Chapter 4 Using Tax Concepts for Planning

Transcript Chapter 4 Using Tax Concepts for Planning

Chapter 4

Using Tax Concepts for Planning

Edited by Laura Lamb, department of economics, TRU 1

Chapter Objectives

• Explain the importance of taxes for personal financial planning • Explain when you have to file a tax return • Outline the steps involved in completing a tax return • Describe the major deductions available to a taxpayer 2

Chapter Objectives (cont’d)

• Show how tax credits can be used to lower tax payable • Describe the difference among tax planning, tax evasion, and tax avoidance • Describe tax planning strategies that can be used to reduce tax payable 3

The origin of the Canadian Income Tax System

• Canada’s income tax system was implemented in 1917 to raise funds to finance its efforts in World War I. Since that time the system has evolved and become quite complicated with tax law presently consisting of about 2500 pages. 4

• Taxes are the single largest expenditure for most families • For this reason, knowledge and consideration of the tax system is important to personal financial planning 5

Background on Taxes

• Taxes are paid on – earned income – consumer purchases – capital assets – property 6

The Federal and Provincial Income Tax Structure

• The Canadian income tax system is progressive meaning that the tax rate rises as income rises.

• Most income tax systems are progressive. Why? 7

Consumption taxes

Background on Taxes

• Excise taxes: special taxes levied on certain consumer products such as cigarettes, alcohol, and gasoline • Taxes Paid on Capital Assets • Capital asset: any asset that is acquired and held for the purpose of generating income 9

You Have to File a Return if

• You have to pay tax for a calendar year • CRA sent you a request to file a return • You & spouse split pension income • You received working income tax benefit(WITB)advance payments • You disposed of property or realized a taxable capital gain • You have to repay any OAS or EI benefits • You have not repaid withdrawals from RRSP, 10 HBP , or LLP.

You Have to File a Return if

• You have to repay any Old Age Security (OAS) or Employment Insurance (EI) benefits • You have not repaid withdrawals from Registered Retirement Savings Plan (RRSP), Home Buyers Plan (HBP) , or Lifelong Learning Plan (LLP).

• You have to contribute to the Canada Pension Plan (CPP). 11

Why Students Should File Tax Returns • You may be eligible for a refundable GST/HST credit • Eligibility criteria: • You are 19 years of age or older • You have, or previously had, a spouse or common-law partner • You are, or previously were, a parent and live, or previously lived, with your child 12

Do You Have to File a Return? (cont’d) • If you do not have any tax payable, your tuition, education, and textbook tax credits can be: • transferred to another taxpayer (a parent or grandparent), or • carried forward to another tax year • You will create RRSP room for future contributions 13

Do You Have to File a Return? (cont’d) • Filing Your Return • Tax year end is December 31 for federal income taxes • Individual income taxes and tax returns must be paid and filed by April 30 th of the following year • Self-employed individual have until June 15 th file income tax returns, although taxes owing must be paid by April 30 th to 14

Background on Taxes (cont’d)

• Filing Your Return (cont’d) • An interest penalty may be payable if any of these deadlines are missed • Penalty (if taxes are owing) 15

Background on Taxes (cont’d)

• Filing Your Return (cont’d) • Two ways to file a tax return: mail and e-mail • Once your return is processed, you will receive a Notice of Assessment from the government • Confirms your calculations or provides corrections • Outlines your RRSP contribution limits for the following year 16

Overview: Completing an Income Tax Return 17

Step 1: Calculate Total Income

• Total income: all reportable income from any source. 18

Step 1: Calculate Total Income (cont’d) • Wages and Salaries • If you work full-time, probably your main source of total income • Self-Employment Income • Consists of income from a business, a profession, commissions, farming, or fishing 19

Step 1: Calculate Total Income (cont’d) • Individuals are considered self-employed if: 1. They have control over the work they do 2. They have taken on the financial risk and reward that comes with being self-employed 3. Their job duties are independent of any employer 4. They provide and maintain their own tools and equipment 20

Step 1: Calculate Total Income (cont’d) • Interest income: governments interest earned from investments in various types of savings accounts at financial institutions; from investments in debt securities such as term deposits, GICs, and CSBs; and from loans to other individuals, companies, and • Tax is due on interest in the year it is earned, not in the year it is received 21

Step 1: Calculate Total Income (cont’d) Dividend income: income received from corporations in the form of dividends paid on stock or on mutual funds that hold stock. • A dividend adjustment calculation reduces the income tax payable by shareholders • Consists of a dividend gross-up and dividend tax credit 22

Step 1: Calculate Total Income (cont’d) • Canadian Controlled Private Corporations (CCPCs) are eligible for a small business deduction on their active business income • Dividends paid by large corporations are referred to as eligible dividends; whereas dividends paid by CCPCs are referred to as non eligible dividends • Eligible dividend income is eligible for an enhanced dividend tax credit (discussed later in this chapter) 23

Step 1: Calculate Total Income (cont’d) • Capital gain: money earned when you sell an asset at a higher price than you paid for it • Capital loss: occurs when you sell an asset for a lower price than you paid for it • A taxable capital gain is currently equal to 50 percent of the capital gain 24

Step 1: Calculate Total Income (cont’d) • A taxable capital gain is currently equal to 50 percent of the capital gain • An allowable capital loss is currently equal to 50 percent of the capital loss 25

Step 1: Calculate Total Income (cont’d) 26

Step 2: Subtract Deductions

• Deduction: income an item that can be deducted from total income to determine taxable 27

Common deductions

• Registered Pension Plan (RPP) contributions • RRSP contributions • union/professional dues • child care expenses • support payments • carrying charges • moving expenses • employment expenses 28

Step 2: Subtract Deductions (cont’d)

