Income Tax Planning - Personal Financial Planning - Lecture Slides, Slides of Finance

Download Income Tax Planning - Personal Financial Planning - Lecture Slides and more Slides Finance in PDF only on Docsity! Income Tax Planning Docsity.com 2 Key Concepts • Progressive nature of personal taxation in Canada • social, economic and political objectives of the Income Tax Act • deferring income tax is beneficial to the taxpayer because of the time value of money Docsity.com Tax Minimization Strategies • TFSA • Make interest tax deductible • Pension Income-split with spouse • Transfer used credits from student to parent • Spousal RRSPs Docsity.com Income Spreading Strategies • Use RRSP to reduce taxable income during high income years…withdraw in low income years (when you go back to school) • Consider using LLP and HBP • Set year end for personal corporations and private companies after the calendar year end. Docsity.com Tax Shelters • Principal residence’s deduction. Docsity.com Income Tax Act • Contains a number of measures to prevent the most obvious kinds of income splitting strategies, however, some opportunities do exist. E.g.: – increase the lower-income spouse’s investment base – employ your spouse and children – transfer of business assets – spousal loans – reinvesting attributed income – transfers for fair market value – transferring capital property to children – spousal RRSP – your children’s employment income – assignment of CPP benefits Docsity.com General Anti-Avoidance Rule • The Act provides a general anti-avoidance rule applicable to all transactions. • If you come up with a way of avoiding the attribution rules that is not caught by existing rules, but is a misuse or abuse of the Income Tax Act, it may be caught by GAAR. Docsity.com Rules that prevent Income Splitting • Indirect payments: – a payment or transfer made “pursuant to the direction of, or with the concurrence of” a taxpayer to some other person is to be included in the taxpayer’s income to the extent it would have been if paid to the taxpayer… for example, if you direct your employer to pay some part of your salary to your child’s account, that income will still be taxed in your hands. Docsity.com Income Splitting Opportunities • Pay the interest on your spouse’s investment loans: • if your spouse has taken out an investment loan from a third party, consider paying the interest. • There will be no attributed provided you do not pay any principal on account of the spousal loan (Since the amount you pay is not actually invested by your spouse, there is no property from which income can be attributed.) • this technique will also preserve your spouse’s assets and thereby increase his or her investment income. Docsity.com Income Taxation and Tax Planning Docsity.com Registered Education Savings Plans (RESPs) • Contributions to RSEPs are NOT tax deductible for the contributor. • There is a tax-deferral opportunity because the contributions accumulate tax-free within the plan. • On withdrawal, the payments will be taxable in the hands of the beneficiary, provided that the beneficiary is enrolled full- time in a qualifying educational program at a designated educational institution. • Presumably, the beneficiary will be in a lower tax bracket than the contributor at the time of withdrawal….hence, withdrawals from the plan would be taxed at a lower rate. Docsity.com RESPs - Use • Usually established by parents or grandparents to assist in the financing of a child (or grandchild’s) post-secondary education. • If the beneficiary (child) does not continue education beyond high school, the accrued income in the RESP remains in the plan or is paid to a designated educational institution……the capital contributed to the RESP can be refunded to the parent (or grandparent) free of tax. Docsity.com Canada Education Savings Grant (CESG) • Federal government will provide a direct grant to the RESP of 20% of the first $2,000 of annual contributions made to the RESP in a year. • The grant will be worth up to $400 per year for each year the beneficiary is under 18, to a maximum of $7,200 per beneficiary. • The grant amount will not be included in the annual and lifetime contribution limits for the beneficiary. • If the $2,000 maximum contribution is not made in a year, entitlement to the grant can be carried forward to a later year (within restrictions). Docsity.com RESPs • There are two ways to invest in an RESP: – enroll in an existing group plan (two or three major ones which advertise heavily in baby magazines and pediatrician’s offices) or, – set up an individual (self-directed) plan, in which case you have control over the investment of funds as well as choosing the beneficiaries of the plan Docsity.com Registered Retirement Savings Plan (RRSPs) • Introduced by the Federal Government in 1957. • Specifically designed as an incentive for Canadians who have ‘earned income’ to save during their working years for retirement. • Is an individual retirement savings plan which has been registered with Revenue Canada • normally permits deductible contributions to the RRSP and income earned in the plan is exempt from tax until payments are received from the plan. Docsity.com RRSP Contribution Limits • 18% of the previous year’s earned income Dollar limits: • $14,500 for 2003 • $15,500 for 2004 • $16,500 for 2005 and • $18,000 for 2006 and there after indexed to inflation, however in February 2005 Budget announcement • $20,000 limit for 2009. Docsity.com Earned Income • All income earned by an individual from Canadian sources except income from securities, investments, capital gains and income-averaging annuities. • Includes: – net Canadian salaries and wages (before deducting RPP and CPP contributions, but after deducting all other employment expenses) plus: – commissions, plus – net business and rental income from real property (including recaptured depreciation) plus – bonuses, plus – other sources of earned income: Docsity.com Checklist for RRSP Selection