “RRSP Deduction Limit Statement for 2007” section of your federal assessment notice for 2006.

Think ahead to 2008. The RRSP limit will increase in 2008, when it will reach $20,000. If you operate a business through your own corporation, have no other source of earned income, and are able to do so, make sure, by the end of December, that you have paid yourself at least $111,111 for 2007, so that you can contribute the maximum amount to your RRSP in 2008.

Unused RRSP contribution room. If you contributed less than the maximum allowable amount to your RRSP in a previous year, and, if you can afford it, use the unused RRSP contribution room for 2007 by contributing an additional amount equal to the unused room. Don’t wait too long to use up unused room, as doing so will give you less time to reap the benefits of untaxed compound interest, and you will have less capital in your RRSP when you retire. Remember that your investment horizon may be for 10 or 20 years, or even 40 years or longer, depending on how old you are now and at what age you think you will need funds from your RRSP.

Be careful of overcontributions. The law allows you to contribute up to $2,000 over the authorized maximum in your RRSP. Do not exceed this limit, because the penalty of 1% per month on overcontributions can add up fast, and the administrative formalities to recover excess contributions are relatively complex. Since the Canada Revenue Agency (CRA) has begun paying much closer attention to overcontributions, do not expect them to go unnoticed.

If you turn(ed) 69, 70 or 71 in 2007. The 2007 federal budget changed the age limit for contributing to an RRSP from 69 to 71. The same age limit applies to withdrawing funds from an RRSP and converting an RRSP to a RRIF or an annuity.

Should you continue to contribute to a spousal RRSP? Under current tax legislation, taxpayers who receive pension income can split this income with their spouse when filing their 2007 tax return. However, contributions to a spousal RRSP are still useful. In fact, these contributions would enable you to double the amount that you, as a couple, can withdraw from your respective RRSPs to participate in the Home Buyer’s Plan.

2. Donate
Did you make any donations in 2007? If you have not already done so, now is an ideal time to reconsider your donation plans for 2007 and benefit from the charitable donations tax credits. The federal credit is equal to 15.5% of the first $200 of charitable donations paid in the year and 29% for any donation in excess of $200 (12.94% and 24.22%, respectively for Quebec residents). For tax purposes of the territories and provinces other than Quebec, the credit varies from 4% to 11% for the first $200 and from 11.16% to 21% for amounts exceeding $200. For Quebec tax purposes, the tax credit is equal to 20% of the first $200 and 24% of the excess.

Another very interesting tax strategy, for both you and the charity, is to donate publicly traded company shares from your portfolio, especially if these shares include a significant gain. In fact, no income tax is payable on a capital gain realized when shares of a public listed company are donated to a charitable organization (including private foundations, since March 19, 2007). Under these circumstances, the charity receives a larger amount than it would if you were to sell the shares and donate the proceeds after paying taxes on the gain.

If you are thinking about making a charitable gift before the end of the year and exercising stock options acquired during the same period, then donating these shares to a charity can also be a very effective tax-saving strategy, since you could deduct the entire benefit you received. This easing measure only applies in respect of shares acquired that were donated in the year and in the 30 days after the option was exercised. Under such circumstances, it seems preferable to exercise the options and donate the shares rather than to sell them once the options are exercised and donate the proceeds less the taxes related to the benefit.

Finally, if you hold shares of public companies in a business corporation, you can also consider donating these shares through your corporation, provided that the taxable income is sufficient to qualify the donation for a deduction (corporations can claim a deduction but no tax credits for charitable donations). The full amount of the capital gain realized by the corporation can therefore be paid to shareholders tax free.

3. Take advantage of the reduced tax rate on eligible dividends
If you are a shareholder of a Canadian-controlled private corporation (CCPC) and this corporation received taxable income that is not eligible for the small businesses deduction (excluding investment income) in 2007 or in previous taxation years starting as far back as 2001, such income accumulated in a “general rate income pool” (GRIP), represents the balance that may be paid out as eligible dividends. The advantage of eligible dividends is that they are taxed at a lower rate than regular dividends. The lower rate varies from one province to the next. For some provinces, such as Ontario, the benefit increases slightly each year until 2010. However, the corporation paying the dividend must respect the rules regarding the designation of eligible dividends and ensure that the amount of eligible dividends does not exceed the GRIP.
If you hold shares of public companies or other corporations residing in Canada that are not CCPCs, the dividends that you receive will generally be eligible dividends.

4. Claim the $750,000 capital gains deduction
Small business corporation shares, qualified farm property, and qualified fishing property (including, for qualified agricultural and fishing properties, shares of a corporation and partnership interests) qualify for the lifetime capital gains deduction of $750,000 ($500,000 for shares disposed of before March 19, 2007). Claiming this deduction often requires a good dose of planning and help from your tax advisor. If you are thinking about selling the assets that qualify for this deduction before the end of the year, consult your tax advisor as soon as possible.

If you have already claimed the $100,000 personal capital gains deduction (abolished in 1994), you are entitled to a maximum deduction of only $650,000. If you plan to use this deduction in 2007, check with your tax advisor to find out whether you have realized an allowable business investment loss in prior years or have cumulative net investment losses as at December 31, 2007. If so, these will be taken into account, and you may not be able to claim the full deduction.

5. Stagger taxation of certain capital gains
If you dispose of property on which you realize a capital gain, you can stagger the taxation of this gain over up to five years if you allow the purchaser to stagger the payment of the proceeds from the sale over at least a five year period as well. The term is increased to 10 years for the transfer of farm or fishing property, shares from a family farm or fishing corporation, or from a small business corporation when this transfer is carried out in favour of a child, a grandchild or a great-grandchild living in Canada.

