Deduct and Save
The deadly combination of lower interest rates, a higher cost of living, the erosion of government and privately funded pensions coupled with longer life-spans has caused many of us to take a harder look at ways to make our money work harder.
One avenue that is available to all Canadians is tax planning. And while the tax filing deadline for the 2011 tax year is fast approaching, it is never too late to start a tax plan. Tax planning after all is about flexibility and taking control of your cash flow and expenses in order to realize tax savings.
There are three basic ways to reduce your taxes, with each method possibly having several variations. You can reduce your income, increase your deductions, and take advantage of tax credits. Let's take a look at each.
Reduce your income
Canada has a graduated tax system; meaning that the more you make the larger percentage the government requires you to pay tax on. For instance the 2012 federal tax brackets begin at 15% for the first $42,707 of income and increases to 29% once income is over $132,406. Determining the tax bracket that you fall into is the first step in tax planning, the second step is determining the tax bracket of your spouse or partner (if applicable).
Once these rates have been determined decisions such as investment ownership, the optimal account type to hold interest, dividend, or capital gains paying investments and the amount of income to be split between spouses can be made.
Increase tax deductions
Perhaps the best understood tax deduction is also amongst the least utilized. Unlike other account types such as the Tax Free Savings Account (TFSA) and Registered Education Savings Plan (RESP) the Registered Retirement Savings Plan (RSP) offers savers a tax deduction for the value of the contribution made into it. Yet despite this immediate tax saving the vast majority of Canadians either do not contribute to their RSP or do not contribute enough.
Other deductions that parents may take advantage of are child-care expenses which are deductible provided the expense is eligible and the child is under the age of 16. For children six and under, $7,000 per child per year is the maximum a parent can claim, while the claim for kids aged seven to 16 is $4,000 total.
While tax deductions reduce income tax, tax credits reduce income tax payable. On this front the disability tax credit is often the most under used. To qualify, a T2201 form must be filled out by a "qualified practitioner" such as a family doctor, physiotherapist or psychologist.
Once approved by CRA the disability tax credit, can be applied retroactively to when the condition first occurred, and can impact a parent's child tax benefit by up to $2,575 a year in addition to the tax savings associated with the credit.
On the federal front, the children's art credit as well as a children's fitness credit, introduced in 2007, are "non-refundable credits" worth 15% of the cost of programs, to a maximum of $500 per child. On top of that, certain provinces, including Ontario, Manitoba and Saskatchewan, offer their own credits for fitness and arts programs.
Many tax credits can also be transferred between spouses, family members or even combined. Examples are credits for students such as the tuition, education and textbook credits can be transferred to a spouse, a parent, or even a grandparent once the credits are used to reduce the student's tax payable to zero. These credits can also be carried forward so the student can use them later when he or she starts earning money.
The filing and collecting of tax information has become a rite of passage into adulthood for many Canadians. However, many undertake this adventure without the proper plan in place. The Canadian tax system while complex can also be navigated successfully resulting in significant savings to those who have structured their expenses and savings with tax in mind.