$trategies Newsletter

 
Accountants & Tax Advisors

 V3.2  April, 2011

       

 


 
 
In this issue:

- Prepare for 2010 taxes

- Tax advantages of small business

Tax $trategies for 2011 

Personal Income Tax

   

 

                                 
                                 
  It is the time of year when I get to talk to all of my clients at least once during the next thirty days. One of the most common questions that I hear ... apart from, "when is it going to be spring?", is how can I pay less tax next year?      
                                 
  Well, there are a few great ways but they take a long time to develop.      
                                 
                                 
   The number one way to pay less tax is to contribute to your RRSP. Sure, you already know about RRSPs ... but I can show you how to realize an average 30% yearly return on an investment that only pays 8% annually. Now that I have your attention ... read on!      
                                     
  In the example below I am assuming that the taxpayer has carefully chosen her investments, decided how much to invest every year and then arranged to contribute 1/12 of that amount monthly ... automatically.  One key to successful RRSP investing is to invest monthly by automatic withdrawal or transfer because it is efficient to have a regular savings plan: you can't try to time the market and ... you won't miss the money.        
           
  The great thing about RRSPs is that you will save 100% of all tax payable on the amount that you contribute. The contribution reduces your income, dollar for dollar and saves the tax at whatever rate you would have otherwise paid.

     For example: you earn $55,000 yearly and pay tax at 32%.
          If you do not contribute to your RRSP you will pay $320 on the last $1,000 that you earn.
          If you contribute $1,000 you save $320 in income tax.

     Now, a lesson in RRSP magic!
 

     
      The real magic of RRSPs occurs if you do not spend the refund or tax saved. Instead, contribute it to your RRSP immediately.

If you contribute the $320 saved in the example above you will save a further $102.40 in the second year. In fact, if you only reinvest the refund or tax saved each year by contributing that amount and earn an average 8% return each year, you will have $3,067.94 after 10 years. That is 300% growth in 10 years or an average of 30% per year.  This, of course, is all legal, low risk and tax sheltered.  Plus you have saved a total of $470 income tax along the way.

     
                                     
                                     
   The number two way to pay less tax is to acquire assets that gain value over time and when you sell them, the capital gain is exempt from income taxes.      
                                     
  This first strategy I will call "keeping your money under your mattress". Literally. Investing in a home. Historically, over time, homes have been the most reliable and best growth investments available to the average person. Tax wise, generally, when you sell your home the capital gain is not taxable, because of the "principal residence" exemption.

The next strategy is to use your Tax Free Savings Account (TFSA) when you strongly believe that a particular investment will create a substantial return and trigger a great deal of tax. Similar in behaviour to an RRSP, the TFSA shelters growth within the savings account. How it differs, though, in that the money that you deposit to the TFSA is not a deduction for income tax purposes but, and this is the good part, it is not taxed when you withdraw it. Contributions to an RRSP grow tax deferred until you withdraw funds, then, regardless of the nature of the growth it is taxed as ordinary income.

The number three way to pay less tax is to invest in products that yield dividends or capital gains rather than interest income. The top marginal tax rate on interest income is 39%, but on dividends it is 17%-27% and on capital gains it is 19.5%.

The number four way to pay less tax is simply to have me arrange for you to pay no tax at all.  Yes, I can give you a rock-solid promise that I have devised a simple, legitimate strategy where I can eliminate absolutely all tax payable. I call it my "Off-Shore" tax haven strategy. Firstly, we calculate your EBITA (earnings before interest, tax and amortization), then we develop a reasonable capital replacement allowance ... and finally, I bill you to the extent of any remaining profit and then Judith and I take your money Off-Shore for a holiday to St. Maarten in the Caribbean.

     
                                     
  2010 Tax Tips: How tax works

The primary purpose of taxation is to raise funds to meet the financial commitments of the government who executes the wishes of the electorate.

The primary purpose sounds lofty .. and in fact is. It's what makes Canada a great country and equal to or better than any other country in the world in terms of leadership, freedom, opportunity and world citizenship. In spite of that, taxation, the way it is done in Canada and the US has had its detractors. 

Famous people have commented on income tax over the years. Very few of them have had anything good to say about the subject. But, while we revel in the knowledge that this wonderful, safe, rich and progressive country is the most coveted in the world ... let's review some "taxation" comments.

"The hardest thing in the world to understand is the income tax." Albert Einstein:

"Taxes, after all, are dues that we pay for the privileges of membership in an organized society."  Franklin D. Roosevelt:

"The Income Tax War Bill will be a temporary measure". Sir Thomas White, Minister of Finance, Canadian Parliament, 1917.
 

Income Splitting to reduce family tax.

1) Income Splitting with Spouses:

Special rules called attribution rules will prevent the higher income spouse from lending or giving money or other property to the lower income spouse to take advantage of the lower income spouse's lower tax rate.  However, if property is transferred at fair market value then the lower income spouse can claim the income without being caught by the attribution rules. We can help you arrange such a transaction.