6. Defer tax on certain stock option benefits
If you exercised stock options in 2007 on publicly traded shares and expect to keep these shares until at least December 31, 2007, you can defer the benefit related to exercising options worth $100,000, as this amount is based on the fair market value of the shares at the time the stock options were granted. To defer the benefit, you have to notify your employer in writing before January 16, 2008, so this information can be included in your T4 (Relevé 1) for 2007. Your tax advisor can help you to determine whether the deferral is beneficial and, if so, how to optimize it.

7. Use your capital losses
Under the tax rules governing capital losses, you can use your 2007 capital losses to decrease the current year’s taxes if you have realized at least an equal amount in capital gains. Many taxpayers also sell their investment losses before the end of the year once they have realized significant gains earlier in the year. But be careful! If, within the thirty days prior to or following the sale of an asset that resulted in a capital loss, you purchase an identical asset, the superficial loss rules prevent you from claiming a capital loss on an asset you clearly intended to continue holding. This rule also applies if your spouse or a company under your control purchases the identical asset.

8. Offset taxable income with an allowable business investment loss
Whereas capital losses can be used only to reduce capital gains, an allowable business investment loss (ABIL) can be used to reduce your overall income. Therefore, if you are a shareholder or creditor of a financially unstable private corporation, consider selling your shares or debt to an unrelated person before December 31 to realize an ABIL for 2007. Remember, however, that if you have already claimed a capital gains deduction in the past, the amount of the ABIL is reduced by the claimed amount. Furthermore, pay particular attention to the documentation related to this loss, as the tax authorities could require you to produce it during the assessment process.

9. Repay shareholder loans
If you took a loan from your corporation in 2006, repay it before the end of 2007. If you delay, the full amount of the loan will be added to your income for 2006. An exception is available if the loan was made to an employee-shareholder for purchasing a residence, securities issued by the employer, or a car for work purposes. Other restrictions apply to these types of loans, however.

10. Pay a bonus
The small business tax deduction (SBD) is available to Canadian-controlled private corporations with active business income of less than $400,000 federally in 2007 (this amount varies regarding provincial and territorial taxes). If the active business income derived from your company exceeds the $400,000 threshold, a common suggestion has been that the corporation pay out a bonus to bring its income below the threshold. However, since 2006, changes to federal and many provincial (including Quebec) corporate tax rates have been both announced and effected for future years. The implementation of eligible dividends has also affected dividend tax rates. Given these modifications, it is important to ensure that this strategy remains on target with your situation and generates the best tax savings possible. Talk to your tax advisor. If you opt for this solution, your company will be able to claim the tax deduction as long as the bonus is paid within 180 days of your corporation’s fiscal year-end.

11. Check whether interest on your loans is deductible
To be able to deduct loan interest when computing your income, the loan must have been contracted for the purpose of earning income from a business or property. If you are currently paying interest that is not deductible (for example, on a home mortgage loan, on a loan to contribute to your RRSP, or to acquire an interest in a life insurance policy), ask your tax advisor if you could reorganize your business affairs to make the interest deductible. Recent legal precedents and the CRA’s administrative positions regarding interest deductibility should prompt taxpayers at least to review their current situation.

If you are a taxpayer living in Quebec, you will also have to consider the rule which limits the deduction of financing costs related to “passive” investments to the amount of investment income generated from these investments. If your financing costs since 2004 were limited by the application of this rule and you were unable to defer the amount exceeding the limit in prior years, check if you could increase your investment income in 2007 to absorb both your financing costs from 2007 and your excess financing costs from previous years. As the capital gains are part of the investment income for purposes of this rule, you could realize additional capital gains for this purpose, if circumstances permit.

12. Make certain disbursements before the end of the year
Some deductions and credits can only be claimed if the amount was disbursed before the end of 2007. This is the case for charitable donations, child support (if deductible), childcare expenses, interest on loans for investment purposes, tuition fees, and union and professional dues.

13. Contribute to a registered education savings plan
Although contributions to a registered education savings plan are not deductible, the income that accumulates on the capital is only taxable when it is paid out to a student as an education assistance payment. Of course, contribution limits must be respected. Possible federal and provincial grants that are not included in calculating the lifetime contribution limit make the registered education savings plan even more interesting.

14. Review your December instalment
If you are required to pay your income taxes in instalments and estimate that your 2007 income will be significantly less than it was in 2006, decrease the amount, if you have not already done so, of your December 15, 2007 instalment. However, be careful when making this estimate: if your actual income in 2007 is higher than expected, you could be required to pay interest that is not tax deductible.

Reviewing your December tax instalment may be especially useful for federal tax purposes if you plan to split your 2007 pension income with your spouse. If you receive pension income qualifying for the pension income amount, you can allocate up to 50% of your eligible pension income to your spouse in your 2007 income tax return. By decreasing your income for 2007, you can reduce your federal instalment to be made in December 2007. However, under Quebec tax law, taxpayers who elect to split their pension income with their spouse cannot reduce their tax instalment accordingly.

15. Keep your transit passes
Individuals can claim a non-refundable tax credit for monthly or longer-duration public transit passes in their federal tax return. The 2007 federal budget also included a tax credit for weekly transit passes that are valid after 2006, provided that the taxpayer purchases at least four consecutive passes. The budget also includes measures to make electronic payment cards issued after 2006 eligible for the tax credit, provided that certain conditions are met.

Jean-Luc Beauregard, Montreal
Marina Panourgias, Toronto

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