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Tax planning you should be doing now to save a bundle next April

by Wayne Cheveldayoff, 2006-04-13

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

To get you thinking seriously about tax planning, particularly related to the investment scene, here are some ideas beyond the usual steps of making RRSP contributions and setting up RESPs for the kids:

1. Take advantage of the lower tax rates for dividends and capital gains. If you have income trusts, consider switching to trusts that pay out a higher proportion in the form of return of capital, on which taxes (at the capital gains rate) are deferred until you sell the investment. It may be wise to shift interest-bearing investments (on which there is no tax break) to a RRSP or RRIF while holding those generating dividends, capital gains or return of capital outside.
2. Invest in resource tax shelters. Do it now instead of waiting until the fall when they may be 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 only cost you $5,300 after tax, although when you eventually sell it, any proceeds will be considered a capital gain and subject to tax.
3. 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, thereby triggering 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.
4. Consider ways to make any interest that you are paying tax-deductible. This could mean selling non-registered investments, paying down your home mortgage, and then increasing the mortgage again to make other non-registered investments. By doing some juggling like this, the interest on the increased mortgage will be tax-deductible. Be sure to have a proper paper trail to prove things in case you are audited.
5. Make use of corporate class mutual funds for non-registered investments. This will allow you to move from one fund to another without triggering a disposition for tax purposes. Any gains would be subject to income tax only when you withdraw the investment from the corporate structure.
6. Arrange your affairs so that investment earnings are attributed to the lower-income spouse with the lower marginal tax rate. For example, the higher-income spouse can pay all living expenses while the lower-income spouse’s income is directed into investments.
7. If you are turning 69 in 2006, you must 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, thus reducing the amount that needs to be withdrawn and therefore subject to tax.
8. If you are going to set up a RRIF and have employment income, consider making a RRSP contribution for 2006 before the conversion takes place. Technically, you should not be making a contribution for 2006 until 2007, but you won’t have an RRSP then. By making a premature RRSP contribution in December, the amount of penalty that could apply will be small compared to the income tax refund you will receive next April.
9. Take advantage of a special tax break by donating stock instead of cash to a charity. Normally, half 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. Set up in-trust accounts for children under 18. Any interest or dividends will be attributed back to you, but any capital gains will be taxed in the hands of the children.

When it comes to tax planning, mistakes can be costly. Ensure you keep proper records. It may be best to first check any planned moves with a tax accountant.

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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©2006 Wayne Cheveldayoff