Personal Finance Chapter 3: Planning Your Tax Strategy PDF

Chapter 3: Planning Your Tax Strategy Ted Stephenson, MBA, CFA, CFP George Brown College © 2024 McGraw Hill Limited Chapter 3: Learning Outcomes Learning Objectives: LO1 Describe the importance of taxes for personal financial planning. LO2 Illustrate how federal income taxes are comp...

Chapter 3: Planning Your Tax Strategy Ted Stephenson, MBA, CFA, CFP George Brown College © 2024 McGraw Hill Limited Chapter 3: Learning Outcomes Learning Objectives: LO1 Describe the importance of taxes for personal financial planning. LO2 Illustrate how federal income taxes are computed by completing a federal income tax return. LO3 Select appropriate tax strategies for different financial and personal situations. LO4 Identify tax assistance sources. 2 © 2024 McGraw Hill Limited Taxes and Financial Planning (1) ▪ Paying taxes is inevitable; you pay tax when you get a paycheque from a job or when you make a purchase. ▪ For most Canadians, about one-third of each dollar you earn goes to pay taxes. ▪ An effective tax strategy is vital for successful financial planning. ▪ Familiarity with tax rules and regulations can help you maximize after-tax cash flows and net worth. 3 © 2024 McGraw Hill Limited Taxes and Financial Planning (2) ▪ To help you cope with the many types of taxes you should: ▪ Know current tax laws as they affect you. ▪ Maintain complete tax records. ▪ Make employment, purchase and investment decisions that leave you with the greatest after-tax cash flows and net worth. 4 © 2024 McGraw Hill Limited Taxes and Financial Planning (3) Four types of taxes are: 1. Taxes on purchases 2. Taxes on property 3. Taxes on wealth 4. Taxes on earnings 5 © 2024 McGraw Hill Limited Filing Your Federal and Provincial Income Tax Return (1) ▪ First, you must determine whether you are required to file a return ▪ Next, which form best serves your needs? ▪ Finally, are you required to submit additional schedules or supplementary forms? 6 © 2024 McGraw Hill Limited Filing Your Federal and Provincial Income Tax Return (2) Who Must File? ▪ All residents of Canada must file a federal income tax return for any year in which they have a balance of taxes owing. ▪ Your province of residency as of December 31 of the taxation year determines which provincial income tax return you are required to file. ▪ Canadian residents are taxed on their worldwide income. 7 © 2024 McGraw Hill Limited  Filing Your Federal and Provincial Income Tax Return (3) Generally, you should keep tax records for three years from the date you receive your notice of assessment. However, you may be required to provide backup documentation for up to six years from filing (seven years total). Certain records, such as housing documents, should be kept indefinitely. 8 © 2024 McGraw Hill Limited Income Tax Fundamentals (1) Steps for Computing Taxable Income and Tax Liability 1. Step 1: Determine Total Income 2. Step 2: Calculate Net Income 3. Step 3: Calculate Taxable Income 4. Step 4: Calculate Federal Taxes Owing 5. Step 5: Calculate Net Federal Tax 9 © 2024 McGraw Hill Limited Income Tax Fundamentals (2) 10 © 2024 McGraw Hill Limited Income Tax Fundamentals (3) ▪ Step 1: Determining Total Income ▪ Total Income consists of five main components: 1. Employment income 2. Net business income 3. Investment income 4. Taxable capital gains 5. Other income – retirement income, Old Age Security, Canada Pension Plan and Employment Insurance payments 11 © 2024 McGraw Hill Limited Income Tax Fundamentals (4) ▪ Step 2: Calculating Net Income ▪ Net Income is the total income reduced by certain deductions: ▪ Contributions to RRSP, RRP and IPP’s ▪ Union and professional dues ▪ Childcare expenses ▪ Disability supports deductions ▪ Moving expenses ▪ Other deduction – business investment loss, interest paid on loans, employment expenses 12 © 2024 McGraw Hill Limited Income Tax Fundamentals (5) ▪ Step 3: Calculating Taxable Income ▪ Taxable Income is the net amount of income after allowable deductions on which income tax is computed. ▪ Additional deductions and losses carried forward from prior years ▪ Security options deduction ▪ Capital gains deduction ▪ Net capital loss of prior years ▪ Other deductions 13 © 2024 McGraw Hill Limited Income Tax Fundamentals (6) ▪ The first four federal tax brackets and corresponding rates in 2022 were: Taxable Income Tax Rate 0–$50,197 15% $50,197–$100,392 20.5% $100,392–$155,625 26% $155,625-$221,708 29% ▪ (Income over $221,708 has a federal tax rate of 33 percent.) 