bout de papier, Vol. 9, No. 2 (1992) — Spring 1992 // Printemps 1992, pp. 34–35
Today may seem a bit early to worry about your 1992 income tax. However, this is probably the very best time, while the pain of 1991’s sins and omissions is still fresh in your mind, to look into what changes you should make now to improve your bottom line for next year.
General Items
There are some obvious areas to check. Did you make your charitable donations before the end of the year? If in 1991 you were only able to make donations of $250 or less, in 1992 you should consider doubling them up and claiming them only every second year, or even carrying them forward over five years, thus receiving at least part of your overall tax credit at your higher rate of tax. Did you remember to save all the family’s medical receipts, including any medical plan premiums that you may have paid, together with the payment notices returned under your plan which paid back less than the full 100 per cent reimbursement? Can your spouse make a claim against taxes payable if your income is too high for you to be able to make the claim? If your child or spouse is attending a qualified educational institution, have they signed over their education and tuition deduction certificates for you to use?
Have you been reporting the interest earned on your compound Canada Savings Bond (CSBs) every year? If yes, then when you cash them in, you should ensure that you claim only the current year’s portion of the interest shown on your T-600 form. Starting in 1991, the Bank of Canada will be issuing annual T-5 slips for those compound CSBs issued after 1989. However, you will still need to calculate the interest yourselt for earlier series. This coming November, you may wish to consider cashing in older CBs and buy the 1992 series to help simplify your bookkeeping.
RRSPs
Did you receive a Contribution Limit Statement from Revenue Canada which indicated that you could have contributed even a small amount to a Registered Retirement Savings Plan (RRSP) in 1991? The rules governing RRSPs changed in 1991. The new contribution limits for 1992 are 18 per cent of your previous year’s earned income to a maximum of $12,500 (in 1992) minus your previous year’s pension adjustment (PA) and (any other adjustments) as reported in Box 52 of your 1991 T-4 form. In the past, you may have found that your contributions to your Registered Pension Plan (for example government superannuation) were too high to allow a contribution to an RRSP. However, beginning in 1991, we have found that most people are now eligible to contribute to an RRSP even if they were a member of a pension plan during the previous year.
To calculate “earned income”, you should be aware that this term includes salary plus net rental income, alimony received, net business incomes, royalties and research grants. From your earned income you must deduct union and professional dues, net rental losses, alimony paid, and net business losses.
The February 1992 Federal Budget changed the RRSP rules slightly. The maximum RRSP contribution limits will increase by annual increments of $1,000 (except 1993) to a maximum of $15,500 in 1996, as shown in the following table. Thereafter, the maximum contribution limit will be adjusted for the increase in the average industrial wage for the preceding year.
Prior year’s
earned
income
required for
Contribution maximum
Year limit contribution
1992 $12,500 $69,444
1993 $12,500 $69,444
1994 $13,500 $75,000
1995 $14,500 $80,556
1996 $15,500 $86,111
Individuals may contribute or deduct amounts that are lower than their contribution limit for the year. The difference between an individual’s contribution limit and their RRSP deduction limit for the year is added to their unused RRSP deduction room which may be carried forward for seven years and used to increase deductible RRSP contributions during the carry-forward period.
Alternatively, you may accumulate up to $8,000 of excess contributions (over and above your current contribution room) in your RRSP at any one time without immediate penalty. If you or your spouse are already receiving pension income (for example, if you or your spouse are former members of the Armed Forces or the RCMP) do not forget about your $6,000 spousal pension roll-over. This is an excellent way to save taxes now while still providing for your retirement.
RRSP contributions should be made as early in the calendar year as possible in order to maximize your tax-free earnings within the plan. If you find that you do not have the ready cash, but you do have other investments such as Canada Savings Bonds, GICs, stocks or mutual funds, you may want to consider opening a self-directed RRSP and contributing those qualifying investments directly to the RRSP. However, if you do choose this route, you should be aware that you could be triggering a deemed capital gain at the time of transfer into your self-directed RRSP.
In addition, many organizations offer their employees attractive early retirement and severance packages. Much of the money received under these circumstances can be invested in an RRSP. However, there can also be major tax consequences relating to alternative minimum tax. You should consult a tax specialist before you accept any offer and before you make any RRSP contributions.
Income-Splitting
Income-splitting is a form of tax planning that has received a lot of attention in the past. Although the rules have been tightened, there are still a few beneficial things that can be done.
The objective of income-splitting is to arrange your savings carefully so that in retirement both spouses have relatively equal incomes. The benefit to be derived from this equality of incomes relates to our three tier tax system. If one spouse has all the income, they likely pay tax at a high tax rate. If the spouses split the income, they may each be able to pay tax at a lower tax rate, thus minimizing the portion of their income that goes to the government. If it appears that your spouse will have a smaller retirement income than you will have, a logical step is to make contributions to a spousal RRSP. Even if the allowable annual contribution is small, it still represents some progress, and over the years with the effect of compounding, the benefits will multiply.
