Tax Minimization Strategies

The adage that nothing is certain but death and taxes is actually not quite correct. Death remains everyone’s destiny, but some taxes can be postponed for one’s entire life or shifted beyond one’s life to people in whose hands actual amounts payable to government may be negligible. Taxes can also be minimized by investments that postpone amounts payable, investments in assets that have relatively low tax rates, income splitting with a spouse or children, and changes in the nature of income or how business is organized. What is required to achieve these tax savings is careful control of investments, employment income, and bonuses in order to achieve income averaging where possible and, for investments, cash flow shifting where it is lawful. None of the following discussion of tax management presumes or suggests actions that are not in compliance with Canadian tax law.

Let’s look at tax management for the individual taxpayer with a list of the easiest things almost anyone can do to cut a tax bill:

  1. Use RRSP space to reduce current taxes.
  2. Use a spousal plan to split RRSP income.
  3. Average CPP benefits.
  4. Split income with children through a Registered Education Savings Plan.
  5. Have the higher income spouse pay household expenses.
  6. Employ spouse or children.
  7. Loan money to a lower-income spouse to make an investment.
  8. Create a corporation to carry on an active business.
  9. Blend interest into the sale price of an asset.
  10. Reinvest interest income in common stock or preferred shares...
  11. Use life insurance to convert a growing body of money into the property of family members.
  12. Invest in devices, such as tax-efficient mutual funds or natural resource income trusts...
  13. Buy convertible bonds that allow a switch from income producing interest coupons to common shares...
  14. Make sure children with earned income file a tax return.
  15. Claim medical expenses proficiently.
  16. Make a vow of perpetual poverty.
  17. Split pension income with your spouse or common-law partner.
  18. Save receipts for your children's physical activity programs.
  19. Realize losses to offset gains.
  20. Contribute to a Tax-Free Savings Account.
  21. Gift public company shares to a charity.
  22. Registered Disability Savings Plan.

1. Use RRSP space to reduce current taxes.. For individuals who are members of pension plans, their RRSP limit is reduced by a pension adjustment. RRSPs have the effect of deferring income until money is paid out of the RRSP either as a lump sum, an annuity, or as payments from a Registered Retirement Income Fund. While investment income generated inside an RRSP grows with no taxation, all tax preferences on capital gains and dividends are cancelled when the money is paid out as ordinary income at full tax rates.
Back to the List

2. Use a spousal plan to split RRSP income. The most common strategy is to contribute a part of one’s annual RRSP limit to a spousal plan. If the receiving spouse is likely to have a lifetime income appreciably less than that of the giving spouse, then there are two vital results. First, the spouse will wind up with a significant amount of wealth which, when taken out of the RRSP in a RRIF or annuity, will be taxed at a lower rate than if no transfer had been done. Second, the spousal RRSP split may enable the family to preserve the full amount of Old Age Security payments that are subject to clawback.
Back to the List

3. Share CPP benefits. Spouses or common-law partners, who are both at least 60 years old, and who receive CPP retirement pensions can share their pension benefits. This may result in tax savings. If only one of you is a CPP contributor, you share that one pension. The overall benefits paid do not increase or decrease with pension sharing.
Back to the List

4. Split income with children through a Registered Education Savings Plan. Children can be part of splitting strategies too. If a parent contributes to a Registered Education Savings Plan, there is no tax deduction, but income earned within the RESP grows without tax until withdrawals are made, at which time the income withdrawn is taxed in the hands of the child who is pursuing post-secondary education. This strategy effectively splits income into a student's lower tax bracket. Note that the Canada Education Savings Grant of at least 20% of amount contributed each year is also taxed in the hands of the post-secondary student. If the child - or grandchild for that matter - fails to pursue post-secondary education by age 21, up to $50,000 of the income portion of RESP funds can be transferred to the RRSP of the contributor provided that the RESP has been in operation for 10 years or more.
Back to the List

5. Have the higher income spouse pay household expenses. The higher income spouse can also pay the income taxes of the lower income spouse. Since the amount paid on behalf of the lower income spouse is not invested (it goes directly to the government), there is no need to attribute any income back to the paying spouse. The lower income spouse can then invest the amount of tax saved.
Back to the List

6. Employ spouse or children. A person with a business can employ a spouse or children and pay them wages or salaries appropriate to the work they do. The pay must be reasonable in terms of what they do for the business. There is some flexibility in this, but it is unlikely that paying a five-figure salary to a six year old to lick envelopes would pass muster. It is unwise to be very aggressive in making use of this form of income splitting.
Back to the List

7. Loan money to a lower-income spouse to make an investment. This strategy will work provided that the spouse borrowing the money pays interest of at least the rate prescribed by the Canada Revenue Agency or, if it is less, the going commercial rate. If no interest is charged, then attribution rules may be triggered and wind up taxing the proceeds of investment in the hands of the spouse making the loan.
Back to the List

8. Create a corporation to carry on an active business. Manitoba small businesses have a preferential tax rate of 12% on the first $400,000 of corporate income (rates vary by province). This low tax rate allows investments held in the company to accumulate at a faster rate than those held personally and create permanent tax savings if dividends are paid to lower income family members.
Back to the List

