As year-end approaches, taking some time to review your financial affairs may yield significant tax savings. To ensure that you leave no stone unturned, here’s a summary of some common year-end tax planning strategies.
Any reference to a spouse in this article also includes a common-law partner.
Tax loss selling
If you have realized capital gains during the year, and you’re holding securities with unrealized losses, consider selling those securities to realize the losses. This strategy of selling securities at a loss to offset capital gains realized during the year is a year-end tax planning technique commonly known as “tax loss selling.” Review your portfolio with your RBC advisor to determine if any investments are in a loss position and no longer meet your investment objectives. Consider all costs, including transaction costs, before selling investments solely for the purpose of triggering the tax loss.
When disposing of a security, the sale for Canadian tax purposes will be deemed to have taken place on the settlement date. Assuming a two-day settlement period, in order to utilize the tax loss selling strategy for the 2021 tax year, transactions must be initiated by December 29, 2021, for both Canadian and U.S. securities in order to settle during 2021. Canadian and U.S. option transactions have a one-day settlement; therefore, option transactions must be initiated by December 30, 2021, to ensure a 2021 settlement. Check with your RBC advisor for mutual fund settlement dates.
Superficial loss rules
If the investment still has strong fundamentals and meets your investment needs, you may be thinking of selling the investment to trigger the loss, then repurchasing the security. However, in order to ensure your capital loss can be claimed, you should be aware of the superficial loss rules. A superficial loss will occur when a security is sold at a loss and both of the following occur:
- During the period that begins 30 days before and ends 30 days after the settlement date of the disposition, you or a person affiliated with you (i.e., your spouse, a company controlled by you and/or your spouse, or a trust in which you and/or your spouse are a majority interest beneficiary) acquires property that is identical to the property that was sold at a loss.
and
- At the end of that period (i.e., on the 30th day after the settlement date of the disposition), you or a person affiliated with you owns or has a right to acquire the identical property.
You need to consider your holdings across all accounts when determining if the superficial loss rules apply. For example, if you purchase mutual funds on a pre-authorized contribution plan, be sure to check all of your accounts to make sure you’re not buying the same mutual fund you’re selling (in a different account, perhaps) for tax loss purposes within the 61 days that may trigger a superficial loss.
Carrying forward and carrying back capital losses
A capital loss must first be applied against any capital gains (including capital gain distributions from mutual funds) you realize in the current year. Once the capital gains of the current year have been offset, the balance of the loss can be either carried back three years (to capital gains realized in 2018, 2019 and/or 2020) or carried forward indefinitely to offset future years’ capital gains. When you carry back a net capital loss to a previous year’s taxable capital gain, it will reduce your taxable income for that previous year. This reduction may result in a refund of previously paid taxes. However, your net income, which is used to calculate certain credits and benefits, such as old age security (OAS), will not change. This is the last year in which you can carry back your losses to 2018 and offset them against your 2018 capital gains.
If you plan on triggering a capital loss in a corporation, you should speak to your qualified tax advisor, as it may be advantageous to pay out a capital dividend if your capital dividend account is positive, prior to triggering the loss.
Capital gains deferral
As we approach the end of 2021, if you currently have unrealized capital gains, you may want to consider deferring the realization of capital gains until 2022 for the following reasons:
- Your marginal tax rate may be lower in 2022 than in 2021;
- Realizing capital gains at the end of this year means that any tax payable associated with the gains would have to be remitted to the Canada Revenue Agency (CRA) by May 2, 2022. Realizing capital gains at the beginning of 2022 means that any tax payable would not have to be paid until May 1, 2023 (unless you’re required to make tax instalments); and,
- If you have net capital losses in 2021, you can carry back those losses against previously realized capital gains in 2018, 2019 and/or 2020. However, before losses can be carried back, they must first be used to offset capital gains in the current year. Therefore, realizing capital gains at the end of 2021 would reduce the amount of capital losses you could carry back.
As always, the investment merits of deferring the sale of a security to the following year must be considered first, before looking at the potential tax benefit.
