Leaving Canada? Minimize the departure tax when going

Image-Leaving Canada

Last week I introduced James and Kate – friends who will be moving to the United States in the new year. I reminded James that the U.S. can be a strange place with some crazy laws.

If you believe what you’ll find on the Internet, it’s illegal for chickens to cross the road (Quitman, Ga.), police officers are allowed to bite a dog if they think it will calm the dog down (Paulding, Ohio), it’s against the law to sing off-key (North Carolina), and you’re not allowed to eat fried chicken other than by using your hands (Gainesville, Ga.). The good news? James and Kate are moving to California – which is not on the list.

Nevertheless, James and Kate are moving. Last week, I spoke about how they should handle their registered retirement savings plans, tax-free savings accounts and registered education savings plan before leaving. Today, I want to share another idea for them to consider.

The facts

James and Kate are leaving for the U.S. because James has accepted a job offer south of the border. It wasn’t an easy decision for them because Kate has a successful business here. She owns a retail store that sells jewellery and accessories. James will be heading to Texas the first week of January, while Kate is staying behind to complete the sale of her business and the sale of their home. She’s expecting to join James in the U.S. three or four months after he moves.

The fact is, leaving Canada can give rise to an ugly tax hit because Canada imposes a “departure tax” on those who give up residency. Specifically, those giving up residency are deemed to have sold, at fair market value, most assets when they leave. This can give rise to tax on capital gains when those assets have appreciated in value. So, James and Kate could pay tax when they move to the U.S. There’s a strategy that James and Kate are planning to use to reduce this tax hit.

The idea

James currently owns shares worth $400,000. His adjusted cost base (ACB) is just $220,000, so there’s an accrued capital gain on the shares of $180,000. If James fails to do any planning, he’ll trigger the $180,000 capital gain upon his departure from Canada and will face tax of about $44,500 since he’s in the highest tax bracket in Ontario.

Here’s what James plans to do: This month, prior to leaving Canada, he is going to transfer to Kate all of his shares. There will be no tax consequences when he does this because our tax law allows transfers between spouses to take place at cost, so that no capital gains are triggered. Now, when James leaves Canada, he won’t face the departure tax on the shares he owned because they will be owned by Kate at the time of his departure.

When Kate leaves Canada, she’ll face tax on the $180,000 capital gain due to the departure tax. The good news? She’s in a much lower tax bracket than James, and will pay about $21,700 in taxes at that time. They will have saved about $22,800 in taxes – more than half of what James would have paid.

Normally, the attribution rules in our tax law would kick in and require Kate’s capital gain to be attributed back to James to face tax in his hands, but not in this case since James will no longer be a resident of Canada.

The nuances

You should be aware that, normally, the taxman will consider two spouses to have given up residency in Canada at the same time when departing. If the taxman were to take this approach with James and Kate, they may not be able to transfer the departure tax bill to Kate as they did in my example above. So, James and Kate are building an argument that they are giving up residency at different times. And they have a good case because Kate has a valid reason for staying behind. She has to stay back to wrap up the sale of her business and their home.

Giving up residency in Canada is not as easy as simply leaving the country. While our tax law doesn’t define the term “resident,” there are court decisions and government publications (particularly Income Tax Folio S5-F1-C1, available at cra.gc.ca) that provide guidelines as to who will be considered resident here. There are primary and secondary residential ties that the taxman will look at to determine where you are resident. It’s important to visit a tax pro to talk over a departure, and to properly plan to minimize taxes before you leave.

Article:  Globe & Mail

Forget hockey skates. Here’s five (financial) gifts for the grandkids

 

Image-Hockey Skates

This past weekend, I asked my kids what they would like for Christmas. The list included things like an iPad, hockey stick, scooter, clothes and video games. There was one item that the kids, together, decided they would ask for. A group gift, if you will. I’m talking about the Henry River Mill Village. A village. No kidding.