QUESTIONS FOR GUARANTEED PLANS: • What is the annual administration fee? This must be deducted when calculating a net yield. • What has been the pattern of such interest rates in recent years? • How often is interest calculated? • How often is interest credited? Semi-annually, quarterly, or monthly? • At what rate is interest reinvested - at the initial rate when the deposit was made, or , as is more frequently the case, at the current rate when the interest is credited. • How often is the interest rate adjusted and, in the case of a savings plan, is it related to some key interest rate such as the non-chequing savings rate, or say a term deposit rate? • Is there a registration or termination fee? What are the details? • Are there minimum initial and subsequent contribution limits? Docsity.com Checklist for RRSP Selection QUESTIONS FOR INVESTMENT FUND PLANS: • What has been the performance record of the fund’s shares? • Is there an acquisition charge, or, as it is frequently called, a front-end or rear-end load? • Is there a termination fee? How much is it? • What are the investment management fees? Are there other charges? • How quickly is income reinvested? • What are the underlying investments? What risks are involved? • In the case of a mortgage fund, ask whether the fund consists of residential or commercial mortgages or both. Where are the properties located? What percentage of the fund is invested in mortgages versus short-term money? Docsity.com Checklist for RRSP Selection QUESTIONS FOR SELF-DIRECTED PLANS: • What is the basic fee and will the size of your portfolio justify the minimum fee? • How many free transactions are allowed each year and what is the cost of each additional trade? (These charges are apart from brokerage commissions.) • Are annual fees based on the book value (cost to the plan) or market value of securities? Since the trust company has nothing to do with appreciation or depreciation of the portfolio, many advisers say fees should be based on book value. • Have you the time, knowledge of the tax rules and investment acumen to manage the portfolio better than managers of other types of plans? • What services or advice does the plan issuer provide? • Is there a charge for terminating a self-directed plan. If so, what is it? Docsity.com Income Splitting Techniques • Spousal RRSPs • between other family members: – preferred shares in small business – higher income earner pay the family expenses – gifts to children – RESPs – estate freezes (realize capital gain, retain control, allow further growth to be taxed in the hands of offspring or others.) Docsity.com Why Income Splitting? • The Canadian tax system uses progressive tax rates (the marginal tax increases as taxable income increases): • Tax payable on two $40,000 incomes will be significantly less than that on one $80,000 income Docsity.com Income Tax Act • Contains a number of measures to prevent the most obvious kinds of income splitting strategies, however, some opportunities do exist. E.g.: – increase the lower-income spouse’s investment base – employ your spouse and children – transfer of business assets – spousal loans – reinvesting attributed income – transfers for fair market value – transferring capital property to children – spousal RRSP – your children’s employment income – assignment of CPP benefits Docsity.com Rules that prevent Income Splitting • Attribution Rules: – these rules attribute income from property back to the person who transferred or loaned the property. • Example: let’s say you transfer or loan a bond portfolio to your spouse…the income from that portfolio will taxed in your hands – exception: if you transfer for fair market value consideration and report the resulting gain, the rule will not apply. Docsity.com Income Splitting Opportunities • Increasing the lower-income spouse’s investment base: – the higher-income spouse should pay household expenses…leaving the lower income spouse more disposable income for investing for future income. • Pay your spouse’s tax bills with your own funds – simply make sure that the cheque paying your spouses’ taxes is drawn on your own account. Since the amount you pay goes directly to the government and is not invested by your spouse, there is no property from which income can be attributed. The result is that any funds your spouse would otherwise use to pay income taxes can be invested with the income being attributed back to you. Docsity.com Income Splitting Opportunities • Pay the interest on your spouse’s investment loans: • if your spouse has taken out an investment loan from a third party, consider paying the interest. • There will be no attributed provided you do not pay any principal on account of the spousal loan (Since the amount you pay is not actually invested by your spouse, there is no property from which income can be attributed.) • this technique will also preserve your spouse’s assets and thereby increase his or her investment income. Docsity.com Specialized Tax Shelters • Limited partnerships • films and television productions: – ‘at risk’ rules of limited partnerships – tax benefits for pre-1996 film shelter investments depend on whether the particular production is certified or not (certification means that the production meets a number of Canadian content rules) – certified productions entitle you to a deduction for CCA of 30% on the balance sheet of your investment each year…that is on a $1,000 investment you can deduct $300 in the first year. – Flow-through shares Docsity.com Other Tax Shelters • Real estate investments… – mortgage interest expense, property taxes and maintenance costs can all be written off – CCA for buildings is normally 4% per year, but cannot be used to create or increase a loss used against other income. (no CCA on land) • Labour-sponsored venture capital corporations – an investment in a LSVCC of up to $3,500 entitles you to a special federal tax credit of 15% of your investment. You may get a further 15% or 20% credit