Year-end bonus planning
Receiving a bonus prior to year-end creates additional registered retirement savings plan (RRSP) contribution room for 2022 if you’ve not yet reached the maximum 2022 RRSP limit. Furthermore, receiving a bonus prior to year-end may also allow greater employee/employer pension contributions and/or employee profit sharing plan contributions for 2022, if these contributions are based on the prior year’s total compensation.
On the other hand, if you expect to be in a lower tax bracket next year, consider deferring the receipt of your bonus (if your employer permits) to early 2022.
If the bonus is paid directly to you, there will be withholding taxes at source on the bonus payment. However, if your employer permits, some or all of the withholding taxes on the bonus may not have to be withheld, if the bonus or a portion of the bonus is transferred directly to your RRSP. You must have adequate unused RRSP contribution room in the year of transfer.
Low-income year
If you expect to be in a low marginal tax bracket for 2021 and expect to be in a higher marginal tax bracket in retirement, you may want to consider making an early withdrawal from your RRSP before year-end. The advantage of this strategy is that you can avoid a higher tax rate on these RRSP funds if withdrawn in the future when your marginal tax rate may be higher.
If you have contribution room, consider reinvesting the RRSP funds withdrawn in your tax-free savings account (TFSA) so that you do not pay any future tax on the income earned or capital gains realized in the TFSA. If you don’t have TFSA room, you can reinvest the RRSP funds withdrawn in your non-registered account. Consider the type of income you will earn in the non-registered account, as you may be able to take advantage of the preferred income tax treatment on capital gains, Canadian dividends and return of capital. The drawbacks of this strategy is a prepayment of income tax and lost tax deferral on the growth of the RRSP funds withdrawn.
Tax instalments
If you’re required to make quarterly tax instalment payments to the CRA, you should make your final payment on or before December 15, 2021, to avoid late interest charges. If you missed an earlier instalment payment deadline, you may want to consider making a larger final instalment payment or making your final instalment payment earlier than the December 15, 2021 deadline to minimize late interest charges.
You may have the opportunity to reduce or defer your tax instalment liability by switching the method you use to calculate your instalments. For example, it may be more advantageous to base your instalments on the current year’s estimated taxes, rather than on taxes owing for the prior year. However, you must be careful when paying less than the amount indicated on the CRA tax instalment statements. If you underestimate your tax instalments for the current year, you may be subject to interest and penalties for not paying the full amount that’s indicated on the CRA tax instalment reminder statements.
Charitable donations
Making a charitable donation is one of the ways you can significantly reduce the personal tax you pay. The final day to make contributions to a registered charity in order to claim the donation tax receipt on your 2021 income tax return is December 31, 2021.
As an alternative to cash, you can also donate publicly listed securities in-kind to qualified charities without being subject to tax on the realized capital gain. You will receive a donation tax receipt equal to the fair market value of the security at the time of the donation, which can help reduce your total taxes payable.
If you plan on donating securities in-kind, the transfer must take place before year-end, so ensure you start this process well in advance to allow for processing and settlement time, typically at least five business days. Also, be sure to verify that the charity is willing to accept such in-kind donations.
TFSA contributions
If you have not yet done so, you can make your TFSA contribution for 2021 (up to $6,000) and catch up on any unused contribution room from previous years. The TFSA enables you to earn tax-free investment income, including interest, dividends and capital gains, which may result in greater growth compared to a regular taxable account. You can make tax-free withdrawals at any time, for any reason, and any amount you withdraw is added back to your available contribution room on January 1 of the following year. If you’re thinking of making a withdrawal from your TFSA in the near-term, consider doing so before December 31. This will allow you to recontribute the amount withdrawn as early as January 1, 2022, rather than having to wait until 2023 to recontribute.
RRSP contributions
You have until March 1, 2022, to make a contribution to your RRSP or a spousal RRSP in order to be able to deduct the amount on your 2021 tax return. However, if you have contribution room, contributing to your RRSP early (i.e., before December 31, 2021) may help maximize the tax-deferred growth in your plan, which may increase your savings for retirement.
RRSP contributions if you’re turning 71
An RRSP must mature by December 31 in the year you turn age 71. On maturity, you must withdraw the funds, transfer them to a RRIF or use them to purchase an annuity. You will not be able to make any further contributions to your own RRSP after this date.