As it turns out, this little village located in North Carolina, consisting of 22 abandoned buildings on 72 acres of land, is for sale for $1.4-million (U.S.). The village lost its textile economic base in 1987, was abandoned, and was the filming location for many scenes of the movie The Hunger Games.

I wasn’t planning on spending that much on the kids for Christmas this year. As you contemplate the gifts you might be buying your children or grandchildren this holiday season, consider financial gifts that could reap big rewards for them in the future. Consider these five ideas.

1. Set up a registered education savings plan.

I’m not sure what a gift-wrapped RESP placed under the tree would actually look like, but an education is about the most valuable thing you can give to a child or grandchild. If you socked away $2,500 annually per child, for 18 years, and earned 6 per cent on that money, you will have accumulated $77,264 by the time the student in your life is ready for postsecondary school. You can add an additional $7,200 in Canada Education Savings Grants from the government, plus growth on those grants of $7,114 over 18 years at an assumed 6 per cent, so the RESP value after 18 years will be about $91,578. Believe it or not, that may still not be enough to pay for four years of postsecondary education if your child lives away from home, but it will go a long way to covering those costs.

2. Transfer securities to an adult child.

Why not consider giving certain securities in your portfolio to your kids. You’ll be deemed to have sold the securities at market value, so there could be tax to pay if they’ve appreciated in value. On the flip side, if they’ve declined in value, you can claim the capital loss, and if you still like the prospects of the investment your kids can hold onto the securities and benefit from their future growth.

3. Set up an in-trust account for minors.

You can invest in the name of your minor children or grandchildren by setting up an in-trust account for them. Capital gains realized in the account can be taxed in the hands of the children (so invest for growth, not for income, since income will be attributed back to you and taxed in your hands). Once the children reach age 18, they will be legally entitled to do as they wish with the money.

4. Buy insurance on the life of your child.

I recently had projections done and learned that I can invest $250 monthly in an insurance policy on the life of one of my kids. In my case, this amounted to a $500,000 policy with a growing pool of investments that would be worth an estimated $47,000 in 20 years, and no more payments would be required on the policy if I so choose. Once my child is over 18, I can transfer the policy to him with no tax implications. I may make that transfer when he’s a little older. He’ll then own a $500,000 policy on his own life with investments that he can access to help with a down payment on a home, use for some other purpose, or he can simply allow the investments to continue to grow if he chooses to contribute more to the policy on his own.

5. Establish a family foundation.

There is perhaps no better way to build a common set of values, and teach your kids about good governance, business principles and investment strategy than by creating a foundation for the family to give charitably. The simplest way to do this is to establish a donor-advised fund through a public foundation, such as a community foundation or Scotiabank’s Aqueduct Foundation, for example. The public foundation will look after all paperwork, including tax filings, and all you have to do is decide where to distribute your charitable dollars. Give each family member the ability to donate to charities of their own choosing, and perhaps choose one or two charities together for the balance of the money donated. Private foundations are another option for larger amounts set aside for charity – but that’s a topic for another day.

Article:  Globe & Mail

 

How a kind gesture on your part can actually lead to a tax hit

 

Image-Kind Gesture

As the Christmas season approaches we’ll be having a couple of parties at our home. There are certain topics that are taboo when it comes to starting conversations with guests. Talking about the state of someone’s finances, condition of their marriage, their incontinence, life expectancy or physical ailments didn’t work well for me last year. And I don’t like to talk much about the Income Tax Act either – particularly subsection 56(2). Not that most guests would mind having a conversation about it (I read parts of section 80.01 to guests last year), but that particular provision gets my blood boiling. Let me explain.

The law

What you should understand about subsection 56(2) of the Act is that it deals with what are called “indirect payments.” The subsection is meant to catch situations where you should receive and face tax on certain amounts, but you direct the payments to someone else with the intention of avoiding tax.