9. Blend interest into the sale price of an asset. A taxpayer can avoid taxation on interest charged when property is sold but not paid in full at time of sale or transfer. Interest on a loan is taxed at full marginal rates. But if a sales agreement is structured to include the interest in the price of the thing being sold, then the difference between price and cost will be taxed as a capital gain.
Back to the List

10. Reinvest interest income in common stock or preferred shares that pay dividends that have lower tax rates and that, if sold at a loss, can produce deductions against other capital gains.
Back to the List

11. Use life insurance to convert a growing body of money into the property of family members. Because money that is used to pay insurance premiums is already tax-paid, the benefits that emerge after the policyholder’s death are tax-free in the hands of a named beneficiary. To avoid costly and time-consuming probate, it is essential to name the beneficiary or beneficiaries - a simple procedure that the insurance company can handle in a few moments, and, after death, money will have become the property of the beneficiary in full. One can use the same procedure to provide tax-paid money to pay taxes that may be due on one’s own final tax return.
Back to the List

12. Invest in devices, such as tax-efficient mutual funds or natural resource income trusts, which return some of their earnings to unit or shareholders in the form of return of capital. There are no taxes on capital per se, so the return of capital is regarded as tax-free. Such investments become annuity-like in that they pay a return that includes some of the original contribution. In tax-efficient mutual funds, careful construction makes it possible to pay money to unit holders out of capital while maintaining normal distributions. In the case of natural resource trusts, capital is returned to compensate for the depletion of the asset base. In each case, however, a return of capital reduces the adjusted cost base and therefore raises the potential capital gain from sale of the asset prior to exhaustion of the capital. This tax deferral can make future tax minimization strategies more complex.
Back to the List

13. Buy convertible bonds that allow a switch from income producing interest coupons to common shares that can produce capital gains and dividends. This switch may be accompanied by higher volatility of the asset because dividends are less secure than bond interest and because bondholders rank before preferred shareholders in the event of insolvency of the issuer. Convertible bonds are more complex to manage than are straight bonds, but they change the character of investment income very effectively.
Back to the List

14. Make sure children with earned income file a tax return. Even income from a paper route or from bagging groceries at a supermarket can be used to create RRSP space that can be used in later years when, with a substantial income, the child - now an adult - faces high tax rates and can save a lot of money by using up that space. In some cases, filing a return showing low income may make it possible to claim certain low-income provincial tax benefits or to obtain a GST low-income credit for children over 19. The Manitoba Cost of Living Credit can be paid to children over 18.
Back to the List

15. Claim medical expenses proficiently. To be deductible, medical expenses, which can include payments to a wide variety of service providers that range from MDs to dentists, registered nurses and psychologists, must exceed 3% of net income or, if one's income is over $65,400, a flat $1,962 (the amount changes each year). But expenses are claimable within any 12-month period ending in the tax year for which a claim is made. As well, they may include hospital charges, drug costs, nursing home bills, care of persons with severe and prolonged disabilities, guide dogs for the blind including cost of purchase and upkeep (including vet bills), eyeglasses, hearing aids, dentures, costs of moving to accessible housing, cost of a training course related to the care of a disabled relative, and medical appliances that range from crutches, canes and wheelchair lifts, to insulin needles and blood monitoring equipment.
Back to the List

16. Make a vow of perpetual poverty. Members of religious orders who take a vow of perpetual poverty can deduct an amount equal to his or her earned income and an amount equal to the pension benefits in the year if these amounts were paid to the order. Where this claim is made, the claimant cannot also claim a charitable donation tax credit for the year. This procedure is not as silly as it may sound, for retirement into a monastery or another form of contemplative life with abundant reading and prayer time and a planned way of life is desirable to some people.
Back to the List

17. Split pension income with your spouse or common-law partner. If you're receiving income that qualifies for the pension income tax credit and you're in a higher tax bracket than your spouse or common-law partner, consider allocating to him or her up to half your pension income.
Back to the List

18. Save receipts for your children's physical activity programs. If you have children under the age of 16 who have been involved in physical activity programs, you may be eligible to claim a tax credit on your tax return.
Back to the List

19. Realize losses to offset gains. If you have capital gains in a given year and have accrued losses on other investments, consider selling your losing investments before year-end.
Back to the List

20. Contribute to a Tax-Free Savings Account. If you contribute to a TFSA, you will not obtain a tax deduction for the contributions, but income earned in your TFSA is tax-free and all withdrawals are tax free
Back to the List.

21. Gift public company shares to a charity. If you're planning to make a significant donation to a charitable organization, consider giving shares of a public company so you can benefit from the special rules that apply to such donations.
Back to the List

22. A registered disability savings plan (RDSP) is intended to provide for the long-term financial security of a beneficiary who has a prolonged and severe physical or mental impairment. Contributions to the RDSP can be made to the plan by the beneficiary, by his or her parents or family members, or by other authorized contributors. Contributions are not tax deductible. However, the earnings generated on contributions are tax-exempt while they stay in the plan. When earnings are withdrawn as part of a disability assistance payment, they are taxable in the hands of the beneficiary. In addition, due to savings grants and savings bonds, a contribution of $1,500 into the plan each year can receive as much as $4,500 of federal government contribution.
Back to the List