If you’re turning age 71 in 2021 and have earned income for the year, consider making one last RRSP contribution based on your 2021 earned income before your RRSP matures. Otherwise, this RRSP contribution room is likely to be lost, unless you have a spouse who’s under age 71.
You will want to consider making this early contribution (sometimes called the “forgotten RRSP contribution”) close to year-end. This is because your 2022 contribution room (based on your 2021 earned income) is not available until January 1, 2022. Therefore, assuming you’ve already made the maximum RRSP contributions based on your existing room, this contribution will be considered an excess contribution from when it’s made until January 1, 2022. You will be subject to an over-contribution tax of 1% of the excess amount per month. By making this contribution later in the year, you can minimize the over-contribution tax. On January 1, 2022, your new contribution room, based on your previous year’s earned income, will absorb the over-contribution.
For example, if your RRSP contribution limit for 2022 will be $29,210, you may want to contribute this amount to your RRSP in December 2021. You will have the over-contribution tax of approximately $272.1 (1% of ($29,210 - $2,000)), taking into account your allowable lifetime over-contribution limit of $2,000. However, your tax deduction for your RRSP contribution on your 2022 tax return, combined with the benefit of tax-deferral and compounding growth in the RRIF, should outweigh the penalty. Speak to your qualified tax advisor if you’re considering this strategy.
If you have a younger spouse, consider making the contribution to a spousal RRSP in 2022; this still allows you to use your RRSP contribution room and you will not be subject to the over-contribution tax. In addition, if you continue to earn RRSP contribution room, you can continue to make spousal RRSP contributions until the end of the year in which your spouse turns age 71.
RESP contributions
A registered education savings plan (RESP) is a way to save for a child’s or grandchild’s post-secondary education and can also be used as an income splitting vehicle. The lifetime contribution limit is $50,000 per beneficiary and there is no annual contribution limit.
By making RESP contributions, you may be eligible to receive the Canada Education Savings Grant (CESG). The government will match 20% of the first $2,500 in annual contributions to a maximum grant of $500 ($2,500 x 20%) per beneficiary, per year. Each beneficiary can receive a lifetime maximum of $7,200 in CESG. Consider contributing to the RESP by December 31 if you haven’t maximized your contributions to take advantage of tax-deferred growth in the RESP.
The income earned on the CESG and the contributions within the RESP can be taxed in your child’s or grandchild’s hands, who likely has a lower marginal tax rate than you, when paid out to them.
Capital gains realized in a trust
If a trust is properly structured, capital gains realized by the trust may be allocated to a minor beneficiary and taxed in their hands, generally, with little or no taxes payable. Individuals, including minor children, with no other taxable income can realize around $20,000 of capital gains tax-free each year due to their basic personal exemption. The amount varies by your province or territory of residence.
Timing of mutual fund purchases
When you purchase a mutual fund partway through the year, you purchase the fund at its net asset value, which includes any accumulated income and gains that have not yet been distributed. When the fund makes a distribution, the distribution includes these accumulated earnings and the distribution is fully taxable, even though you purchased the accumulated earnings with your after-tax dollars.
There are ways to avoid the distribution. For new purchases, you could simply purchase the fund after the distribution date. This way, you purchase the fund without any accumulated income and gains.
If you’ve already purchased the fund, consider selling the fund prior to the distribution date. Before selling, you should first consider the size of the potential distribution and the resulting tax liability. It is important for you to determine how much you’ll save by avoiding the receipt of this distribution in comparison to the costs that a sale could trigger (e.g., redemption fees, capital gains).
Tax shelters
You may consider purchasing a tax shelter such as limited partnership units or flow-through shares before year-end in order to be able to claim tax deductions. A tax shelter is generally structured so that the expenses incurred by the tax shelter in the first few years are flowed directly to you so that you may deduct them against any of your taxable income.
The investment potential of the tax shelter and not just the initial tax savings should be considered when deciding whether it is a suitable investment.
