TaxBreaks, October 2004
The year 2004 saw no major changes that affected our tax regimes; not many changes for 2005 have been announced to date, and we can only speculate about how government budgetary situations will affect our tax regimes next year. You may ask yourself if it is still worth thinking about tax planning. Without a doubt, the answer is yes: whether you are in business for yourself, operate through a corporation, or are simply a taxpayer wishing to minimize your tax bill, tax planning is always the answer. There is still plenty of time left before the end of the year to make the necessary adjustments to your 2004 tax planning. Here are fifteen ways, among others, to save on taxes for 2004.
Contribute to your RRSP
If you haven’t contributed to your RRSP for the year 2004, don’t wait until the end of February 2005. Contribute now. The earlier you contribute to your RRSP, within the allowable limits, the more the capital to finance your retirement will grow, sheltered from taxes. Contributing to your RRSP should always be at the top of your tax-planning list, and you shouldn’t let talk of market fluctuations cast doubt on your decision to contribute, as it is important to distinguish between the decision to contribute to your RRSP, which has an immediate effect on your income tax, and how you invest RRSP funds (e.g., in GICs, bonds, shares, mutual funds), these investment choices being affected by market fluctuations.
2004 contribution. Your maximum contribution is 18% of income earned in 2003, principally from employment or a business, up to a maximum of $15,500, an increase from $14,500 in 2003. The maximum RRSP contribution for 2004 applies to earned income of $86,111 in 2003. If you participate in a pension plan, you should keep the pension adjustment in mind, and the pension adjustment reversal, if applicable.
Think ahead to 2005. The RRSP limit will again increase in 2005, when it will be $16,500. If you have your own corporation, have no other source of earned income and are able to do so, pay yourself a salary of $91,667 this year if you wish to ensure that you can contribute the maximum amount to your RRSP in 2005.
Unused RRSP contribution room. If you contributed less than the maximum allowable amount to your RRSP in a previous year, use the unused RRSP contribution room for 2004 by contributing an additional amount equal to the unused room, if you can afford it. Don’t wait too long to make up unused room, or you will benefit from the effect of compound interest over a shorter period and have less capital in your RRSP when you retire. Remember that your investment horizon may be for 10, 20 or even 40 years, depending on how old you are now and at what age you think you will need your RRSP nest egg.
If you turn 69 in 2004. If you turn 69 in 2004, you must terminate your RRSP no later than December 31. It is extremely important not to wait until the last minute to plan for your RRSP maturing. If you do not make a decision as to how you wish to receive your retirement income by December 31, the full market value of your RRSP will be added to your taxable income in 2004. There are many options available: transferring your RRSP to a Registered Retirement Income Fund (RRIF), receiving an annuity, receiving a lump sum, or choosing a combination of these options. Discuss them with your tax advisor.
Is your spouse younger than you are? If your spouse is younger than you and you anticipate that his or her retirement income will be less than yours, consider creating a spousal RRSP. You can then continue contributing to the spousal plan until your spouse turns 69, provided that you have unused contribution room.
Claim the principal residence exemption
In the past few years, the real estate market has been remarkably active. If you owned more than one residence and sold one of them in 2004, whether it was in the city, the countryside, or even in the United States, you and your tax advisor will have to designate which residence was your principal residence during the period in which you owned the residence you sold. This is important because the profits realized on the sale of a principal residence are not taxable. Remember that you may designate only one residence as your principal residence for a given year, that this designation can apply only to the years in which you were resident in Canada, and that only one residence is permitted per family for tax years subsequent to 1981.
Claim the $500,000 capital gains deduction
Small business corporation shares and qualified farm property (including shares of a corporation and partnership interests) still qualify for the lifetime capital gains deduction. 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 can only claim an exemption up to $400,000. If you plan to use your deduction in 2004, check with your tax advisor to find out whether you have realized an allowable business investment loss (ABIL) in prior years or have cumulative net investment losses (CNILs) as at December 31, 2004, as these will be taken into account, and it is possible that you will not be able to claim the full deduction.
Defer the tax on deferred stock option benefits
If you exercised stock options in 2004, you can defer the benefit from exercising options worth $100,000 that were acquired during the year. The $100,000 amount is based on the fair value of the shares at the time the stock options were granted. However, you cannot have disposed of the shares giving rise to the taxable benefit. Furthermore, to defer the benefit, you also have to notify your employer before January 16, 2005, so this information can be reflected in your T4 (Relevé 1 in Québec), which must be provided to you for 2004. Your tax advisor can help determine whether there is any advantage in deferring the benefit.
