By Canada Life | Jan. 9, 2024
Now is the time of year that many Canadians start thinking about tax planning and preparing to file their personal tax return. This process should include discussions with an advisor and tax professionals to ensure their entire situation and circumstances are being considered. There are several concepts, strategies, tips and tricks you should consider for your clients as part of this overall planning.
What’s in this article?
Most investors know the markets have historically delivered positive returns over the long term. But, not even the best risk management can smooth out all the bumps in the road. Due to high market volatility, your clients may have capital losses that could be used to offset future taxes on potential gains and income.
Capital losses arising in the 2023 taxation year can offset capital gains in the current year, the prior three years or in any future year. An unrealized capital loss exists if investments currently have a fair market value less than their adjusted cost base (ACB), which the Canada Revenue Agency (CRA) defines as the cost of a property plus any expenses to acquire it, such as commissions and legal fees.1 If these investments are held in a non-registered account and sold while the market value is less than the ACB, these losses will be realized and available for use to offset capital gains. This is why some describe capital loss planning more simply as tax-loss selling.
The investment should be evaluated and sold for a loss only if the reduction in fair value is the result of a permanent loss of value or impairment of the investment, or if the investment does not continue to fit with your client’s goals. Generally, investments shouldn’t be sold when the value is reduced, so the sale shouldn't be initiated to simply obtain the tax outcome.
Considerations for capital losses
Capital losses may be denied or deemed to be nil under certain circumstances.
1. Superficial loss rules
A superficial loss arises when a capital property (for example, units of a mutual fund trust) is sold for a loss and the owner or an affiliated person buys back the property (or identical property) within a period that begins 30 days before and ends 30 days after the ‘disposition’, which means selling or otherwise giving up the property. The owner or the affiliated person must own the property or have the right to buy the substituted property 30 calendar days after the sale.
The main examples of an affiliated person are a spouse or common-law partner, or a corporation owned by the individual, their spouse or common-law partner. If a loss is denied, the amount of the superficial loss can usually be added to the ACB of the substituted property. This would result in a reduced capital gain or an increased capital loss when the substituted property is sold.
2. Transferring assets in-kind
When non-registered assets are transferred in-kind into a registered account (for example., RRSP or TFSA) it’s a deemed disposition for tax purposes. If a capital gain arises on this deemed disposition, it must be reported on the client’s personal tax return since this transfer creates a tax obligation.
On the other hand, if a capital loss arises on the deemed disposition, it would be denied similar to the superficial loss rules above. This is because it’s seen as repurchasing the identical property that was disposed of in the registered account. If a client still wishes to complete the transfer to the registered account, they should first consider selling the assets to realize the loss. They can then contribute the cash generated from that sale to a registered account and purchase the desired assets.
Income allocations, distributions and other income
Be sure your clients are aware and comfortable with taxable income and capital gains or losses arising from any investments owned during the year.
- Income and capital gain or loss allocations may arise on segregated funds.
- Distributions of income and capital gains may be paid on mutual funds. Distribution estimates are usually available during December to assist with year-end income planning.
- Dividends may be paid on securities (for example, stocks).
- Interest income will arise on fixed income investments.
Clients need to be conscious of timing their investment purchases close to year-end. Participation in allocations and distributions may be realized depending on the date of these transactions, and there is typically a minor delay after a sale is initiated. Tax arising on these allocations and distributions would only affect non-registered accounts, as registered accounts defer the taxation until money is removed from the account.
Dispositions during the year may also cause capital gains (not just losses as described above) that must be included in taxable income for the year.
Capital gains
Capital gains or losses are realized when a capital property is disposed of. The capital gain or loss is the difference of market value less the property’s ACB. Realizing capital gains may be desired in years of low income (to be taxed at low marginal tax rates) or when capital losses may exist to offset the gains. Clients may also be able to defer the realization of capital gains:
- Disposing property over multiple years instead of in the current year may allow clients to take advantage of lower marginal tax rates, which can potentially reduce their overall tax obligation relating to the disposition.
- Clients may also consider deferring a gain from the current year to next year by delaying the disposition to January 2024. This strategy may open the option to utilize a lower marginal tax rate in the following year or to simply defer the tax obligation from April 2024 to April 2025, when tax payments are due.