If 56(2) applies, it can cause an amount, that you do not receive, to be added to your income. Specifically, you’ll face tax if four conditions are met: (1) There’s a payment or transfer of property to someone other than you, (2) the payment or transfer takes place at your direction or concurrence, (3) there’s a benefit to you, or that you intend to confer on the other person, and (4) you would have been taxed on the amount if the payment or transfer had been made to you rather than the other person.

The examples

Okay, I get it. The subsection is important in certain situations. What if, for example, you’re an independent salesperson and you’re owed commissions, but you direct the payer of the commission to make payment to someone else instead – perhaps your spouse. In this case, you should pay the tax, and 56(2) will ensure that happens. Or take another example where you’re the shareholder of a corporation and you cause your company to make a gift to your Aunt Bessie (who is not a shareholder or employee).

Or perhaps you own a rental property and instruct your tenant to pay the rents to your corporation even though you own the property personally. Or maybe you direct your business to pay a salary to your spouse when she didn’t truly provide any services to the business. Subsection 56(2) can apply in all of these cases. The list of examples is endless.

The story

Earlier this year, a taxpayer wrote the Canada Revenue Agency a letter asking for the taxman’s views on a matter that involved 56(2). Here’s the story: An employee – let’s call him Mr. Donor – would like to donate some of his vacation time to a co-worker – call him Mr. Friend – who is experiencing hardship and needs the additional time off to deal with personal family matters. It’s clear that vacation time has monetary value. In this case, the employees have the option to take their vacation time (and be paid for it, of course) or take cash instead of the time off. It’s also fair that someone should pay tax on that value received from the employer.

CRA responded to the taxpayer’s letter (in document 2013-0514321E5) by suggesting that Mr. Donor would face tax on the value of the donated vacation time under 56(2). The taxman also said that it’s possible that Mr. Friend would also face tax on the value of that vacation time, although they’d likely be willing to forgo taxing Mr. Friend to avoid double-taxing the amount. Given this response, I wouldn’t blame Mr. Donor if he decided not to donate his vacation time after all.

The moral

You’ll notice that the conditions for 56(2) to apply (noted above) say nothing about the intent to avoid tax – but really should. In the story above, Mr. Donor, who was willing to donate his vacation time to his co-worker, was not trying to avoid tax. He was trying to help a friend and co-worker. In fact, avoiding tax was not even on his radar. Yet, according to CRA, 56(2) will apply to tax Mr. Donor on the value of the vacation time. I bet the co-worker who received the vacation time would be willing to pay tax on the compensation he receives when taking those vacation days. And that would be fair. Instead, CRA plans to penalize the donor. The problem is that subsection 56(2) of our tax law isn’t well-written.

So, the moral of the story? Be aware that 56(2) is out there, and be careful any time you transfer or direct payments, property, or something of value to another person, because you might just face tax.

Article:  The Globe & Mail

 

Seven important tax tips to consider before year-end

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What’s on your to-do list before year-end? At my house, we talked about this over dinner last weekend. My son, Win, turned 16 recently and so driving as much as possible is on his list. I’m not sure he’s really ready for the road.

I asked him a simple question: “Who has the right of way when four cars approach a four-way stop at the same time?” To which he responded: “The guy in the pickup truck with the gun rack and bumper sticker that says ‘I gave up anger management.”

My father, on the other hand, has different plans before year-end. High on his list is to review his investment portfolio. Not exciting, maybe – but it could be profitable. I shared with him seven ideas to consider before year-end. If you’re an investor, you’d be wise to consider these, too.

1. Time the sale of your winners.

It’s almost always better to pay tax later, rather than sooner. If you’re thinking of taking some profits on the winners in your portfolio, consider waiting until January to sell. This will push the payment of your tax bill on the sale to the spring of 2016.

On the other hand, if you have unused or accrued capital losses, consider selling your winners today and offset your capital gains with your allowable capital losses. You can reinvest the proceeds and your new investment will have a higher adjusted cost base (ACB) than your current winners. You get the benefit of this “step-up” in ACB without triggering tax when your capital losses offset your gains.

