Take the guess work out of tax and financial planning

Canadians - if you received CERB benefit payments in 2020, have you considered taking steps to reduce the taxes due on these benefits? If you have experienced an unexpected increase in income in 2020, have you considered taking steps to reduce your taxes?

A basic tenet in the Income Tax Act (the Act) allows Canadians to structure their affairs in the most tax effective manner, and there are many legitimate deductions and/or tax credits to help offset or reduce the tax owing (or to increase your refund) when you file your return. While I am presenting some possible options here, please ensure you are consulting certified and qualified tax and financial professionals to determine what strategy is right for you. Although I have a working knowledge of The Act by the nature of being a Certified Financial Planner (CFP) and a specialist in the areas of personal and corporate tax planning strategies from that perspective, I am not a Certified Public Accountant (CPA) and do not dispense tax advice.

RSPs

One of the most common and simple ways to create a tax deduction is to contribute to an RSP. This may not be possible for all Canadians, either because you have no income to contribute*, or you have no contribution room, or you may also be of the mindset that RSPs are not for you. While they can reduce the current years tax payable, they are a tax deferral vehicle, not a tax dismissal vehicle. You will be paying the taxes back to the government at some future time. The theory behind RSPs is that your retirement income would be in a lower bracket than when you made the contribution, and you have the advantage of growing your capital without paying tax before you start making withdrawals. When you make a contribution to an RSP, it reduces the amount of income subject to tax. This could provide a refund of taxes already withheld, or a reduction of taxes payable on income with no withholding amounts such as CERB.

For example, if you earned $4,000 in CERB and were in a 30% tax bracket, without considering any other deductions or credits, you would owe $1,200 in taxes. Your taxable income is reduced dollar for dollar with RSP contributions so if you contributed $4,000 to your RSP and no taxes would be payable based on $4,000 of CERB, all other things being equal. If you contributed $2,000, your taxes owing on CERB would still be $600 at a 30% marginal rate of tax.

RSPs are not for everyone. The investment choices are limited, early access is penalized, and as mentioned it only defers the tax until a later date. If tax rates are higher when withdrawn than when contributed, the tax deferral benefits may be reduced. Currently, the government has not provided any guidance about future tax increases, so even plausible predictions about future tax increases are only speculative.

Before making an additional contribution, check your available contribution room to avoid punitive penalties for over-contributions.

*A note about not having the funds to contribute. Many financial institutions offer RSP loans but borrowing to invest carries additional risks that borrowers should not take lightly.

Labour-Sponsored Venture Capital Corporation (LSVCC) credits

These are federal/provincial tax credits offered for investments in a non-registered, RSP or TFSA account in smaller to mid-sized companies that are providing employment in the province. While not able to help you with your prior year income tax payable, these credits can assist with current or future years tax payable. Not all LSVCC investments are created equally, could have higher degrees of risk and return, and credits may vary between provinces; so, ensure that you engage the advice of qualified professionals in this area.

Canadian Exploration Expenses (CEE) and Canadian Development Expenses (CDE) – Flow Through Share Credits

These investments in the mining and energy sector in companies that choose to renounce their eligible exploration and development expenses. These expenses pass or “flow through” to investors to claim investment tax credits (ITCs) such as the CEE and the CDE. Certain provinces also offer credits similar to these federal Flow Through Share Credits. Before making a decision, consider that a complex “look-back” rule exists which could help offset your 2020 taxes payable and not just 2021 or future years. 

Of course, just like any other option, investments have risks that could include a total loss that you should seriously contemplate before taking the plunge.

Charitable or Political donations

In terms of offering a big bang for your buck (and making a social difference), making a gift to a bona fide and registered charity will give you significant benefits to reduce your taxes. The tax credits available for charitable donations are dependant on the amount contributed - so do your research.

Credits offered for making political contributions can be quite significant and offer a 75% tax credit for the first $400 of contributions. There are additional bands of credits for higher donations but are generally limited to contributions up to $1,275.00.

Special COVID related credits and benefits

The Federal government introduced some unique credits and deductions in 2020, such as the Home Office Expense for Employees, or some RRIF minimum withdrawal reductions. There are many government online resources available to gather information on these tools.

Applying other deductions or credits

There are a number of other credits and deductions available, which include but are not limited to the Tuition Fee Credit, interest on student loans, Caregiver credit, medical expenses, moving expenses, eligible dependents, self employment expenses, legal fees, etc. If you can use them, or have any carry forward amounts from prior years such as business use of home expenses, you may decide to use them for maximum effect for 2020. Again, advice of a certified tax professional is crucial to maximize the usefulness and effectiveness of these deductions and credits.

Pay the tax and be done with it

If you are opposed to RSPs, have no other carry forward credits (or decide that your politicians are crooks and do not deserve your political donations), you can simply pay the tax and dispense with any further planning. Based on the balance of your 2020 income, you may find that the sting of taxes due on CERB may be less than you think, but that sting could be greater than you think.

At the end of the day, do not play a guessing game or rely on an uninformed – even if well-intentioned - opinion. Do the due diligence to gather the information necessary to help eliminate your doubts. That is why they call it financial planning, not financial guessing.