14 © 2024 McGraw Hill Limited Income Tax Fundamentals (7) ▪ Step 4: Calculating Federal Taxes Owing ▪ Taxable income is basis for computing amount of your income tax owing ▪ Tax rates and tax credits are used to compute taxes payable ▪ Marginal Tax Rate (MTR) ▪ Is rate of tax paid on the next dollar of taxable income ▪ Average Tax Rate (ATR) ▪ Total tax due divided by total income 15 © 2024 McGraw Hill Limited Income Tax Fundamentals (8) ▪ Marginal Tax Rate (MTR) ▪ Is rate of tax paid on the next dollar of taxable income ▪ For example, suppose you earn $53,000 of taxable income. ▪ Your 2022 federal tax liability is calculated as 15 percent on the first $50,197, while the remaining $2,803 ($53,000 - $50,197) is taxed at 20.5 percent. ▪ In total, your federal taxes equal 15 percent of $50,197 = $7,529.55 and 20.5 percent of $2,803 = $574.62, for a total of $8,104.17 before the consideration of any tax credits. ▪ Your federal marginal tax rate is 20.5 percent, the rate applied to the next dollar of taxable income. 16 © 2024 McGraw Hill Limited Income Tax Fundamentals (9) ▪ Average Tax Rate (ATR) ▪ Total tax due divided by total income ▪ To continue our example, your average federal tax rate is calculated as your total tax bill of $8,104.17 divided by your taxable income of $53,000, resulting in an average federal tax rate of 15.29 percent. 17 © 2024 McGraw Hill Limited Income Tax Fundamentals (10) ▪ Step 5: Net Federal Tax ▪ Tax Credit an amount subtracted directly from the amount of taxes owing ▪ Non-refundable tax credits are subtracted from the amount of taxes owed but can never reduce federal tax below zero ▪ Refundable tax credits are refunded to individuals if they qualify even if their tax liability is zero 18 © 2024 McGraw Hill Limited Income Tax Fundamentals (11) Examples of tax credits include: ▪ Basic personal amount ▪ Contributions to CPP/EI ▪ Age Amount (65 or older) ▪ Caregiver Amounts ▪ Infirm Dependant (over ▪ Disability amount 18 years old) ▪ Tuition and education ▪ Spousal (equivalent-to expenses/interest on spouse) amount student loans ▪ Medical expenses ▪ Charitable donations 19 © 2024 McGraw Hill Limited  Income Tax Fundamentals (12) Non Refundable Tax Credit Federal Basic personal amount $14,398 Spouse or common-law partner/equivalent-to-spouse/eligible dependent amount 14,398 maximum; if infirm, see also Canada Caregiver below –eliminated when spousal/dependent income exceeds 14,398 Age amount (65+ years of age) 7,898 –reduced when income exceeds 39,836 –eliminated when income exceeds 92,479 Disability amount 8,870 Disability amount supplement for taxpayers under 18 years of age 5,174 –reduced when total child care and attendant care expenses claimed for this 3,030 taxpayer by anyone exceed –eliminated when above expenses exceed 8,204 Canada Caregiver Credit—infirm spouse/eligible dependant or child under 18— line 30500 (infirm child under 18) or added to Line 30300 or 30400, and Line 2,350 30300 or 30400 threshold increased by this amount 20 © 2024 McGraw Hill Limited  Income Tax Fundamentals (13) Non Refundable Tax Credit Federal Canada Caregiver Credit—infirm adult dependent relative, spouse or eligible dependant age 18+; line 30425 is reduced 7,525 by line 30300 or 30400 claim –reduced when relative's income exceeds 17,670 –eliminated when relative's income exceeds 25,195 Pension income amount—lesser of eligible pension income or 2,000 Medical expense tax credit is for expenses in excess of 2,352 the lesser of 3% of net income or Tax credit for medical for other dependants is for expenses in 2,479 excess of the lesser of 3% of dependant net income Eligible adoption expenses—maximum per child 17,131 Canada Home Buyer’s Amount 10,000 Canada employment amount 1,287 21 Indexing factor for 2022 1.022 © 2024 McGraw Hill Limited Income Tax Fundamentals (14) Making Tax Payments ▪ Source Withholding ▪ Employees withhold from source to pay income tax, CPP and Employment Insurance contributions ▪ Reported to you on your T4 (Exhibit 3-5) ▪ Can reduce source withholding ▪ Installment Payments ▪ Deadlines and Penalties ▪ Must file by April 30 of each year ▪ Automatic 5% penalty on balance owing if late 22 © 2024 McGraw Hill Limited Income Tax Fundamentals (15) ▪ Genevie Seymour’s 2022 Tax Return ▪ Identification ▪ Total Income ▪ Net Income ▪ Taxable Income ▪ Net Federal Tax ▪ Refund Owing ▪ Income Tax Return and Benefit Return 23 © 2024 McGraw Hill Limited Tax-Planning Strategies (1) ▪ Tax planning is the use of legitimate methods to reduce one’s taxes. ▪ Tax Evasion is the use of illegal actions to reduce one’s taxes. ▪ To maximize after tax cash flow some simple strategies can be investigated. 