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10 tax planning ideas that could help investors save a bundle next April

by Wayne Cheveldayoff, 2004-04-29

Now that the 2003 income tax returns have been put to bed, itís time for investors to do some serious tax planning.

If you want to avoid paying any more in income tax than absolutely necessary next April, you have to get organized as soon as possible.

The common saying ďIf you snooze, youíll loseĒ applies every bit as much to saving taxes as it does to many other things in life.

Here are 10 investment-related ideas to consider beyond the usual steps of making RRSP contributions or setting up RESPs for the kids:

1. Invest in resource tax shelters and do it now instead of waiting until the fall when they are likely to be more expensive or harder to find as others try to beat the year-end deadline. Such shelters allow you to deduct the investment against regular income, thereby significantly reducing the after-tax cost. If you have a marginal tax rate of 46 per cent, a $10,000 investment will have an after-tax cost of only $5,300, although when the investment is sold, any proceeds will be considered a capital gain and subject to tax.
2. If you are turning 69 in 2004, you have to convert your RRSP into a RRIF by the end of the year. When setting up the RRIF, base the withdrawal schedule on the age of the younger spouse. This will make the amount of the withdrawals less than otherwise would be the case and thereby will save on income taxes, since any RRIF withdrawals are taxed as income..
3. If you are setting up a RRIF in 2004 and if you also have employment income, you can make a RRSP contribution and get a tax refund next April. This is tricky to do, since technically you are not supposed to make the RRSP contribution on this yearís employment income until 2005. However, you wonít have an RRSP then. But you can arrange things so that you make the RRSP contribution in December just before you convert the RRSP into a RRIF. The amount of penalty owing as a result of the premature RRSP contribution will be small compared to the income tax refund you will receive.
4. If you reported and paid tax on capital gains in the past three years and now have investments that are showing a capital loss, sell them to book the loss. Capital losses can be applied back three years to offset capital gains. Doing so will trigger a tax refund for the previous year in which it is applied. You may get a better price now for your losers than if you wait until year-end when others may be selling the same security to book losses.
5. Make any interest that you are paying tax deductible. Often, people have significant non-registered investments but are also paying interest on a home mortgage. In order to make the mortgage interest tax deductible, which would save a considerable amount of tax, it may make sense to sell the investments, pay down the mortgage, and then increase the mortgage again and make new investments. This may not make sense to do if a significant taxable capital gain is generated by selling the original investments. Be sure to have a proper paper trail in case you are audited and remember that the rules say you cannot deduct the interest unless the investments produce income like interest or dividends. Investments that produce only capital gains would not qualify for this tax break.
6. Take advantage of the lower tax rates for dividends and capital gains. For some, it may be advantageous to shift investments around so that those paying interest (on which there is no tax break) are held in an RRSP and others which generate dividends and capital gains are held outside.
7. Make use of corporate class mutual funds for investments held outside of RRSPs, RRIFs and RESPs. If the money is held within a corporate structure in this way, it can be moved from fund to fund within the corporation without triggering a taxable capital gain. The gains would be subject to tax only when they leave the corporate structure.
8. Set up in-trust accounts for children under 18 years of age and skew the investments in such accounts towards securities that generate capital gains. Any interest or dividends earned in such in-trust accounts will be attributed back to you, but capital gains will be taxed in the hands of the children, which usually have much lower incomes and marginal tax rates.
9. Donate stock instead of cash to a charity to get a special tax break. Normally, half of a capital gain is taxed as income. But for any capital gain triggered by a donation of stock, only a quarter is taxed as income.
10. Arrange your affairs so that investment earnings are attributed to the lower-income spouse with a lower marginal tax rate. For example, the lower-income spouse could invest his or her earnings (and subsequently report the investment income) while the higher-income spouse pays for living expenses. Also, it is possible for the higher-income spouse to lend money to the lower-income spouse, who would then proceed to make investments. The prescribed interest rate for such loans is about 3 per cent. So, this type of income-splitting will not work for investments paying income (interest, dividends, or cash distributions from income funds) below that rate.

Whatever tax-saving moves you have in mind, itís best to check them out first with a tax accountant, as a mistake could be very costly. With the tax rush now over, the accountants have more time to focus on your circumstances and help you with some long-term tax planning.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.




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©2004 Wayne Cheveldayoff