2. Sell your losers to save tax.

If you’ve got investments that have dropped in value, consider selling these to realize the capital losses before year-end (place trades by Dec. 24 if you want them to settle in 2014). This makes the most sense if you reported capital gains on your 2013, 2012 or 2011 tax returns. You’ll be able to carry your capital losses back up to three years to offset gains in those years and recover taxes you paid. Or perhaps you have capital gains this year that you can apply those capital losses against. Don’t jump to sell your losers if you don’t have capital gains to offset and you still like the prospects of the investment.

3. Make use of a TFSA.

If you haven’t already set up a tax-free savings account, do it before year-end. The ability to contribute starts when you turn 18, so perhaps a child of yours should open an account. The contribution limits were $5,000 per year for 2009 through 2012, and $5,500 for 2013 and 2014, for total contribution room of $31,000 over those years. The TFSA will allow you to grow investments tax-free and withdraw the funds later tax-free as well.

4. Transfer assets to a child.

Giving a child assets before year-end can reduce the value of your estate, saving income tax and probate fees upon your death. If you give them your losing investments, you’ll be able to claim the capital losses that are triggered when making the gift, which can save tax. In addition, if your child is an adult, she could sell the assets and contribute to her TFSA or registered retirement savings plan (RRSP) to accelerate her own savings, or pay down debt.

5. Donate securities to charity.

Are you thinking of donating money this year? You’ll save more tax by donating some of the winners in your portfolio. Any accrued capital gain on a security that is donated to charity will be eliminated. Not only is the taxable capital gain set to zero, but you’ll still be entitled to a donation tax credit to boot.

6. Transfer capital losses to your spouse.

If you have unrealized capital losses but no capital gains this year or in the past three years, consider transferring those losses to your spouse if they have capital gains that can offset the losses.

7. Rebalance your portfolio for tax efficiency.

If the performance of your portfolio has caused certain asset classes to become over- or underweighted, think about rebalancing your portfolio. Don’t forget that capital gains and eligible Canadian dividends receive more favourable tax treatment than interest or foreign income. I’m not suggesting that you take on more risk than appropriate, but if you’re reinvesting proceeds, think about the tax that will be generated by your portfolio.

Article: Globe & Mail

Your RRSP and your will: How to keep more money in the family

Image-Tax mattersI think that every male on the planet secretly wants to be a superhero. I’m not talking about one with superhuman powers. That would be unrealistic. But a superhero with such intelligence, resourcefulness and creativity that he could save the world with nothing more than a pair of tweezers and some duct tape – which is entirely doable.

You might recall the 1980s television show MacGyver, the secret agent who had such creativity that he always managed to turn what he had into what he needed – and save the world in the process.

That type of creativity can go a long way when it comes to tax planning too. We have to think outside the box sometimes. Here’s an example of one idea that involves your registered retirement savings plan (RRSP) and your will.

The story
Jack and Diane were married many years ago. Jack passed away this year. At the time of his death, Jack owned some investments that had dropped in value. In fact, he had paid $500,000 for the investments, and they were worth just $350,000 at the time of his death this year, so he had an unrealized capital loss of $150,000. Jack also had an RRSP worth $400,000 when he passed away. In addition, Jack didn’t have much income this year, prior to his death. He passed away early in the year and hadn’t earned much income to that point.

Like many Canadians, Jack had named his spouse as the beneficiary of his RRSP and he left his other assets to Diane as well. And why wouldn’t he? This is common advice because leaving assets to your spouse is a good way to defer the ultimate tax bill. But Jack could have improved on his plan. Consider the results experienced by Jack and Diane.