• Net income: income the amount remaining after subtracting deductions from your total 29

Step 2: Subtract Deductions (cont’d)

Step 3: Calculate Taxable Income

• Taxable income: = net income – some additional deductions • Net income is used to make adjustments to certain benefits • Taxable income is used to calculate net federal and provincial income tax 31

Step 4: Calculate Net Federal Tax Payable • Marginal tax rate: the percentage of tax you pay on your next dollar of taxable income • Average tax rate: the amount of tax you pay as a percentage of your total income 32

Step 4: Calculate Net Federal Tax Payable (cont’d) 33

Tax Credits

• Tax credits: specific amounts used directly to reduce tax liability • Refundable tax credit: the portion of the credit that is not needed to reduce your tax liability may be paid to you (e.g. GST credit) 34

Tax Credits (cont’d)

• Non-refundable tax credit: the portion of the credit that is not needed to reduce your tax liability will not be paid to you and cannot be carried forward to reduce your tax liability in the future • Most tax credits are considered non refundable 35

Tax Credits(cont’d)

• Examples of non-refundable tax credits: • Basic Personal Amount • Spousal or Common-Law Partner Amount 36

Tax Credits(cont’d)

• Age Amount • May be claimed by a taxpayer who was 65 or older on December 31 of the tax year in question • Clawback: used to reduce a particular government benefit provided to taxpayers who have income that exceeds a certain threshold amount • Disability Amount • Must have had a severe and prolonged impairment in physical or mental functions during the tax year • Disability Amount Supplement 37

Tax Credits(cont’d)

• Caregiver Amount • Taxpayers may qualify for credit if they provided in home care to a parent of grandparent 65-plus years of age, or to infirm adult relatives • Infirm Dependent Amount • Pension Income Amount • Claim a credit on the first $2000 of eligible pension or annuity income 39

Tax Credits(cont’d)

• Canada Employment Amount • Employees are eligible to claim this non-refundable tax credit • CPP/QPP Contributions • Claim the amount shown in boxes 16 and 17 of your T4 slip • EI Premiums • Claim the amount shown in boxes 18 of your T4 slip 40

Tax Credits(cont’d)

• Public Transit Passes Amount • Interest Paid on Your Student Loans • Interest must have been paid on a student loan made to you under the Canada Student Loans Act, the Canada Student Financial Assistance Act, or similar provincial or territorial government laws for post-secondary education 41

Tax Credits(cont’d)

• Tuition, Education, and Textbook Amount • Claim the amount you paid for full-time tuition • Full-time students: claim an education amount of $400, and a textbook amount of $65 for each month of full-time enrolment in a qualifying education program • Part-time students: claim an education amount of $120, and a textbook amount of $20 for each month of full-time enrolment in a qualifying education program 42

Tax Credits (cont’d)

• Medical Expenses Amount • To qualify, total medical expenses must be greater than either 3 percent of your net income of $2024, whichever is less • In general: • net federal tax = tax payable – non-refundable tax credits 43

Tax Credits (cont’d)

• Transferable tax credits are credits that can be transferred to other individuals • Transferable Tax Credits: • Tuition, education, and textbook amount • Pension income amount • Age amount • Disability amount 44

Tax Credits (cont’d)

• Certain tax credits may be carried forward by the taxpayer • Tax Credits Eligible for Carry Forward: • Medical expenses amount • Tuition, education, and textbook amount • Charitable contribution amount 45

Tax Credits (cont’d)

Step 8: Refund or Balance Owing

• Tax refund : amount of total tax payable is less than the amount of total tax already paid • Tax owing: amount of total tax payable is greater than the amount of total tax already paid 47

Reducing Your Taxes

• Focus on Ethics: Reducing Your Taxes • Tax planning : involves activities and transactions that reduce or eliminate tax • Tax avoidance: a term used to describe the process of legally applying tax law to reduce or eliminate taxes payable in ways that the CRA considers potentially abusive of the spirit of the

Income Tax Act

Reducing Your Taxes (cont’d)

• Tax evasion: occurs when taxpayers attempt to deceive the CRA by knowingly reporting less tax payable than what the law obligates them to pay 49

Tax Planning Strategies

• Types of Income • Interest income is earned on investments such as savings accounts, term deposits, GICs, and CSBs • Dividends are classified as eligible or non eligible • Tax payable on eligible dividend income is reduced through an enhanced dividend gross-up and dividend tax credit • Only 50 percent of capital gain is taxable 50

Tax Planning Strategies (cont’d)

• Sources of Income • Since 2006, student income from scholarships, bursaries, and fellowships is not taxable • Contributions by the subscriber to an RESP are received tax-free by the student who receives an educational assistance payment 52

Tax Planning Strategies (cont’d)

• Sources of Income • Tax-free savings account (TFSA): a registered investment account that allows you to purchase investments, with after-tax dollars, without attracting any tax payable on your investment growth • Contributions are not tax deductible • Contributions and any growth can be withdrawn tax-free • Unused contribution room is carried forward 53

Tax Planning Strategies (cont’d)

• • Any money you withdraw, contributions plus growth, is added back to your contribution room for the following calendar year • Proceeds can be used for any purpose RRSP Contributions • Tax deduction is based on your highest marginal tax bracket 54

Tax Planning Strategies (cont’d)

• Record Keeping • Maintain a record of the purchase transaction for capital assets, such as stock, in order to make the future calculation of capital gains or losses easier • Maintain a record of the non-refundable tax credits that can be carried forward: the medical expenses amount, the tuition, education, and textbook amount, and the charitable contribution amount • At minimum, retain copies of your completed tax forms along with receipts for a period of seven years 55

Tax Planning Strategies (cont’d)

• Are Big Refunds a Good Thing?