Moving within Canada
Tax rates may vary significantly by province or territory. For example, combined with the federal rate, the top marginal tax rate in Nunavut is 44.5% and the top combined rate in Nova Scotia is 54.0%. Since you are generally subject to tax based on your province or territory of residence on December 31, if you’re moving to a province or territory with a lower tax rate, consider moving prior to year-end. If you’re moving to a province or territory with a higher tax rate, consider delaying your move until early 2022.
Interest on family loans
If you set up a spousal loan or funded a family trust with a prescribed rate loan, remember to pay the interest owing by January 30, 2022. The borrower may be able to claim a deduction for the interest paid on their tax return. The lender will have an income inclusion on their tax return.
Year-end expenses
Generally, you can deduct or claim a credit for certain expenses you paid in the year on your personal income tax return. Therefore, remember to pay all eligible investment management fees, tuition fees, deductible accounting and legal fees, childcare expenses, alimony, medical expenses and any business expenses (if deductible on your personal tax return) by December 31, if it’s your intention to deduct or claim them on your 2021 tax return.
Re-filing your tax waiver
If you normally file a tax waiver (CRA Form T1213 Request to Reduce Tax Deductions at Source) to have your employer reduce taxes withheld at source from your pay, don’t forget to re-file this form, as it may need to be submitted and approved by the CRA annually. If you have not filed this form in the past, consider doing so if you normally receive a tax refund when you file your tax return. This will allow you to have more cash flow during the year to accomplish various financial goals such as making monthly RRSP contributions, making additional mortgage payments, or reducing or eliminating other personal loans or credit card debt.\
The CRA will normally approve the tax waiver for individuals who expect the following types of deductions: RRSP contributions, alimony payments, carrying charges, childcare expenses and employment expenses, among others. Approval of the tax waiver by the CRA usually takes about six weeks; therefore, for the 2022 tax year, you should start applying in late October or early November of 2021.
Tax planning for business owners
If you own a business, you may want to consider the following strategies.
Consider an individual pension plan (IPP)
If your business is incorporated, as a shareholder and an employee of your business, you have the option of considering an IPP as a method of saving for retirement. An IPP is a defined benefit registered pension plan, similar to many large company sponsored plans, except it is established and sponsored by your company. IPPs generally have only one plan member; however, certain family members may also participate if they are employees of the company.
In order to establish a plan, you must receive employment income from your company which is reported on a T4 slip. An IPP is usually most suitable for those who have significant employment income and are at least 40 years of age.
If your company is incorporated and you’re looking for both year-end corporate income tax deductions and a structured retirement savings plan for yourself, consider speaking with your RBC advisor about establishing an IPP.
Pay salaries before year-end
If you operate your own business, consider paying additional salary or bonus to yourself, and reasonable salaries to family members who work in the business, before year-end. This year-end payment constitutes earned income, which may create RRSP contribution room for the following year. The payment will also give your business a tax deduction. The salary paid must be reasonable based on the services performed by your family member. A good rule of thumb is to pay your family member what you would pay someone who isn’t related to you for the work performed in the business.
Declare bonuses before year-end
If your business is incorporated and you want to decrease corporate income without increasing your personal income in the current tax year, consider declaring a bonus before the end of your corporation’s tax year, and pay the amount before 180 days after the corporation’s year-end. This will ensure your business will get a corporate deduction for the current year.
Shareholder loans
If your business is incorporated and the corporation loaned you money, ensure the loan is repaid before the end of the corporation’s tax year after the year the loan was granted to avoid having to include the value of the loan as income on your personal tax return.
Purchase assets for your business
If you intend on purchasing assets for your business (i.e., a computer, furniture, equipment, etc.), consider making this purchase before year-end. If the asset is available for use, this year-end purchase will allow your business to deduct capital cost allowance (CCA) which represents depreciation on the asset for tax purposes. For most assets, half of the regular allowable CCA can be claimed for tax purposes in the first year of an asset purchase, regardless of when it was actually purchased during the year.
Conclusion
This article covers some common individual and small business tax planning strategies that you may want to consider before year-end. Speak with your qualified tax advisor to determine if any of these strategies are suitable for you in your circumstances.
This article may contain strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal, tax or insurance advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified tax, legal and/or insurance advisor before acting on any of the information in this article.