The results
When Jack left his RRSP assets to Diane, those assets transferred to an RRSP for her free of tax. Similarly, the other assets he left Diane were deemed to have been sold at his adjusted cost base (ACB). Diane stepped into the shoes of Jack from a tax perspective. That is, she inherited Jack’s ACB on the assets she received.

At the end of the day, Dianne inherited $750,000 of investments from Jack, but $400,000 is inside an RRSP, and any withdrawal of those assets will be taxable in Diane’s hands. Diane also owns the $350,000 non-registered investments with an adjusted cost base of $500,000. Diane will have to somehow generate capital gains in the future in order to use up the $150,000 in capital losses she inherited (capital losses can generally be applied only against capital gains). Is there something different that Jack could have done to leave Diane better off financially? Sure.

The idea
If Jack had planned ahead better, he could have left Diane the same $750,000 in assets, but with $325,000 in an RRSP, and $425,000 outside the RRSP with an ACB of $425,000. This would have left Diane better off since there would have been less money trapped in the RRSP subject to high taxes upon withdrawal, and she wouldn’t have to worry about using up the capital losses since they’d be fully used up already.

How can this be done? It’s not hard. Jack could have named his estate, not Diane, as the beneficiary of his RRSP. You see, if Jack’s estate had been named as beneficiary of his RRSP it would have been possible to trigger some income in Jack’s hands in the year of his death by causing some of his RRSP to be taxable to him. We could have then offset that income with the capital losses from his non-registered investments. The fact is, our tax law will allow you to apply your capital losses against any type of income in your year of death, not just against capital gains (with some exceptions).

Jack’s executor could have elected to transfer just a portion, say $325,000, of his RRSP to an RRSP for Diane on a tax-free basis. The balance of the RRSP, or $75,000, could have been left in the estate to face tax in Jack’s hands in his year of death. Jack’s executor could have then elected to transfer the non-registered investments to Diane at fair market value rather than cost, triggering the $150,000 in capital losses, resulting in $75,000 (one half of the losses) being available to offset the taxable portion of the RRSP. As an aside: In the case of a registered retirement income fund, the executor cannot elect to transfer less than 100 per cent of the plan to the surviving spouse.

Article:  The Globe & Mail

How a key tax shelter will be affected by a divorce

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Earlier this year, British resident Jane Mulcahy attempted to sue her divorce lawyers. Why? Because they didn’t explain to her that finalizing her divorce proceedings would result in her marriage coming to an end. She argued that they should have taken into account her belief in the sanctity of marriage and should have recommended a judicial separation instead. The court rejected her claims.

If you happen to be going through a divorce, there are a couple of important things to keep in mind. First, finalizing your divorce will mean that your marriage will officially end. Second, divorce can complicate your income tax situation – particularly as it relates to your family home. Let me explain.

The rules

Our tax law provides a principal residence exemption (PRE) which can shelter all or part of a capital gain on the sale of your home. The catch is that each family unit (you, your spouse and any unmarried children under 18) will be allowed to designate just one property as your principal residence for each calendar year.

Suppose, for example, you own both a city home and cottage. For simplicity, let’s assume you purchased both properties in the year 2000. If you were to sell, say, the cottage this year, you could designate the cottage as your principal residence for the years 2000 to 2014 if you wanted. This means you would be sheltering the cottage for all of the years it has been owned, so that 100 per cent of any capital gain would be sheltered from tax. This also means that those 14 years are spoken for and you won’t be able to designate the city home as your principal residence any of those same years.

If, instead, you were to designate the cottage for, say, seven of the 14 years, then part of the capital gain on the cottage would be sheltered. This would allow you to use the other seven years for the city home and shelter part of its capital gain as well. But, you can’t fully shelter both properties from tax because you can only designate one property as your principal residence for each calendar year. (By the way, the rules are a little more complex than this, since our law does allow you to own two properties that overlap by one year, and still fully shelter each property from tax.)

When you divorce, each former spouse will be entitled to his or her own PRE, but not for the years in which you were married. Let me explain by way of a story.