 

2) Transfer capital losses to a spouse with a capital gain.

Very technical and complex so don't try this at home.

3) Joint Line of credit.

Where the LOC is used to acquire investments in one spouses name ... could be very complex due to attribution rules.

4) RRSP spousal contributions.

5) Pension Splitting : split pensions from employer pensions at any age and from RRIF accounts after age 65.

6) Loans / Transfers to minor Children:
     - RESP contributions
     - no capital gains attribution on property transferred to children.
     - no attribution on second generation income.

7) Interest free loans to children used to generate active business income will not fall under the attribution rules.

8) The FAMILY TRUST.
     - Funds contributed to a trust set up for minors may be used to purchase shares on an exchange and the capital gains are not attributed back to the contributor (settlor).

9) Salaries paid by a small business to family members. The CRA position is that amounts paid must be "reasonable".  If a spouse, adult child or minor child is actually performing work for the business and the work is documented, it may be reasonable.

10) Income splitting through a corporation. Estate Freeze.

 

Ideas to mark on your calendar

1) Open a TFSA, contribute to it and then acquire that next great stock inside of your TFSA. Also, contribute to your RRSP by February 28, 2012.

2) Arrange a loan to a spouse to split income from investments (inter-family loan) . The CCRA prescribed rate (the rate of interest your spouse will pay you for the loan) is 1% so if the income exceeds that percentage the income split will save the family tax. If you have already set up an inter-family loan the interest must be paid by January 30, 2012.

3) Review your portfolio for tax loss selling. Carry a current loss back up to three years and recover tax paid on capital gains.

4) Pay medical expenses, charitable donations, professional membership fees, support amounts, political contributions, deductible legal fees, among other before December 31 to claim the tax credit or deduction.

5) If you turn 71 in 2010 and own RRSPs and must wind up the RRSPs you only have until December 31, 2010 to make your final contribution.

6) Catch up on deficient income tax instalments.

7) Amend your 2009 tax return to claim any Home Renovation Tax Credit amounts you may have missed.

8) First time home buyers: don't forget the $750.00 tax credit if you qualify.

9) Repay your business shareholders' loan with the inheritance or winnings.

10) Pay yourself a retiring allowance from your small business. In certain circumstances you may pay yourself a sometimes large amount that can be contributed to your RRSP without affecting your usual RRSP contribution room.

 

New for 2010:

- The medical expense tax credit is no longer available for cosmetic procedures (Mar 4, 2010)

- Shared custody arrangements can see the Canada Child Tax Benefit and the Universal Child Care Benefits amounts split between the two parents.

- Universal Child Care Benefit may be claimed by the dependant for whom an eligible dependant credit is claimed (or for whom the UCCB is received).

- Rollover of a deceased individuals' RRSP/RRIF or RPP proceeds to the DRSP ( Registered Disability Savings Plan) of a financially dependant inform child or grandchild.

 

Some tax fundamentals

1) Marginal tax rate: your income is taxed incrementally at different rates. In Alberta we pay taxes as follows (2011)

                   Employment income                 Capital Gains                   Eligible dividends        Non-eligible dividends
                    including interest                                                       listed corporations       most small business corp

First $41,544           25.00%                            12.50%                          -2.02%                         10.21%

$41,544 to $ 83,088 32.00%                            16.00%                            7.85%                        18.96%

$83,088 to $128,000 36.00%                            18.00%                          13.49%                         23.96%

Over $128,000         39.00%                            19.50%                          17.72%                        27.71%

 

Income deductions v tax credits:

An income deduction is a direct reduction in income saving tax at your marginal rate. A tax credit is a subtraction of taxes. For example, your RRSP contribution is an income deduction so if you pay taxes at the top rate of 39% your $10,000 RRSP contribution will save $3,900 in tax.  If you otherwise spend $10,000 on medical costs you will receive a tax credit for part of the 10k and your tax saving will be $784.00. However, had you made a charitable donation of $10,000 your tax savings would be $4,363.

 

Tax advantages of having a small business:

So, what is a "business"?

A "business" exists when something of value is traded for something else of value in a commercial sense. Generally, small businesses start at home. I had a client in Saskatchewan who built a portable greenhouse for his mother. Then a neighbour wanted one, then a relative, then the relative's friend, then the RCMP were driving by and thought the portable greenhouse was a great idea for an emergency shelter and a crime scene cover. Within a year he had orders for $200,000 worth of the shelters from the RCMP. The following year he licensed a US military supplier to manufacture them.

The point here is not the success of the home business ... but the legitimacy. If you bake at home and sell it you have a home business. If you fix lawnmowers and get paid in cash or barter the value, you are in business. Do you build decks for a paid hobby? Paint? Clean houses? Pet sit? Sell on E-Bay, have commercial garage sales?  If so, you have a business and are entitled to deduct all the related expenses: proportional home office (mortgage interest, property taxes, insurance, maintenance and repairs), and business use of vehicle costs, to start with! And if the expenses exceed the revenue you may be entitled to claim the surplus amounts against other income: employment or investment.

