Gold’s Legal Minute*
A Good Tax Formula:
Volume 1 – The ‘Golden’ Rules
Learning the Basics + Better Preparation = Savings*
*****Just in time for 2009 tax season *****
In a lifetime, a person will pay out much of their income on account of taxes. Taxpayers are intent on lowering their tax bills throughout their working years, then during retirement and finally at death. There are several ways to reduce and defer tax, but it is first necessary to become informed. This is the purpose of this article.
The theory of taxation
The function of taxes is to fund the State for the common and collective good. As in the case of cigarettes, a tax may also be a means of deterrence and the financing of remedial measures. Taxation is founded upon representation. Every citizen is obliged to bear his or her fair share. Pursuant to the constitution, Canada’s parliament and provincial legislatures have their own respective spheres and means of taxation. At the federal level, the major federal laws are the Income Tax Act, the Excise Act,and the Goods and Services Tax (GST), the same of which is overseen and enforced by the Canada Customs and Revenue Agency (CCRA), formerly Revenue Canada. In Quebec, there is the (Quebec) Taxation (Income) Act, the Quebec Sales Tax; and the Ministère du Revenu has the equivalent role to the federal level in virtue of the Ministère du Revenu Act. Each year, legislation is enacted to alter or change the tax acts through budgets and appropriation bills.
The following are what I deem are the ‘Golden’ rules on taxation:
THE ‘GOLDEN’ RULES
- Become informed about the basics of taxation.
- Invest strategically, taking into account taxes; in this regard,
2.1 Consider lower tax rate opportunities. As for example,
2.1.1 Make investments, generating Canadian dividends and capital gains, such with more preferential tax treatment.
2.1.2 Bear in mind tactics regarding capital gains – they are taxable only when realized, that is to say, when a capital asset, which has appreciated in value is sold or transferred. Capital assets include equities, mutual fund units, bonds, real estate, and more. Only one-half of the gain is taxable. For example, if you realize a capital gain of $1,000, only $500 will be taxable at your marginal rate. Some tips are as follows:
- Choose when to sell or transfer a capital asset. If taking a capital gain in a low-tax year, less tax will be payable.
- Take a long-term, buy-and-hold approach; the realization of capital gains may be deferred for many years.
- Trigger a capital loss intentionally, this in order to offset capital gains recognized in the same year.
- Consult a tax advisor who can help determine if this strategy is right for you.
2.2 Opt for tax breaks. These are to defer or minimize the amount of tax payable. (N.B. The state encourages citizens to defer or minimize the amount of tax payable. The legal minimal amount of tax exposure is the aim of tax-efficient investing.) As a result, an investor can keep more of his or her investment dollars to work towards building a nest egg for retirement or accelerating asset growth. To this end,
2.2.1 Use a Retirement Saving Plan (RSP); it being added;
- That the choice over the allocation of investments between a RSP, Tax-Free Savings Account (TFSA), and/or non-registered accounts will depend on the investment objectives and time frame.
- That a RSP is an excellent available tax break as well as an effective way to save for retirement.
- That an RSP offers an upfront tax deduction.
- That those contributions to a RSP are tax-deductible. In general, a taxpayer can contribute either 18% of the previous years earned income subject to a dollar limit plus any unused RSP room carried over from previous years. The easiest way to confirm a contribution limit is to look at the Notice of Assessment issued after filing the income tax return.
- That savings compound tax-free within the plan.
- That contributing smaller amounts on a monthly basis with a pre-authorized contribution plan is the easiest way to accomplish the saving of the money and the receipt of the tax break; it also gets around the RSP rush near the deadline date.
2.3 Make the Tax Free Savings Account (TFSA) a part of the portfolio. It used to be said: “A penny saved is bound to be taxed” (Source: joke-of-the-day.com). This is no longer as accurate. With a TFSA, it should be noted:
- That all Canadians 18 years of age or older with a social insurance number are allowed to contribute up to $5,000 each year into a TFSA. (N.B. Unlike an RSP, TFSA contributions are not tax-deductible.)
- That any interest or investment income earned in a TFSA account is not taxable.
- That withdrawals from the TFSA can be made at any time without paying tax.
- That withdrawals create contribution room for future savings, and unused contribution room can be carried forward indefinitely.
- That a TFSA is very flexible as there are no restrictions on its use.
- That a contribution to a spouse’s TFSA is an effective way to gift funds to a spouse; it being added that the investment income earned is not attributed back to the contributor.
- That there is no necessity to choose doing a TFSA or an RSP as one can contribute to both; allocating effectively between them is the most tax-effective manner.
- Make tax-smart allocations, even with bonds or GICs, and to this end,
- That it is usually best to hold GICs or bond inside a tax-sheltered RSP or TFSA, where they can compound tax-free.
- That salaried spouses may wish to consider having the higher-income earner pay all household bills and ongoing expenses. This frees up the earnings of the lower-income spouse for investment. The investment income generated should be taxable in the lower-income spouses hands, at his or her lower tax rate. (Source SCOTIA BANK, April 2008)
- Keep accurate records as well as retain bank statements, cancelled cheques, invoices, receipts, etc; it being added that this is an obligation bearing upon all taxpayers;
- Tabulate the required information, respecting foreign reporting requirements. In this regard,
5.1 Assemble the applicable documentation;
5.2 Make a complete declaration, since the penalties for falling to file can be quite significant.
- Take all available deductions and credits.
- Be extremely conservative when considering tax shelters.
- 8. Choose a tax (return/declaration) preparation professional who is experienced and reputable, if you do not consider yourself able or not having the time; in this regard,
8.1 Gather up the paper work and organize it an orderly fashion;
8.2 Prepare an explanatory memo explaining the broad-lines of your activities, revenue streams and major deductions, giving totals of the same;
- File your return electronically or in paper, but on or before the deadline date and time. Respecting Tax Day in the U.S., it has been said that, “The IRS is concerned that if the taxpayers begin deducting the cost of gasoline to drive to the post office to mail their returns, the Treasury will be bankrupt in no time…”(Source: joke-of-the-day.com)
- Be cautious when it comes to tax. The methodology stated above may appear simple enough, but it is not. A tax novice must act with restraint. He or she should consult with experienced professionals, (e.g., lawyers, accountants, financial planners, etc.), and fully brief them of the entire situation. Only afterwards, taking into account the counsel there from, can an informed decision be truly possible.
People earn revenue. Many acquire property. Some accumulate wealth. Taxation comes with the territory – it is very much a taxing problem. In dealing with tax, the first step is to learn the basics and thus become more informed. The second step is to prepare better. To this end, this means making investment decisions, not only as per prudent investment guidelines, but also taking taxes and tax situations into account. Indeed, proper investment vehicles with lower tax exposures are an even better investment. Good preparation also comprises the retention of bank records, invoices, receipts, etc. and the recording of moneymaking affairs. And as a personal tool and/or for the aid of the tax preparation professional, one should draft a one-page annual summary enumerating (along with totals) of the major revenues, deductions, credits, etc. If all this is done, hopefully savings will result.
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