The story

John and Jan divorced in 2010. During their marriage the couple owned a cottage (purchased in 2000) and a city home (purchased in 1994). As part of their divorce, they sold the cottage, and Jan kept the city home. They sold the cottage tax-free by using the PRE available to them. That is, they designated the cottage as their principal residence for the years 2000 through 2010, and paid no tax.

Now, four years later, Jan wants to sell the city home that she owns. She’ll be able to designate the home as her principal residence for the years 1994 through 1999 (because she and John did not use up those years when designating the cottage sold earlier), and for the years 2011 through 2014 (because she is entitled to her own PRE after their divorce), for a total of 10 years. But the home has been owned for a total of 20 years. The result? Years after her divorce, a good portion of Jan’s capital gain on the home will be taxable. She may not have expected that.

What if John and Jan had not sold the cottage when they divorced? Rather, what if they had each kept one of the properties? In that case, the first person to sell their property might “win the race” to claim those years while they were married and designate their own property as a principal residence for those married years. This suggests that any good separation or divorce agreement should clarify how the PRE will be claimed upon a subsequent sale of a particular property.

As a side note, you’ll each be entitled to your own PRE after you’re living apart only where you have a written separation agreement or a court order in place. Similarly, if you each own a property on the day you get married, you may want a marriage contract that details who will be entitled to the PRE for years prior to a divorce.

Article:  Globe & Mail

A marriage breakdown comes with tax consequences

Image-Marriage breakdown

I’ve heard of divorce battles going on for quite a while. The story of Frances and Philip Ragusa, however, takes the cake. Their battle lasted for 34 years, starting in 1977, until Frances was 75, and Philip 77. Frances was making a claim for child support of $14,394, which Philip hadn’t paid. The amount, with interest, grew to be about $100,000.

If you’re going through a marriage breakdown, the best advice is to wrap things up sooner, rather than later. And take the time to understand the tax implications of splitting up. Here are the top tax issues to consider when you part ways:

The meaning of being ‘married’

For tax purposes, the definition of “married” matters a lot. Even common-law partners can be considered married if they’ve been living together in a conjugal relationship for at least 12 months, or they have a child. When does marriage end? In a legal marriage, you’ll usually separate for a time and then your relationship ends officially when you obtain a divorce. For tax purposes, your status as “married” is considered to have ended on the day you started living separately, provided you’ve been living separately and apart for 90 days or longer.

Dividing up assets

When you separate, you may be required to divide up assets. Generally, you’ll be able to transfer assets between the two of you without a tax hit. Capital property (most assets) can transfer at adjusted cost base (ACB) so that the recipient spouse inherits the current ACB of the property, and there’s no tax to pay on the transfer. Registered Retirement Savings Plan (RRSP) assets can transfer directly to the other spouse’s RRSP without a tax hit. It’s the same with assets in a Tax-Free Savings Account (TFSA). In the case of a TFSA, the transferor doesn’t receive a reinstatement of contribution room.

Sharing pension assets

Canada Pension Plan credits earned by both spouses during marriage can be combined and split without any immediate tax. Other pension plan assets can often be split without tax, but speak to a lawyer in your province, since family law and pension law are provincial matters.

Tax on support payments

Spousal-support payments are generally deductible to the payer, and taxable to the recipient. Lump-sum payments that reflect arrears support for prior years are generally taxed when received, but the recipient can request to be taxed as though they were received in those prior years if this works out better and if the amount that applies to previous years is $3,000 or more (not including interest). Child-support payments are generally tax-free to the recipient and not deductible by the payer (an exception applies with some pre-May, 1997, support orders or agreements).

Deductibility of legal fees

Legal fees are generally deductible if they relate to collecting late support payments, establishing a right to support, increasing your support, or to make child support payments tax-free. If you’re the payer of support, legal fees are generally not deductible. Nor are fees related to child custody or visitation issues. If your deductible legal fees happen to exceed your income in a year, a non-capital loss is created which can then be carried forward, or back, to other tax years.

