Reducing Your Tax Bill

Taxes are a necessary evil, but no-one really enjoys paying them. It’s a rare person that doesn’t feel a bit resentful at the amount they have to pay. But what if you could reduce your tax liability and hold on to more of your paycheque every year? Limiting your tax liability might make you think of of shady accountants and sun-kissed island tax havens, but it’s really a lot less dramatic than that. Most Canadians can take some easy steps to reduce their tax bill, and most of these steps make good financial sense anyway. At this point, we should stress the difference between tax evasion and tax avoidance. Tax evasion is illegal, and can carry long prison sentences if you are caught. This guide will not teach you how to evade taxes. Tax avoidance, on the other hand, is perfectly legal. Often, it just comes down to taking advantage of state-provided tax incentives.

 

  • Save for retirement. Everyone should have a Registered Retirement Savings Plan anyway, but an additional advantage of the RRSP is that any contributions are tax-deductible. The maximum contribution for 2015 is 18% of your previous year’s income up to a maximum of $24,930. It should be noted that RRSPs are not entirely tax-free, as withdrawals may be taxed. However, you will probably be in a lower income tax band after retirement than you will be while you are working. When deciding which kinds of investment your RRSP should be made of, look at whether they are taxed as income, like bonds, or at a lower rate, like dividends. People with higher incomes should use bonds in their RRSPs or TFSAs and dividends outside them, while people with lower incomes may wish to do it the other way around.
  • Use your TFSA. Unlike the RRSP, contributions to your Tax-Free Savings Account are taxable. However, any earned interest on your TFSA is yours to keep, and withdrawals do not count towards your taxable income. They also do not count towards means testing for federal benefits and credits. The current maximum annual contribution, as set in 2013, is $5500, and all Canadian residents aged 18 or above can participate. If you don’t have a TFSA open, open one as soon as possible. Your unused TFSA allowance carries over year to year, making it a great place to store windfall income. Making your investment decisions purely on the basis of their tax liability is rarely a good idea, but TFSAs are flexible and useful.
  • Take advantage of tax credits. The government offers a huge variety of tax credits, and yet most Canadians aren’t aware of the money they can trim from their tax bills. For example, the children’s fitness tax credit allows you to claim up to 15% of your child’s membership and registration fees for various sports teams, sports lessons, and sports camps, up to a maximum of $1000. This is refundable, so you receive your money back even if you don’t earn enough to pay income tax. One tax credit that many Canadians will be able to claim makes monthly public transport passes (and weekly ones, so long as you buy at least four consecutively) tax-exempt, although non-refundable. Take the time to research the tax credits available at national and provincial levels. Parents, small business owners and caregivers tend to get the best offers.
  • Split your family income. Many Canadian households have one higher and one lower earner. Unfortunately for those families, the progressive income tax system means that one big income pays more tax than two incomes of half the size. American-style joint tax returns do not yet exist, although there has been some movement in that direction, but there are still ways for a higher-income spouse to subsidise a lower-income spouse, or even other members of the family. One slightly complicated way to do this is to issue a spousal loan. This is exactly what it sounds like: the higher-income partner loans money to the lower-income partner. The Canada Revenue Agency knows that this is open to abuse but, so long as you follow the rules, you can lend and borrow money within your family for income splitting purposes. Paperwork must be filed, and the receiving spouse must pay the interest by January 31st of the following year, but the current minimum interest is a mere 1%.
  • Split your family invesments. Investment money should be allocated carefully. Generally, the higher-income spouse should take on as many household expenses as possible, so as to be eligible for all of those useful non-refundable tax credits. Meanwhile, the lower-income spouse should be financially responsible for as many of the family’s investments as possible, as they will have to pay less tax on any returns that are classed as income. This is a great use for the spousal loan detailed above: the higher-income spouse loans money to the low-income spouse, who invests it for a return greater than 1%.

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