For many, tax planning means the once-a-year mad scramble to organize the necessary paperwork before the tax filing deadline.
In reality, this is not tax planning. Real tax planning requires a comprehensive approach to finances and should be tackled year-round.
Careful planning for your tax obligations should be an integral element of a well-crafted financial planning strategy. Essentially, tax planning involves trying to accomplish all of the other elements of your financial plan in the most tax-efficient manner possible.
All financial transactions have tax consequences. Although the tax consequences of some financial actions might not always take precedence, knowing the options will lead to better decision making.
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Decisions that tax planning can help with include:
- Timing of income and expenses.
- Selection of which investments to put in registered versus unregistered plans.
- Filing of common available deductions.
Your tax plan should focus on four specific elements: tax deferral, income splitting, income conversion and optimization of tax credits, incentives and deductions.
Tax deferral
The basic concept in tax deferral is the idea that it is better to pay tax later than sooner.
This is related to the time value of money and may also result in paying a lower marginal income tax rate when the amounts are brought into income in the future. This may involve the delayed recognition of income or the accelerated recognition of expenses.
An example of delayed recognition of income can be a Registered Retirement Savings Plan. An example of accelerated expenses is capital cost allowance on farm equipment or rental property.
Income splitting
Canadian federal income tax legislation is based on the application of progressive tax rates. Essentially, this means that taxes payable on a given amount of taxable income will be greater for a single taxpayer than if the amount is split between two or more family members.
Income conversion
You can receive tax-advantaged rates in a non-registered portfolio.
Different types of income are taxed at different rates, which means you want to ensure that your investments are getting the best returns and cash flow on an after-tax basis.
Be aware of how the government treats the taxation of different investment vehicles. Interest income is fully taxable in your non-registered accounts, just like any salary, net business income and other regular income. However, Canadian dividends and capital gains receive preferential tax treatment.
Optimize tax credits, incentives and deductions
To take advantage of existing tax laws requires a certain amount of knowledge. It’s not always easy to stay on top of such things , which is why I recommend that you involve the help of a tax specialist.
Keep all tax-related documents in one accessible location. Also, be sure to keep on top of your bookkeeping and keep your records up to date throughout the year.
There are many more things you can do, but a good tax planner can help manage the process and keep more money in your pocket.