24 © 2024 McGraw Hill Limited Tax-Planning Strategies (2) ▪ To maximize after-tax cash flows, some simple strategies can be investigated: 1. Are you choosing the form of remuneration that is most advantageous to you? 2. Are you taking full advantage of all deductions and credits that are available to you? 3. Are you taking advantage of all possibilities to defer the payment of taxes to a later date? 25 © 2024 McGraw Hill Limited Tax-Planning Strategies (3) 4. Should you adopt “income-splitting” techniques that permit a lower-income member of your family to declare investment income and pay less tax on it? 5. Have you organized your investment portfolio so that it attracts the lightest tax liability? 26 © 2024 McGraw Hill Limited Tax-Planning Strategies (4) How should you receive income? 1. If paid commission may deduct expenses from your employment 2. Some employee benefits receive more favorable tax benefits 3. Take bonus after end of tax year ▪ Tax concerns for small business owners ▪ Is it better for a small business owner to pay them-self a salary or receive remuneration in the form of dividends? 27 © 2024 McGraw Hill Limited Tax-Planning Strategies (5) Tax Free Savings Account (TFSA) ▪ 2023 can contribute up to $6,500 annually ▪ Regardless of amount contributed to RRSP/RSP ▪ Unused room can carry forward ▪ Contributions grow tax free ▪ Withdrawals are tax free as well ▪ Withdrawals create contribution room for future years ▪ Gains/withdrawals not considered when determining eligibility for federal income tax benefits (OAS) or credits ▪ TFSA is subject to same investment restrictions as RRSP/RSP ▪ For more information visit http://www.cra-arc.gc.ca 28 © 2024 McGraw Hill Limited Tax-Planning Strategies (6) First Time Home Savings Account (FHSA) ▪ Designed to help Canadians save for a principal residence. ▪ Can contribute up to $8,000 annually with a $40,000 lifetime limit and must be used within 15 years of starting. ▪ For more information visit Department of Finance Canada: Design of the Tax-Free First Home Savings Account 29 © 2024 McGraw Hill Limited Tax-Planning Strategies (7) Maximizing the benefits of deductions and tax credits ▪ Be aware of current tax laws and regulations ▪ Use contributions to retirement plans to defer taxes on income ▪ Maximize your contribution each year ▪ Child support, alimony and spousal maintenance payments are no longer deductible ▪ Interest on funds used to earn taxable income is tax deductible ▪ Capital losses incurred can be subtracted from capital gains 30 © 2024 McGraw Hill Limited Tax-Planning Strategies (8) Maximizing the benefits of deductions and tax credits ▪ Be aware of the tax treatment of stock options, capital losses and gains and lifetime capital gains exemptions ▪ All people qualify for basic personal deduction amount and income tax credit ▪ Also, can claim for eligible dependents ▪ Interest paid on student loans ▪ Tuition fees and education amounts ▪ Medical expenses ▪ Charitable contributions 31 © 2024 McGraw Hill Limited Tax-Planning Strategies (9) Tax Deferral Techniques: ▪ Defer taxation of income until a later date when combined average tax rate will be lower ▪ During deferral period investment income earned can be reinvested tax free ▪ Registered Retirement Savings Plans ▪ Registered Pension Plans ▪ Individual Pension Plan ▪ Deferred Profit-Sharing Plan ▪ Investing in capital assets ▪ Registered Education Savings Plan 32 © 2024 McGraw Hill Limited  Tax-Planning Strategies (10) Income Splitting Techniques: ▪ Unlawful to invest in name of lower income earning spouse or minor child to have income taxed at lower rate ▪ Legal means of income splitting include: ▪ Contributions to spousal RRSP ▪ Splitting CPP/QPP benefits with spouse ▪ High income spouse pays living expenses and lower income spouse invests ▪ Transfer assets used to generate business income 33 © 2024 McGraw Hill Limited Tax-Planning Strategies (11) ▪ Income Splitting Techniques include: ▪ Legal means of income splitting include: ▪ Open Registered Education Savings Plans (RESP) ▪ Opening a Registered Disability Savings Plan (RDSP) ▪ Set up in-trust investment account for minor child(ren) ▪ Invest in federal Child Tax benefit ▪ Transfer asset to adult child 34 © 2024 McGraw Hill Limited Tax-Planning Strategies (12) Ensuring that your portfolio is tax efficient ▪ Interest income fully taxed at marginal tax rate ▪ Hold such investments in RRSP ▪ Dividends and capital gains are taxed less heavily ▪ Interest for loans made for investment purposes are tax deductible (subject to certain conditions) 35 © 2024 McGraw Hill Limited Tax-Planning Strategies (13) Tax issue important to students 1. Learn how to report income from scholarships, bursaries, fellowships, grants and RESPs 2. Get common deductions such as moving expenses, childcare expenses