Tax Strategies for Financial Planning 3

Chapter 3: Planning Your Tax Strategy

• Taxes are inevitable, paid when receiving a paycheck or making a purchase.
• In Canada, approximately one-third of earned income goes toward taxes.
• A solid tax strategy is crucial for successful financial planning.
• Understanding tax rules maximizes after-tax cash flow and net worth.

Learning Objectives

• LO1: Describe the significance of taxes in personal financial planning.
• LO2: Illustrate federal income tax calculation using a federal income tax return.
• LO3: Select suitable tax strategies for various financial and personal circumstances.
• LO4: Identify reliable sources of tax assistance.

Taxes and Financial Planning (1)

• Paying taxes is unavoidable, occurring with paychecks and purchases.
• Canadians typically pay roughly one-third of their income in taxes.
• Effective tax strategies are vital for effective financial planning.
• Familiarity with tax laws and regulations is essential for maximizing after-tax income.

Taxes and Financial Planning (2)

• Understanding current tax laws is critical.
• Maintaining comprehensive tax records is vital.
• Financial choices (employment, purchases, investments) should prioritize maximizing after-tax cash flow and net worth.

Taxes and Financial Planning (3)

• Four main types of taxes:
  • Taxes on purchases
  • Taxes on property
  • Taxes on wealth
  • Taxes on earnings

Filing Your Federal and Provincial Income Tax Return (1)

• Determine filing requirements.
• Choose the most suitable tax form.
• Identify necessary supplemental forms or schedules.

Filing Your Federal and Provincial Income Tax Return (2)

• All Canadian residents must file a federal income tax return if they have a balance of taxes owing.
• Provincial residency determines the applicable provincial tax return.
• Canadian residents are taxed on worldwide income.

Filing Your Federal and Provincial Income Tax Return (3)

• Maintain tax records for three years from the assessment date.
• Some records (e.g., housing documents) should be kept indefinitely.
• Records include tax forms, income, and expenses.

Income Tax Fundamentals (1)

• Five steps to compute taxable income and tax liability:
  • Determine Total Income
  • Calculate Net Income
  • Calculate Taxable Income
  • Calculate Federal Taxes Owing
  • Calculate Net Federal Tax

Income Tax Fundamentals (2)

• Step 1: Determining Total Income: Employment income, net business income, investment income, taxable capital gains, and other income (e.g., retirement, OAS, CPP, EI).
• Step 2: Calculating Net Income: Total income less permissible deductions.
• Step 3: Calculating Taxable Income: Net income minus other allowable deductions or losses carried forward from the prior year.
• Step 4: Calculating Federal Taxes Owing: Federal taxes based on the tax bracket.
• Step 5: Calculating Net Federal Tax: Total taxes due less applicable tax credits.

Income Tax Fundamentals (3)

• Total income is comprised of five components:
  • Employment income
  • Net business income
  • Investment income
  • Taxable capital gains
  • Other income (e.g., retirement, OAS, CPP, EI)

Income Tax Fundamentals (4)

• Net income calculation: Total income reduced by eligible deductions.
  • RRSP, RRP, IPP contributions
  • Union/professional dues
  • Childcare expenses
  • Disability support deductions
  • Moving expenses
  • Other deductions

Income Tax Fundamentals (5)

• Taxable income calculation: Net income less eligible deductions
  • Additional deductions and losses from prior years.
  • Security options deduction
  • Capital gains deduction
  • Net capital losses from prior years.
  • Other deductions.

Income Tax Fundamentals (6)

• 2022 federal tax brackets and corresponding rates: (Specific income ranges and rates are provided)

Income Tax Fundamentals (7)

• Taxable income is the basis for calculating the amount of income tax owing.
• Tax rates and tax credits are used in the calculation.
• Marginal Tax Rate (MTR): Tax rate applied to the next dollar of income.
• Average Tax Rate (ATR): Total tax due divided by total income.

Income Tax Fundamentals (8)

• The Marginal Tax Rate (MTR) is the tax rate paid on the next dollar of taxable income.
• Example of MTR calculation using $53,000 earned income.

Income Tax Fundamentals (9)

• Average Tax Rate (ATR): Total tax due divided by total income.
• Example of ATR calculation.

Income Tax Fundamentals (10)

• Tax credit: Amount subtracted directly from the tax owing amount.
• Non-refundable tax credits (reduce tax owed but do not generate a refund if tax owed is zero).
• Refundable tax credits: Refunded even if there's no tax liability.

Income Tax Fundamentals (11)

• Examples of tax credits: Basic personal amount, age amount (65 or older), infirm dependent (over 18), spousal amount, contributions to CPP/EI, caregiver amounts, disabilities, tuition, medical expenses, and charitable donations.

Income Tax Fundamentals (12)

• (Table of 2022 federal non-refundable tax credit amounts)

Income Tax Fundamentals (13)

• (Table of 2022 federal non-refundable tax credit amounts)

Income Tax Fundamentals (14)

• Making tax payments:
  • Source withholding: deduction from income for federal, CPP, and EI contributions
  • Tax installments (deadlines vary)
  • Penalties for late filing

Income Tax Fundamentals (15)

• Genevie Seymour's 2022 Tax Return: (Summarized data illustrating calculation of identification, total income, net income, taxable income, net federal tax, refund due, benefit return)

Tax-Planning Strategies (1)

• Tax planning: using legal methods to reduce taxes.
• Tax evasion: using illicit actions to reduce taxes.
• Strategies to maximize after-tax cash flow are important.

Tax-Planning Strategies (2)

• Tax planning strategies:
  • Choosing the most advantageous form of remuneration.
  • Maximizing the use of allowable deductions and credits.
  • Deferring tax payments (where legally possible).