Yes, if you have a small business you can claim expenses like Donald Trump does.

What is an investment under post-2008 correction rules?
My experience tells me that successful investors do more than "expect" and "hope" for favourable returns. Successful investors, firstly, have a:

1) BUYING STRATEGY:
   
Successful investors don't simply buy everything under the sun ... nor do they attempt to "time" the market. Most successful investors  systematically invest on a fairly regular basis; ex. 10% of their income monthly, yearly, etc. They choose an investment vehicle that they like and understand and go in for the long term: stocks, mutual funds, precious metals and real estate to identify a few common examples.

2) SELLING STRATEGY:
    Successful investors sell when the time is right and minimize income taxes. For example, if a client owns investments in both RRSP  and non-registered accounts she will sell when the cash in needed and when tax is minimized. Invading the RRSP account triggers tax at the person's marginal tax rate ... as "ordinary income". Invading the non-registered account will only trigger tax on the capital gain, if any. Investing in non-registered accounts is not usually recommended for people who are paying tax at a high rate and who have RRSP contribution room available. 

3) REBALANCING STRATEGY:
    Successful investors often balance their portfolio risk between several categories of investments: stocks, bonds, mutual finds, real estate, technology, emerging markets ... to name a few. They will allocate a percentage of their total portfolio to each or some of the various categories and over time keep their portfolio balanced between the categories despite gains or losses. Yes, this strategy will limit gains, but also limit losses.

4) STOPLOSS:
    Lastly, for purposes of developing some generic rules, an investment should have an integral strategy for limiting losses. Simplified, a "stoploss" is a mechanism that kicks in to liquidate an investment if its market price drops below a certain point. Many investors chose a percentage, such as between 15 and 25%. An illustration of the usefulness of a stoploss can be seen in the example of the Nortel roller coaster of the last 14 years.  Once the darling of the TSE (now TSX), Nortel has been a volatile stock that, in my mind, has not qualified as an investment since October of 2000. The stock's price during the period from January 2000 to December, 2009 varied from $122.00 to 19 cents.

Imagine that you acquired this stock in 1995 because you were looking at a promising technology investment ... buying 100 shares in January of 1995 for $2,300. The stock split 2 for 1 in 1998 and again in 1999 and again in early 2000. By August of 2000 Rip Van Winkle would have stock worth $121,900 ... a tidy gain of nearly $119,000 or 5,300 percent. If Mr. Van Winkle had placed a 20% decline stop loss order with his advisor he would have sold his portfolio in mid September 2000 for about $97,000 locking in a 4,200% gain. Truth is though that thousands of his colleagues held the stock through its decline to $0.87 ($87.00 total market value).

Nortel Historical Stock Prices:            $  23.00   in Jan   of  1995 (before 3, 2-for-1 stock splits)
                                                      $122.00   in Sept  of  2000
                                                      $  00.87   in June of  2002
                                                      $  00.19  on June 19, 2009 (after a 1-for10 reverse stock split)

It is true that many of us are struggling to recover the losses of the last few years ... but prudent portfolio management is the solution ... not taking more chances. So, develop an investment strategy ... and leave "playing the stock market" to the independently wealthy and those people with good, solid "defined benefit" pensions.

 

 

 

   

     
                                     
 

INVESTING $trategies

Much has changed since the so-called "2008 market correction", but have we "corrected" the way we think about investing?

What is an investment?
InvestorWorlds.com tells us that an investment is"... the purchase of a financial product or other item of value with the expectation of favourable future returns ... or in general terms, the use of money in the hope of making more money..."  Well, no wonder the portfolio "haircut" occurred three years ago. Do we simply invest "expecting" or "hoping" to earn favourable returns ... or do we follow rules and qualifiers that help us to earn favourable returns.

 

 

     
                                     
                                     
        10 Year Performance Table                    
          Contribution Tax Saved Growth RRSP end ot the year                    
        Year 0 1,000.00 320.00 0 1,000.00                    
        Year 1 320.00 102.40 80.00 1,400.00                    
        Year 2 102.40 32.77 112.00 1,614.40                    
        Year 3 32.77 10.49 129.15 1,776.32                    
        Year 4 10.49 3.36 142.11 1,928.91                    
        Year 5 3.36 1.07 154.31 2,086.58                    
        Year 6 1.07 .34 166.93 2,254.58                    
        Year 7 .34 .11 180.37 2,435.29                    
        Year 8 .11 .04 194.82 2,630.22                    
        Year 9 .04 .01 210.42 2,840.68                    
        Year 10 .01 0 227.25 3,067.94                    
         
                                 
             
           
               
               
         

Itís that time of year again.  Please gather all of your  2010 tax information and bring or send it to us early so that we have time to plan your tax return to maximize tax savings.

I have prepared a comprehensive tax information checklist at http://www.gmoberly.ca/MOCO%20T1%20Interview.htm that may be helpful.

Best regards,

Grant Moberly, CGA

         
               
               
               
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