Personal tax credits and deductions

Each spouse may be entitled to the eligible dependant amount. Only one spouse can claim the amount for a particular dependant, so if you have more than one child, it often makes sense to each to claim the credit in respect of different children, otherwise you’ll need to agree on who will claim the credit.

As for child-care expenses, you can claim expenses incurred by you for the period your child resided with you. Finally, in the case of tuition, textbook and education credits, a student can transfer these credits to either parent, but not a portion to both, which will require agreement between you and your spouse.

Universal Child Care Benefit

If one parent has custody of children, then the UCCB will be paid to that parent. With shared custody, you can apply to split the payment equally between the two of you. The UCCB is taxable, and if you’re single at the end of the year, you have the option of reporting the income yourself, or in the hands of your dependant.

Article: Globe & Mail

Tax-smart investing: Eight offsets to income for better returns

Capture-Tax smart

My kids love to read.

“Dad, what’s the most creative work of fiction you’ve ever read?” my son, Win, asked.

“Son,” I replied, “I’d have to say your uncle’s tax return would be at the top of the list.”

Unfortunately, Uncle Charles is no longer with us, but he did suggest in his last days that tax planning would have been a good idea. So, let’s go with that advice.

I’ve been talking about the four pillars of tax-smart investing: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income.

Today, I want to finish off by focusing on pillar number four: Offsets to income.

THE OFFSETS

What I’m talking about is creating deductions or credits to offset income earned, or tax that might otherwise be owing, on your investment portfolio. The most common types of offsets include capital losses, charitable donation tax credits, interest deductions, foreign tax credits, losses from limited partnerships, business expenses in some cases, and other deductions, such as flow-through share deductions.

THE IDEAS

Try the following ideas to reduce your tax using offsets:

1. Argue that it’s a business
If you’re actively trading in securities, you may be able to argue that your profit should be taxed as business income rather than capital gains. Now, only half of your capital gains are taxable, so don’t be quick to make this argument. Having said this, if you do report your profits as business income, you’ll be entitled to deduct many types of expenses against your income, including many things you may be paying for anyway, such as a portion of mortgage interest, property taxes, and similar expenses. See my article dated April 22, 2010, for more.

2. Donate securities to charity
Since 2006 it has been possible to eliminate the tax on capital gains on specific securities by donating those securities to charity. Normally, the capital gains inclusion rate is 50 per cent (meaning that one-half of your gains are taxable), but the inclusion rate is set to zero if the securities are donated to charity. In addition to zero tax on the capital gains, you’ll be entitled to a donation tax credit for the value of the securities donated.

3. Harvest capital losses wisely
As we near year-end, many Canadians will choose to sell some of the losers in their portfolio to realize the capital losses, which can then be offset against capital gains that might have been realized this year, or in the three prior years (2013, 2012 or 2011). This can make good sense if you have capital gains this year or in the past to offset, or if you simply don’t like the investment any more.

4. Track your cost properly
If you’re investing in mutual funds, be sure to add the amount of any taxable distributions each year to your adjusted cost base (ACB) of the investment. If you fail to do this you’ll end up paying tax twice on the same growth in value.

5. Claim foreign tax credits

Don’t forget to claim a foreign tax credit for foreign taxes paid on income you’re reporting on your Canadian tax return. You may also want to avoid dividend-paying foreign shares in your Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP) or other registered account since you won’t be able to claim a foreign tax credit for foreign taxes withheld on income inside those plans.

6. Avoid the superficial loss rules
If you sell an investment at a loss and you, or someone affiliated with you (your spouse or a corporation you control, for example), acquires or reacquires that same security in the period that is 30 days prior to your sale, or 30 days after your sale (a 61-day window), your capital loss will be denied. The loss isn’t gone forever; it will be added to your ACB of the reacquired securities, so that you’ll eventually realize the tax savings from that loss when you ultimately sell those securities.