Another alternative would be for the spouse with the lower income to invest whatever spare cash exists in that person’s name so that it will be taxed at the lowest possible rate. The spouse with the higher income would use their income that otherwise would be invested, to pay the living expenses which the spouse with the lower income otherwise would be paying. This would allow savings to be built-up in the name of the spouse with the lower income thus resulting in lower income taxes.
Children
Family allowance cheques deposited in the account of the child will yield investment income taxable at the child’s effective tax rate, which in most cases will be nil. This tax sheltering technique will be curtailed when the government switches from universal family allowance payments to the tax credit system proposed in the February 1992 Budget.
Consider investing up to $1,500 annually (subject to the maximum benefit rules) in a Registered Education Savings Plan (RESP) on behalf of your children, to a maximum of $31,500 per beneficiary. Although contributions are not tax deductible, the accumulated interest will be deemed to be the income of your children when it is withdrawn by them to fund their post-secondary education. This will, in effect, pay for your children’s education with before-tax money rather than from after-tax dollars. However, this is not a foolproof scheme. You need to weigh the RESP administration fees, the risk of your child not attending a qualifying postsecondary program, the likely investment yield of the plan, and its track-record when considering this route. Your contributions less any administration fee will be returned to you in most cases if your child does not attend a qualifying post-secondary program. However, you will lose the accumulated interest which either will remain in the plan for the overall benefit of other students in the plan if you had contributed to a group plan, or else will go to the designated institution if it was a self-administered RESP. Therefore, assess the plan very carefully before you invest in an RESP.
As an alternative to an RESP, you could consider investing in a mutual fund for your child which is geared to generate capital gains in the name of the child. Properly established, there would be no attribution of the capital gains back to the parent or grandparent who provided the money for the child’s mutual fund. The plan may generate a better long-term yield than most RESP plans, it does not depend on the child attending a post-secondary institution, and you have control of the investment for your child. If the child does not go to post-secondary education, there is no loss and the child can still use the capital gains exemption, assuming it still exists at that time.
Other Investments
Many members of the Foreign Service buy homes when they live in Canada, and then rent them out when they are posted abroad.
While this can be a good investment and tax planning idea, you should be aware that there can be future tax implications. For example, a Cumulative Net Investment Loss (CNIL) is calculated by taking all investment income, including net rental income, incurred since 1988 and then subtracting all investment expenses including net rental losses incurred since 1988. If the resulting number is positive, there is no need for immediate concern. However, if the calculation results in a negative number this will affect any future capital gains deductions that you may wish to claim. Also, there are various tax elections which you will be required to make in calculating your taxable income.
Lower interest rates coupled with the fact that in the highest tax bracket you would pay 49.4 per cent of every dollar earned in taxes has increased investor interest in switching to dividend income. In 1992, dividends are only taxed at a rate of 33.4 per cent in the highest tax bracket. You should therefore re-assess your investment portfolio carefully and frequently as a result of the change in the economic situation.
Investment yields earned in the form of capital gains result in the lowest tax cost, given the availability of the $100,000 lifetime capital gains deduction. This deduction is available to individuals resident in Canada. As Foreign Service members, you and your spouse are automatically deemed by Revenue Canada to be residents of Canada for income tax purposes. This also means that each spouse would have the ability to make a capital gains deduction of $100,000 from capital gains reported
There has been some discussion about how long the capital gains deduction will continue to be available in any form. The February 1992 Budget removed the exemption relating to real estate. Our advice is that if you have investments that you know you intend to sell at some point in 1992, you should keep in mind that this deduction may not continue indefinitely. However, you should assess your position carefully and should not forget the possible effect of your CNIL.
With interest rates lower than they have been in many years, at some point during the year, you may decide to refinance your mortgage or other loans. Be careful when you are restructuring your loans to ensure that interest remains deductible. If you increase the mortgage and use the funds for investment purposes, the interest on the funds is tax deductible. If you increase the mortgage and use the funds to pay off other non-deductible debts or to buy another house for you to live in, the interest on the increased portion would not be deductible.
Many middle-income individuals have been approached to purchase various tax-shelters. While they appear wonderful in the early years because they generate significant tax deductions, ultimately over the long-run, they may result in an overall loss to the investor. Tax shelters should be assessed carefully on their business, investment and liquidity merits, and only secondarily on their potential for tax-savings. Given the possible impact of items such as the minimum tax, CNIL, interest deduction rules, and the Income Tax Act’s numerous anti-avoidance provisions, the alleged tax benefits of a particular tax shelter should be closely scrutinized with the help of a tax accountant before a purchase is made. As well, if you acquired an interest in a tax shelter after 31 August 1989, you must now report its registration number in order to claim the tax deductions associated with the shelter.
View the original scanned pages →
Originally published in bout de papier, Vol. 9, No. 2 (1992) — Spring 1992 // Printemps 1992, pp. 34–35. Read the rest of this issue →