and interest paid on student loans 3. Non-refundable tax credits such as tuition and education amounts 4. Other tax credits such as GST/HST credit and Canada Child Tax Benefit 36 © 2024 McGraw Hill Limited Tax-Planning Strategies (14) ▪ Every year the CRA modifies tax return and filing procedures ▪ Legislation is frequently passed that changes the Income Tax Act ▪ Review changing tax laws when personal financial planning ▪ Consider changes in personal situation and income levels 37 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (1) Tax Information Sources ▪ Tax information sources and assistance can be found at: ▪ Canada Revenue Agency ▪ Libraries and Bookstores ▪ Internet sites ▪ Tax publications ▪ Tax preparation software and electronic filing ▪ Tax preparation services 38 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (2) 39 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (3) Tax Preparation Software and Electronic Filing ▪ Most Canadians file tax returns electronically either directly with the CRA or through a tax service. ▪ Advantages include benefits to the environment; receiving a refund within a few weeks; and being able to keep all original records, reducing the risk of lost documents. ▪ The CRA has two systems to enable electronic filing of tax returns: EFILE and NETFILE. EFILE is a service that lets authorized service providers and send individual income tax return information to the CRA directly from the software used to prepare the tax return. 40 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (4) What if Your Return Is Audited? ▪ A tax audit is a detailed examination of your return for Canada Customs and Revenue Agency ▪ More information is requested ▪ Keep detailed records; receipts, cancelled cheques, evidence to prove amounts claimed ▪ Avoid common filing errors 41 © 2024 McGraw Hill Limited  Tax Assistance and the Audit Process (5) 1. Mathematical errors, such as transposition, adding or subtracting amounts incorrectly. 2. Forgetting to reduce income by identifying workers’ compensation, social assistance payments, and net federal supplements. 3. Calculating and claiming provincial tax credits incorrectly. 4. Not including pension adjustments, which affect RRSP contribution room for the coming year. 5. Claiming GST/HST credits incorrectly by using incorrect spousal income amounts. 6. Entering the wrong amounts on lines referring to Canada Pension Plan, Quebec Pension Plan, and Employment Insurance contribution and overpayments. 7. Claiming incorrect amounts as RRSP contributions. 8. Forgetting to claim the basic personal amount. 9. Claiming the spousal amount incorrectly. 10. Forgetting to claim the age amount or claiming it incorrectly. 42 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (6) Types of audits include: ▪ Desk Audit ▪ Inquiry mailed asking you to clarify or document ▪ Field Audit ▪ Agents visit to have access to records ▪ May request only specific information ▪ You should seek assistance from a professional advisor ▪ Generally, not cause for alarm 43 © 2024 McGraw Hill Limited Tax Assistance and the Audit Process (7) Your audit rights can be listed as following: ▪ Auditor may only request specific information ▪ You can seek assistance from a professional advisor ▪ Reassessment cannot go back more than three years except in cases of fraud or misrepresentation 44 © 2024 McGraw Hill Limited Summary (1) LO1 Describe the importance of taxes for personal financial planning ▪ Tax planning can influence spending, saving, borrowing and investing decisions ▪ Knowledge of tax laws and maintenance of accurate tax records allows you to take advantage of tax benefits ▪ Awareness of income tax, sales tax, excise tax, property tax, estate tax, and other taxes is important for successful financial planning 45 © 2024 McGraw Hill Limited Summary (2) LO2 Illustrate how federal income taxes are computed by completing a federal income tax return ▪ Major sections require you to calculate 1. Your filing status 2. Income 3. Deductions 4. Other deductions 5. Tax credits 6. Your refund or the additional amount you owe 46 © 2024 McGraw Hill Limited Summary (3) LO3 Select appropriate tax strategies for different financial and personal situations ▪ May reduce your tax burden through careful planning and making financial decisions related to ▪ Consumer purchasing ▪ Use of debt ▪ Investments ▪ Retirement planning 47 © 2024 McGraw Hill Limited Summary (4) LO4 Identify tax assistance sources ▪ CRA services and publications ▪ Other publications ▪ The Internet ▪ Computer software ▪ Professional tax preparers ▪ Commercial tax services, accountants, and attorneys 48 © 2024 McGraw Hill Limited