Use your capital losses
Under the tax rules governing capital losses, you can use your 2004 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 30 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 makes the purchase of the identical asset.
Offset taxable income with an allowable business investment loss
Whereas capital losses can only be used to reduce capital gains, an 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 2004. 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.
Defer your income
Good year-end tax planning often includes, among other measures, being able to determine in what year income will be received or an expenditure will be deducted. In some cases, it will be advantageous to shift taxable income from 2004 to 2005 if you think your income will be much lower the following year. In other situations, increasing your 2004 taxable income may lead to greater tax savings. For instance, if you anticipate that your income next year will be substantially higher, or if you think you will have significant deductions this year, then you may want to accelerate taxation on your income this year, and defer certain deductions until next year in order to minimize your tax liability over the two years. Because each case is different and tax rules are often complex, be sure to speak with your tax advisor.
Donate
If you have not already done so, now is an ideal time to reconsider your donation plans for 2004 and benefit from the charitable donations tax credits. The federal credit is equal to 16% of the first $200 of charitable donations paid in the year and 29% for any donation in excess of $200 (13.36% and 24.22%, respectively for Québec residents). For the tax purposes of the territories and provinces other than Québec, the credit varies from 4% to 11% for the first $200 and from 11.16% to 18.02% for amounts exceeding $200. For Québec tax purposes, the tax credit is equal to 20% of the first $2,000 and 24% of the excess.
Another interesting tax strategy, for both you and the charity, is to donate publicly traded company shares from your portfolio. In this scenario, you will benefit from an easing of the capital gain you realized on the donation, as it will be taxed at 25% rather than 50%, and the charitable organization will receive a larger amount than it would have received 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 transferring the shares acquired under employee stock options to a charity can also be an effective tax-saving strategy. Donating the shares to a qualifying charity would allow you to deduct 75% of the benefit you received, which in the end means that you will only be taxed on 25% of the exercised options. 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 option and donate the shares, rather than to sell them once the options are exercised and donate the proceeds.
Repay shareholder loans
If you took a loan from your corporation in 2003, repay it before the end of 2004. If you delay, the full amount of the loan will be added to your income for 2003. 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.
Declare a bonus
The small business tax deduction (SBD) is available to Canadian-controlled private corporations with incomes of less than $225,000 in 2003 and $250,000 in 2004. The SBD will jump to $300,000 in 2005. If the company’s fiscal year is not a calendar year, the amounts must be determined on a pro rata basis from the number of days in its fiscal year that fall within each of the calendar years. If the active business income derived from your company exceeds the $250,000 threshold (or any amount between $225,000 and $250,000, according to its fiscal year-end in 2004), it would be good tax planning for the corporation to pay out a bonus to bring its income below the threshold. 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.
Check whether interest on your loans is deductible
To be able to deduct loan interest when computing your income, the loans 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 latest positions of the Canada Revenue Agency regarding interest deductibility should prompt taxpayers to at least review their current situation. Consult your tax advisor.
If you are a taxpayer living in Québec, you will also have to consider a new measure, proposed in the Québec budget of March 30, 2004, which limits the deduction of financing costs related to “passive” investments to the amount of investment income generated from these investments. It has, however, been proposed that the non-deducted portion of the financing costs could be deducted against the investment income of the three previous years and all subsequent years.
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 2004. 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.
Make your December instalment
If you are required to pay your income taxes in instalments and realize that the income on which they are calculated will be significantly less in 2004 than it was in 2003, decrease the amount, if you have not already done so, of your December 15, 2004 instalment.
Plan how to cash your retirement allowance
If you retire or lose your job in 2004 and your employer will pay you a retirement allowance by the end of the year, find out if all or some of the money can be paid directly into your RRSP. In addition, ask your tax advisor or employer if you would be wise to have the portion of your retirement allowance that is not transferable to your RRSP paid out over more than one taxation year. This would allow you to minimize your taxes if you expect your 2005 income to be significantly lower than in 2004.
Review or rewrite your will
Wills are the primary tool of estate planning. They should be reviewed and, if necessary, amended at least every five years. They should be amended promptly following the death of an intended beneficiary or the appointed executor or following any change in your financial or family situation. By writing or revising your will with the help of a tax advisor, you can be sure to allocate your property according to your wishes, while respecting tax laws and the laws particular to your province (for example, laws applicable to the division of matrimonial assets).
Jean-Luc Beauregard, Montréal
About TaxBreaks
A bi-monthly newsletter on corporate and personal tax.
Subscribe
View Archives