Tax-Planning Strategies (3)

• "Income splitting" strategies: Lower-income family members reporting investment income could reduce tax burden on it.
• Optimize investment portfolios to minimize tax liability.

Tax-Planning Strategies (4)

• Methods of receiving income:
  • Commissions: deduct associated expenses.
  • Employee benefits: tax advantages may apply
  • Bonuses: may be taken at tax year end
  • Small business owners: salary vs. dividends.

Tax-Planning Strategies (5)

• Tax-Free Savings Account (TFSA): contributes up to $6,500 annually (carried forward unused amounts), tax-free growth and withdrawals.

Tax-Planning Strategies (6)

• First-Time Home Savings Account (FHSA): designed for saving for a home, up to $8,000 annually with a $40,000 lifetime limit.

Tax-Planning Strategies (7)

• Tax planning for deductions and credits:
  • Know current tax laws for advantageous use of deductions.
  • Contributions to retirement plans defer taxes on income.
  • Maximize contributions to retirement, child support, alimony and spousal maintenance expenses are no longer deductible.
  • Interest on funds used for taxable income is deductible.
  • Capital losses reduce capital gains.

Tax-Planning Strategies (8)

• Maximize benefits by understanding the tax treatment of stock options, capital losses, capital gains, and lifetime capital gain exemptions.
• Claim basic personal amount and income tax credit for all taxpayers.
• Claim eligible dependents, interest on student loans, tuition, medical expenses, and charitable contributions.

Tax-Planning Strategies (9)

• Tax deferral strategies:
  • Deferring taxes to a later date when the blended average tax rate is lower can benefit taxpayers.
  • Investment income during the deferral period is commonly tax-free (RRSP, RPPS, Individual Pension Plan, Deferred Profit-Sharing Plan, investments in capital assets, RESP).

Tax-Planning Strategies (10)

• Income splitting techniques: using legal methods to reduce tax liability via income splitting among family members (e.g., spousal RRSPs, splitting CPP/QPP benefits, paying living expenses and investments).
• Transferring assets generating income to other family members, may be illegal or unethical depending on circumstances.

Tax-Planning Strategies (11)

• Methods of income splitting:
  • Open Registered Education Savings Plans (RESPs)
  • Opening a Registered Disability Savings Plan (RDSP)
  • Setting up in-trust investment accounts for minors
  • Investing federal Child Tax Benefits
  • Transferring assets to adult children

Tax-Planning Strategies (12)

• Ensure a tax-efficient investment portfolio:
  • Tax-efficient investments - Interest income fully taxed at the taxpayer's marginal tax rate, holding these investments in a Registered Retirement Savings Plan (RRSP) or similar tax-sheltered account
  • Tax-efficient dividends and capital gains are taxed at lower rates.
  • Interest for investment purposes is frequently tax-deductible.

Tax-Planning Strategies (13)

• Tax issues for students:
  • Reporting income from scholarships, bursaries, fellowships, grants, and RESPs.
  • Utilizing allowable deductions (e.g., moving expenses, childcare, student loan interest).
  • Using non-refundable tax credits (e.g., tuition, education amounts).
  • Utilizing applicable tax credits (e.g., GST/HST credit, Canada Child Tax Benefit).

Tax-Planning Strategies (14)

• Tax procedure modifications:
  • CRA's annual updates to tax return and filing procedures
  • Review changes to the Income Tax Act when planning personal finances.
  • Adapt financial strategies to account for changes in personal circumstances and income levels.

Tax Assistance and the Audit Process (1)

• Sources of tax assistance:
  • Canada Revenue Agency (CRA)
  • Libraries and bookstores
  • Internet sites
  • Tax publications
  • Tax preparation software and electronic filing services
  • Professional tax preparation services

Tax Assistance and the Audit Process (2)

• (Calendar outlining key tax deadlines and actions throughout the year).

Tax Assistance and the Audit Process (3)

• Tax preparation software and electronic filing benefits:
  • Environmental friendliness
  • Quick refund processing
  • Secure record-keeping

Tax Assistance and the Audit Process (4)

• What to do if a tax return is audited:
  • Keep detailed tax records (receipts, cancelled cheques) that support claimed amounts.
  • Review the return for potential errors.
  • Seek professional assistance if needed.

Tax Assistance and the Audit Process (5)

• Top ten common tax filing errors:
  • Mathematical errors
  • Incorrect deductions for workers' compensation, social assistance, and net supplements
  • Provincial tax credits
  • Missing pension adjustments for RRSP contribution room
  • Incorrect use of GST/HST credits
  • Incorrect income reporting for CPP, Quebec Pension Plan, and Employment Insurance

Tax Assistance and the Audit Process (6)

• Audit types:
  • Desk audit (inquiry mail)
  • Field audit (agent visit to access records)
  • seeking expert advice is beneficial throughout the process

Tax Assistance and the Audit Process (7)

• Audit Procedures and Rights:
  • Auditors seek information specifically relating to the audit's focus.
  • Taxpayers have the right to seek professional counsel.
  • Reassessments are limited to three years unless related to fraud or misrepresentation.

Summary (1)

• Tax planning impacts spending, saving, borrowing, and investing choices.
• Knowledge of tax laws and record-keeping allows effective use of tax benefits.

Summary (2)

• Completing federal income tax returns involves assessing filing status, income, deductions, other deductions, tax credits, and any additional taxes or refunds.

Summary (3)

• Tax strategies can reduce tax burdens by carefully planning financial decisions related to consumer purchasing, debt use, investments, and retirement plans.

Summary (4)

• Tax assistance resources include CRA, publications, internet resources, professional tax preparers, and commercial tax services.