Contributions
To qualify as a deduction in the 2023 taxation year, registered retirement savings plan (RRSP) contributions must be made during the 2023 calendar year or the period of Jan. 1, 2024, to Feb. 29, 2023 – the first 60 days of the following year. The 2023 contribution limit is 18% of earned income for the 2022 taxation year, up to a maximum of $30,780, plus any contribution room carried forward from prior years. This limit is further reduced by the pension adjustment for 2022 and pooled registered pension plan contributions for 2023.
Those who turned 71 in 2023 have until Dec. 31 to make a final contribution into their RRSP.
There are two RRSP strategies to consider for clients:
Strategy 1 – Excess contribution at age 71
If your client has earned income in 2023, this will generate RRSP contribution room in 2024 Consideration should be given to making a one-time over-contribution before Dec. 31, 2023. This over-contribution will be subject to a penalty of 1% per month, but will stop on Jan. 1, 2024 as this is when the RRSP contribution room becomes available. You can use this RRSP deduction in 2023 or any future year. Your clients will need to file a T1-OVP to report the overcontribution and remit the penalty to the Canada Revenue Agency (CRA) within 90 days of the following year. Note that the CRA does allow a $2,000 once-in-a-lifetime grace amount for over-contributions, but there is no deduction available for this amount, if used.
Strategy 2 – Borrowing to invest
When planning your clients’ RRSP contributions, there are strategies to consider that will affect the amount they contribute to their RRSP and the subsequent deduction available to help reduce overall taxes paid. Keep in mind, strategies involving leverage (the use of debt for an investment) must be suitable for your client and interest paid on RRSP loans is not deductible for income tax purposes.
i. Lump-sum deposit
This strategy represents after-tax money they wish to contribute into an RRSP for the year. This lump-sum amount can be increased by borrowing money to maximize annual contributions or catch up on missed contributions from prior years.
ii. Reinvestment strategy
This strategy is like the one above but considers an additional contribution that represents the tax refund generated by the original RRSP contribution. In other words, the tax refund generated by the RRSP contribution is put into the RRSP.
Converting an RRSP to an annuity or RRIF
Before the Dec. 31 deadline, they can choose one of the following options:
- Withdraw the RRSP in cash
- From a taxation standpoint, this may not be an ideal option, as the full amount would be taxed in the year received. The RRSP issuer would also be required to withhold tax on withdrawals.
- Purchase an annuity
- Transfer the RRSP to a registered retirement income fund (RRIF)
Clients can still contribute to an RRSP held by their spouse or common-law partner until the end of the year that the spouse turns 71. However, they can only do so using their own RRSP contribution room.
Contributions
The tax-free savings account (TFSA) contribution limit remains at $6,500 for the 2023 calendar year. This limit has gone up $500 since last year. To qualify for TFSA contribution room, one must be at least 18 years of age and a Canadian resident. If these qualifications have been met since 2009, when the TFSA was introduced, an individual’s total contribution room available would be $88,000. Based on the current rate of inflation, the TFSA limit for 2024 will remain $7,000.
Withdrawals
The TFSA is quite flexible. Clients can make withdrawals from their account and these withdrawals restore future contribution room. Caution must be used when withdrawals are made, because the contribution room is not restored until Jan. 1 of the following year. If a contribution was made without contribution room being available, the resulting over-contribution is subject to a 1% per month penalty until removed from the TFSA.
If withdrawals are being considered, withdrawing the money before Dec. 31, 2023, will result in contribution room being restored sooner (Jan. 1, 2024). Delaying this withdrawal to the 2024 calendar year means that contribution room will not be restored until 2025. After a withdrawal, contribution room restored in the following year will include the total amount withdrawn (including contribution room and any growth).
Example:
Anna has fully utilized the contribution room for her TFSA of $88,000 since 2009 and in 2023 its value reached $100,000. If she withdraws the full amount of $100,000, contribution room of the full $100,000 will be restored on Jan. 1, 2024. In addition to that amount, she’ll still have the standard $7,000 of contribution room on Jan. 1, 2024, if she continues to qualify.