against your provincial tax depending on the province. Docsity.com Tax Shelters Docsity.com Decision Factors • The main factors to consider when making such investments are: – CCA rate for tax purposes – the amount of downpayment and subsequent payments – the individual’s tax bracket for the current year and future years – the probability of receiving sufficient income from the tax shelter investment to recover the original cost and provide a profit. Docsity.com Current Tax Shelters • Oil and gas ventures • mining exploration investments • Canadian film and video productions • residential or commercial real estate • mutual fund fee partnerships • limited partnership constraints • whole and universal life insurance • farming • provincial venture capital programs Docsity.com Oil and Gas Ventures • Oil and gas ventures through partnerships or “flow-through” shares have become less attractive as tax shelters due to several factors including the introduction of the Alternative Minimum Tax (AMT), the elimination of the capital gains exemption and the impact of “cumulative net investment losses.” • However, oil and gas investments continue to be offered to investors. Docsity.com Mining Exploration Investments • Like oil and gas ventures, mining exploration and development expenses attributed to an investor are deductible against income from all sources at the prescribed 100% and 30% rates respectively. • Investors in mineral exploration activities may also benefit from provincial incentives such as the grants available under the Ontario Mineral Exploration Program. • Investors can no longer earn a depletion allowance, but any unclaimed depletion earned before 1990 should not be forgotten. It is still deductible to the extent of 25% of current resource profits. Docsity.com Canadian Film and Video Productions • Changes in the 1995 Federal Budget replaced the existing incentive CCA system for tax shelters with a refundable tax credit system for eligible films acquired after 1995. • The credit, which is available in respect of films produced and owned by qualifying corporations, will be at a rate of 25% of eligible salaries and wages incurred in the production, not to exceed 12% of the cost of the production. The credit will reduce the capital cost of the related film. Docsity.com Residential or Commercial Real Estate • Ca often prove a worthwhile choice, especially when capital appreciation and a rental income flow are combined with tax benefits. • CCA may be claimed on the cost of buildings, but cannot normally be used to create or increase a loss for application against other sources of income. • Mortgage interest, property taxes, and repair and maintenance costs can usually all be deducted. Docsity.com Whole & Universal Life Insurance • The acquisition of Whole or Universal life insurance policies will give rise to the accumulation of investment income earned by the insurer at a very low tax cost to the company. • Upon death, the entire proceeds from the policy are free of tax. • The returns from virtually tax-free accumulation after the deduction of insurance costs, compared to taxable accumulations, can, over a long period, be quite remarkable. • While professional advice may be required, those with capital to invest would be well advised not to overlook this investment vehicle (and eventual source of capital). Docsity.com Farming • The urban farm investor must demonstrate to Revenue Canada that there is some prospect that the farm will earn a profit. • Farming losses are disallowed by Revenue Canada when there is no expectation of a farming profit and the farm is solely for personal use. • Gains on the disposition of “Qualified Farm Property” are eligible for a lifetime capital gains exemption of $500,000. • Qualified Farm Property includes real property used by the taxpayer or family members for farming in Canada/shares of a family farm corporation and an interest in family farm partnerships or trusts/eligible capital property such as farm quotas may also qualify. Docsity.com Farming ... • Where a transfer of farm property occurs at an amount less than fair market value at the time of transfer, any subsequent capital gain or capital loss of qualified farm property is attributed to the transferor if: • the farm property is transferred to a child under 18 years of age, – the farm property is subsequently sold by the child while under 18 years of age, and – the transferor is still a resident of Canada • a child receiving farm property need not continue to use the land for farming in order for the benefit of the rollover to apply. Docsity.com Tax-Return Tax Tips • Tax planning is best done throughout the year. • Structuring of your financial transactions with the tax-implications in mind …continuously…is the best way of helping yourself at the time you fill out your return. • The following tax-return tips are things that you can do even if you haven’t planned all year! • As you can imagine, tax rules change … Docsity.com MARRIED COUPLE TAX RETURN TIPS • The higher income spouse should claim credits to reduce high-income surtax • seniors - aim for at least $1,000 of pension income for both spouses • combine charitable donations and claim them on the higher-income spouse’s return • combine your family’s medical expenses on one return • choose your own 12-month period for medical expense claims • plan for the timing of your family’s medical expense payments. Docsity.com Other Tax Return Tips • If you’re unmarried and support a family member, don’t miss out on the “equivalent-to-married” credit. • Single parents attending school and two parent/student families - claim your child care expenses for 1996 • if Revenue Canada challenges your disability claim, consider objecting. • Take advantage of the increased charitable donations limits. • Plan to maximize the tax benefits of donations of “cultural property” and “Crown gifts” • political contributions - take advantage of Canada’s most generous tax break Docsity.com