It was T.S. Eliot who once mused, “April is the cruelest month.” No doubt, the poet extraordinaire was referring to tax season—but fear not, MoneySense is here to ease your pain. Over your lifetime, income taxes will likely be the biggest expense you’ll face. But there are several legitimate and legal ways to reduce your tax bill. It’s all about making sure you’re aware of all the credits and deductions for which you’re eligible, as well as setting up your family affairs in a way that benefits from income splitting. And it’s ensuring your investments are located in the correct tax-sheltered accounts. Follow along with this online calendar and make sure to sign up for our weekly #MoneyFit newsletter.
Before we start digging into tax-saving strategies, first take the time to figure out what percentage of your income will go to the taxman. To answer you first need to know your taxable income for the year.
Start with your salary or wages, business income, rental income, and interest from investments. (Dividends and capital gains also contribute to this total, subject to adjustments.) You then subtract certain deductions—like your RRSP contribution—to get your taxable income for the year.
In general, the higher your taxable income, the higher your marginal tax rate (the percentage you pay on your last dollar of income). But if your marginal rate is 25%, that doesn’t mean you’ll hand over one quarter of all your taxable income. Tax rates are progressive: You only pay that rate on the portion of your income that falls in that bracket. For instance, federal tax rates are 15% on the first $45,282 of taxable income you earn in 2016, followed by 20.5% on the next portion (from $45,283 to $90,563). For more information on federal tax rates, go here.
Don’t overlook credits and deductions
Tax credits and deductions can both save you money, but you should understand they are two different things. A credit reduces the actual amount of tax you owe, whereas a deduction reduces the amount of your income that’s taxable. The government often gives tax credits to promote specific behavior: charitable donations, upgrading to energy-efficient appliances, signing kids up for fitness programs and so on. Others are aimed at helping people with disabilities or low incomes. For a list of eligible tax credits for the 2015 tax year, head here
Tax deductions include things like RRSP contributions, child-care expenses, interest on investment loans, expenses incurred to move to a home closer to your job, as well as those incurred when self-employed. You can subtract these amounts from your income to reduce the total amount of tax you pay. For more specific tips, go here.
Avoid an audit
When claiming credits and deductions, keep your receipts. Don’t get sloppy: A lot of people simply round off numbers throughout their tax return. That just invites an audit.
Split income and save
Income splitting is a smart strategy at any age, but once you retire and start collecting government benefits it works even better—especially if you can use it to avoid dreaded Old Age Security (OAS) clawbacks. Many government benefits are income tested so transferring income to a lower-income spouse can help a higher-income spouse reduce taxes and receive more benefits. For instance, if both of you are 60 or older and receiving CPP payments, the higher-income spouse can elect to attribute up to 50% of his or her CPP income to the lower-earning spouse. Want to save even more? If one of you is lucky enough to have a lucrative defined-benefit pension, you’re allowed to allocate up to one half to your spouse. For more information on how pension income spitting works, go here .
Invest in your spouse’s name
Pooling resources with your spouse to pay for household expenses seems like the right thing for committed partners to do. But if one of you is the breadwinner and the other earns much less income, it doesn’t make sense from a tax perspective. Instead, the higher-earning spouse should cover all the day-to-day family expenses, like buying groceries and paying the heating bill, so the lower-income spouse can make the investments. That way, all of the interest and capital gains from those investments will be taxed at the lower tax rate of the lower-income earner. The higher-earning spouse can also lend money to the lower-earning spouse to buy investments, but the Canada Revenue Agency’s prescribed interest rate of 1% must be charged.
Save with a spousal RRSP
Have extra RRSP room (and a spouse)? Try setting up a spousal RRSP account and make contributions to it in the name of your lower-earning partner. You’ll get the same advantage as if you were putting income into your own RRSP (a tax refund on contributions), but here’s the kicker: When the money is later withdrawn, it will be taxed in your lower-income spouse’s hands at a lower rate. Just be aware of the Canada Revenue Agency’s attribution rules: You can’t make a contribution in the same year you withdraw the money, or in either of the two previous tax years. Plus, the total combined contributions to your own RRSP and your spouse’s RRSP cannot exceed your own deduction limit. Check out this video, for more smart ways to use spousal RRSPs.
Don’t make this mistake
Tax efficiency should never be the main reason for buying an investment. Start with the right asset mix for your risk tolerance and investing goals, then look for tax efficiencies.
File for free
You don’t have to pay for tax software to use the NETFILE service. The Canada Revenue Agency lists several online programs that are 100% free and certified to work properly with its systems (see cra-arc.gc.ca).
Refunds are great. And looking forward to a small reward is a great way to help make doing your taxes less painful. Of course, the smartest way to use your tax refund is to reinvest it into your RRSP or use it to pay down your mortgage. However, if can’t resist using that refund on a big splurge, at least be sure you’re spending it on something memorable.
Look ahead to next year
A little bit of tax planning goes a long way. For starters, keep abreast of your taxable income for the year and estimate what it will be in future. As long as you’re not in the same tax bracket throughout your life, you have some ability to take income and use deductions at specific times. Say you’re temporarily earning a low income because you’re on parental leave or taking a sabbatical. You may not want to make an RRSP contribution or claim other deductions this year because you won’t save much in taxes. But it may be a good time to take income from another source (such as a dividend from a family business), since you’ll be in a low tax bracket. If you’re early in your career and expect to earn much more in the future, it may be better to hold off on RRSPs until you’re in a higher tax bracket. (TFSAs for lower-income earners definitely make more sense than RRSPs). Finally, whatever income you earn, having a basic financial plan can help you stay on track and ensure you’re always one step ahead of the taxman.