Contributions
A registered education savings plan (RESP) is a special savings account for parents or grandparents who want to save for their child's or grandchild’s post-secondary education. The federal government provides a Canada Education Savings Grant (CESG) equal to 20% of the first $2,500 of annual RESP contributions per child, up to a maximum of $500. There are certain limits and restrictions on the eligibility for CESGs, so generally it’s preferable to contribute to an RESP as early as possible to take full advantage of the benefits offered.
Withdrawals for students
Once a child or grandchild is attending a qualifying post-secondary educational institution, they’re eligible to take out money from the RESP. These withdrawals can be in the form of an educational assistance payment (EAP), which is included in the income of the student in the year the withdrawal is made and is usually taxed at a very low tax rate. Clients may want to ensure withdrawals are made each year to take full advantage of this low tax rate. Once the child stops attending a qualifying institution, EAPs can only be paid out for the following six months.
Making donations
Tax credits are offered by both the federal and the provincial governments on donations made during the taxation year. This non-refundable tax credit is multi-tiered, meaning the federal charitable tax credit rate is 15% on the first $200 and 29% on the remaining amount (33% on income taxed at the 33% tax rate). The provincial amount is calculated similarly and added to the federal amount to determine the full benefit.
Donations can be carried forward for five years if they’re not used. The donation tax credit is also limited to 75% of an individual’s net income. This amount does increase to 100% of net income in the year of death.
Dec. 31 is the last day to donate and obtain a receipt for the 2023 tax year. Also note that clients can pool charitable donations with their spouse or common-law partner on their personal tax return, which can lead to a larger tax credit.
In-kind donations
In-kind donations to a registered charity made by gifting publicly traded securities (including mutual funds and segregated funds) with unrealized capital gains may have additional benefits. As with charitable donations, individuals are entitled to a tax credit for the fair market value of the security being donated. Additionally, the capital gain is eliminated by taxing it at a rate of zero. In-kind gifts may take more time to be processed, so they should be arranged well before year-end if the desire is to have the credit utilized in the same tax year.
Money can be lent to family members or a trust at the prescribed annual rate of 5% (current rate in effect until Dec. 31, 2023), which will be locked in for the life of the loan if certain qualifications are met. Generally, if money is gifted to a family member, attribution of income may arise, which will tax any income earned on the money gifted in the hands of the person that gifted the money.
The prescribed rate loan strategy may provide the ability for an individual subject to a high tax rate to split income with an individual in a lower tax rate for as many years as the loan is in existence. The interest arising on the loan is included in the income of the individual providing the loan (high tax rate), but any investment income arising on the money invested is taxed in the hands of the individual investing the money (low tax rate). Interest must be paid by Jan. 30, 2024, to avoid attribution of income and the termination of the prescribed rate loan.
This strategy is complex, so clients should work with you, in tandem with legal and tax professionals, to be sure it’s implemented in a way that’s aligned with their goals.
Clients should pay any potentially deductible, investment-related expenses before Dec. 31 to use the deduction for the 2023 taxation year. To qualify for the deduction, expenses must be paid within the calendar year and paid, in line with a legal obligation. These may include investment counsel fees, interest on borrowed money and interest on student loans.
With all the options available to your clients, it’s important to consider tax implications and planning over the entire year. And we need to pay special attention to their plan as we near the end of the calendar year. Many of the ideas, strategies and tips discussed here can help provide additional benefits and potentially provide tax savings when clients prepare to file their 2023 personal tax return.
This should not be construed as legal, tax or accounting advice. This material has been prepared for information purposes only. The tax information provided in this document is general in nature and each client should consult with their own tax advisor, accountant and lawyer before pursuing any strategy described herein as each client’s individual circumstances are unique. We have endeavored to ensure the accuracy of the information provided at the time that it was written, however, should the information in this document be incorrect or incomplete or should the law or its interpretation change after the date of this document, the content provided may be incorrect or inappropriate. There should be no expectation that the information will be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise. We are not responsible for errors contained in this document or to anyone who relies on the information contained in this document. Please consult your own legal and tax advisor.
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