7. Choose your funds wisely
If you invest in mutual funds that have unused capital losses, future capital gains in that fund could be partially sheltered using those losses, which can result in higher after-tax returns for you.

8. Deduct interest costs
It can make sense to borrow to invest if you do this prudently. Interest on money borrowed to earn income can generally be deducted, offsetting some of your investment income, and providing tax savings.

Article: Globe & Mail

 

Tax-smart investing, Part 3: Find the right location for your income

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I’ve been talking recently about the four pillars of tax-smart investing: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income. Today, I want to chat about the third pillar: The location of income.

When I told my wife Carolyn about the topic this week, she said “the location of income should be very simple: in my bank account.” Then I told her that the location of income has less to do with where the money ends up, and more to do with who pays the tax on the income, if anyone. She wasn’t as excited by that concept.

Location matters

Location. Location. Location. Perhaps you thought this matters only in real estate. Not so. The location of your investments has a big impact on how much tax you’ll pay. Common “locations” include: Your personal hands, your spouse’s hands, the hands of your children or other family, inside a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF), inside a tax-free savings account (TFSA), or inside a corporation, family trust, or partnership.

Speaking of location, people often ask whether holding assets in another jurisdiction can save tax. As a general rule, this won’t help you because you’ll face tax on your worldwide income if you’re a resident in Canada, and our tax law and recent court decisions are tough on taxpayers who try to use offshore trusts or corporations to avoid tax.

Location ideas

Consider the following ideas to optimally locate your investments to save tax:

1. Use registered plans when earning interest

To the extent you own interest-bearing investments, hold them inside a registered plan (RRSP, RRIF or TFSA) so that the interest, which is otherwise highly taxed, is sheltered from the taxman. This is not to say that equities, which you’re holding for capital growth, should not be held in a registered plan, but not if it means you then have to hold interest-bearing investments outside the plan.

2. Consider a corporation to hold investments

By holding some or all of your non-registered investments inside a corporation you won’t face tax personally on the investment income. This could reduce a clawback of government benefits such as Old Age Security, minimize U.S. estate tax on U.S. securities, and minimize probate fees. In some provinces, in some years, the tax you’ll face on investment income inside the corporation could be less than what you’d pay personally if you’re in the highest tax bracket.

In 2014, it’s the case that capital gains and interest earned in a corporation offer no benefit over earning the amounts personally, but certain dividends earned in a corporation, rather than personally, may leave you better off in some provinces.

3. Place assets in trust

Putting assets in trust can provide you with continued control over the assets while passing the tax bill on any investment income to the beneficiaries of the trust – if you structure it properly. You do have to be concerned about the attribution rules in our tax law, but if you lend money to the trust and charge interest at the prescribed rate on the loan, or are careful about which beneficiaries are entitled to the income (adult children only, for example) you may be able to reduce the overall tax of the family.

4. Transfer assets to family

I’m talking here about splitting income by moving assets to the hands of family who will pay tax at lower rates than you. If you do this properly you’ll avoid the attribution rules in our tax law and you’ll save tax. You might also gain a measure of asset protection and reduce taxes and probate fees on death when moving assets out of your name.

5. Avoid superficial losses and average costs

If you own a security and sell it at a loss, your loss could be denied if you reacquire that security in the 61-day window that starts 30 days prior to, and ends 30 days after, your sale. By repurchasing the security in the name of a child you can avoid this superficial loss. Also, when you buy a security at different points in time, your adjusted cost base (ACB) on each purchase is averaged to arrive at a weighted average ACB per share. Any future gain or loss will be based on this average ACB.

If you want to avoid averaging your cost amounts, perhaps to keep flexibility in the ACB that will be used when selling the security, consider making subsequent purchases in the name of your corporation, a family member, or your family trust.

Article: Globe & Mail