|Tax Planning & Advice|
Your tax bill is likely your single biggest expense, year in and year out. (Unless you’re prone to buying large yachts and tropical islands, of course.)
Here are a few hints about how to legitimately reduce your tax returns:
Income Splitting: It is Legal and It is Profitable!
Essentially, income splitting involves trying to balance out the amount of money the various members in your family make. Although the numbers don’t work in every situation, this can often cut a household’s tax bill because of the effect of different tax brackets.
For example, a household where one person makes a good deal of money and the other person makes very little may pay a much larger total sum to Revenue Canada than a household where both partners have modest incomes. In this case, the goal of income splitting is to simply move some income out of the hands of the person in the higher tax bracket and into the hands of the person in the lower tax bracket.
How Your Investments Are Taxed
What makes things more complicated is that the tax you pay varies with the type of investment. This can have a great impact on your after–tax return, as well as how you arrange your portfolio. (Note that you don’t have to pay any tax on gains earned by money in a tax–sheltered accounts such as an RRSP, RRIF or RESP until you make a withdrawal.)
The most heavily taxed type of investments are those that earn you interest income, such as GICs or CSBs. Stocks, real estate, and other investments that entail more risk but have the potential for higher returns in the form of capital gains are taxed less. Dividends from Canadian corporations have the lowest effective tax rate.
Here is how you are taxed on
Here are the approximate effective tax rates on capital gains for the different tax brackets (subject to change):
The next step is designed to give you a credit for the amount of tax it’s assumed the company has already paid on that income. This is done by taking two thirds of the amount of the 25 per cent gross–up from the step above. The result is you receive a tax credit worth 13.33 per cent of the inflated figure for dividend income you put down on your tax return. This tax credit is actually worth in the neighbourhood of another 50 per cent, because the reduced federal tax will mean a reduction in your provincial tax as well.
Here’s a look at what this means in terms of the tax rate you’ll pay after the number crunching is done (subject to change).
The different tax rates on investments makes it difficult to compare your investment options. Investment A may look like it pays a lot more than Investment B, but your after–tax rate of returns may mean that B is your best bet.
For those trying to compare different income opportunities, there is an easy trick that allows you to quickly compare dividend and interest investment options. To find the interest rate you would have to get to make the same after–tax return on a dividend–paying investment, multiply the dividend yield by 1.3. For example, say you were looking at a preferred share offering that paid a 6 per cent dividend. To make the same amount after tax, you would have to find a GIC or other interest–bearing investment paying around 8 per cent (To be exact, 1.3 x 6 per cent, or 7.8 per cent).
Self Employed? Let’s Talk Tax
This can be a mistake, and can cause you some entanglements at tax time. It doesn’t matter what you call yourself. In order to file a return as a self–employed person, you must meet Revenue Canada’s requirements. If you don’t, you’ll be treated as an employee, and your self–employed tax planning efforts will go to waste.
Preparing Your Tax Return: Calling in the Hired Help
A competent financial advisor will be able to do much more than simply add the numbers together correctly. They will be able to point out money–saving moves you may have missed, as well as suggest planning strategies you can use to cut your taxes down in the future. Hiring help can also reduce your chances of being audited because of mistakes you might otherwise make.
However, you will incur no cost if the tax advice given is relative to your purchase of mutual funds, for retirement, education or other form of investment planning, through MoneyWI$E Financial Inc.
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