How your Investment Income is Taxed

When investing outside of the tax-sheltered environment of an RRSP or RRIF, it is important that financial advisors consider an investment’s after tax rate of return in conjunction with your risk tolerance and investment goals.

To reduce the tax paid on your investment income, you should consider investments that generate capital gains or Canadian source dividends as they are taxed more favourably than interest income.
Interest income earned from investments such as T-Bills, bonds, and GICs are generally taxed at the highest marginal tax rate. The marginal tax rate is the rate applied to each additional dollar of income you earn.

Dividends earned from a Canadian Corporation are taxed at a lower rate than interest income. This is because dividends are eligible for a dividend tax credit, which recognizes that the corporation has already paid tax on the income that is being distributed to shareholders. This however only applies to dividends from a Canadian corporation. Dividends paid from a foreign corporation are not eligible for the dividend tax credit.

Capital gains result when you sell an asset for more than you paid for it. This gain is offset by any losses and can be further reduced by any expenses that are incurred by the purchase or sale of the asset. The result is your net capital gain, however only 50 percent of that net gain is taxable at the appropriate federal and provincial rates.

Estate Planning & Taxes

We all want to save on taxation and it makes sense to plan your estate properly so the least amount of tax is paid. However, just trying to avoid taxes is not always the best idea if it interferes with other more important plans. Please note that any of these strategies should be discussed with your family, as well as your accountant, and lawyer. Implementing any of these strategies without the guidance of a professional may cause other unforeseen problems for you or your executor.

Joint Ownership of Property

When property is registered as joint with right of survivorship, it bypasses the estate and transfers directly to the survivor. However, there are drawbacks and issues to consider when registering assets jointly with an individual who is not a spouse. The assets become exposed to the creditors of the joint owner, they could become part of the equalization claim in a marriage breakdown, and they can be used as collateral by the joint party.

Alter Ego Trusts and Joint Partner Trusts

One of the main benefits of these trusts is the avoidance of probate fees on the assets within the trust upon your death. For this strategy to work, you must be at least 65 years of age and have be entitled to receive all of the income from the trust during your lifetime. With an alter ego trust, you must be the income beneficiary, whereas the income beneficiary of a joint partner trust must be both you and your spouse. Unrealized gains on assets that are transferred into these trusts are not subject to income tax in the year of the transfer.

Naming Beneficiaries

It is recommended that a beneficiary should be named whenever possible on registered products, pension plans or life insurance policies. When this is done, these assets may generally bypass the estate and be distributed directly to the named beneficiary.

Business Tax Planning

If you’re self employed or the owner of a business, planning for business succession can be like writing a Will – you know it needs to be done, but you don’t really want to do it. However, like a Will, you’ve got to get it done before it’s too late. Leaving business succession to chance could allow someone else to decide what happens to your business, and potentially at significant cost.

Here are some of the issues you need to consider when planning for the future of your business.

Personal Needs First

If your business is your primary asset and main source of income, it’s critical to take care of immediate, day-to-day planning issues first. On the personal side, you need adequate life and disability insurance to make sure you and your family can sustain your current lifestyle in the event of illness or death. You also need a personal financial plan that addresses your savings and cash flow needs. Will you have enough to pay for current expenses, such as your children’s education, and still be able to buy that cottage or take that trip you’ve been thinking about?

Taking Care of Business

It’s tempting to wait until retirement is near to start making succession plans for your business, but there can be substantial savings when you plan further ahead. According to Todd Herzog, Managing Director, Financial & Estate Planning Group at Scotiabank, “Business owners need insurance to protect their business property, but that’s only part of the story. What if their business can’t function because of the loss of a key employee or some other unexpected interruption? And what happens when the business owner eventually passes away? Insurance can provide ways to plan in advance for these situations.”

Your business succession plan is something that should be reviewed on a regular basis or whenever there is a major event such as a birth, marriage, illness or death, family member entering the business, or even a relevant change in tax legislation.

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2009 Year-End Tax Tips

Note: These points are by their nature general and brief, and not applicable to all situations. Your tax advisor can assist in determining if any of these points are relevant to specific situations.

Securities Trading

Consider realizing losses, particularly if there will be a net loss that can be carried back to reduce taxable capital gains in the prior three years. Losses not carried back can be carried forward indefinitely against future years’ capital gains. Don’t forget to watch out for the superficial loss rules if the individual or the individual’s spouse or related corporation acquired the same security within 30 days of the sale (the rules will work to prevent the immediate claiming of the loss). To maximize the loss, consider deferring sales of securities with gains until January (this could also be used to defer tax where there are no accumulated losses).

It is important to note that dispositions of securities by individuals that are repurchased by their RRSP will be subject to the superficial loss rules.

Registered Plans

Deadline for 2009 RRSP contributions is March 1, 2010.

Reminder: The annual contribution limit for 2009 is the lesser of 18% of 2008 earned income up to a maximum of $21,000 (increased from $20,000 in 2008), less the Pension Adjustment for 2008. Your 2008 Notice of Assessment will indicate the allowable amount along with any unused amounts from prior years.

If the annuitant turns 71 in 2009 RRSPs must be terminated and, to avoid being fully taxable in 2009, converted to a RRIF and/or annuity by December 31. Note: Contributions to the plan must be made by December 31, not 60 days after year end as the plan won’t exist after December 31! Where the individual still has contribution room, contributions can continue to be made to a spousal plan if the individual’s spouse is not over 71.

The RRSP limit for 2010 will be $22,000.

Contribute to RESPs no later than December 31 to maximize the annual contribution amount to a lifetime maximum of $42,000 per beneficiary, maximize the income deferral and benefit from the Federal Education Savings Grant (20% of contribution to maximum of $500 per year beneficiary is under 18).

Personal Payments

Final tax installment payment for 2008 is December 15.

Remember: In addition to non-deductible interest on late or deficient installments (currently 9%), a penalty of up to one-half the interest may be payable where the interest exceeds $1,000.

Charitable donation payments must be made before the end of the year. The maximum annual claim is 75% of net income. Unused amounts can be carried forward up to five years. Where publicly listed shares are donated, the gain is no longer taxable.

Other payments that must be made by December 31 to be considered in the 2009 tax return include:

Interest on family loans (generally at the prescribed rate) must be paid by January 30, 2009 to avoid income attribution. Consider new arrangements while the prescribed rate is low – in early 2009, this rate was 1%.

Review family trusts for any action that’s required by December 31.

Shareholder Loans

Shareholder loans not repaid before the year-end may result in the full amount of the loan being fully taxable on your 2009 tax return. If the loan was made to help with the purchase of a home, automobile for work, or corporate shares an exemption would apply.

Mutual Fund Purchases

Defer the purchase of non-registered mutual fund units near the year-end to avoid having to report year-end distributions.

Tax Tips provide a brief overview of specific topics, and are not intended to make the reader a technical expert. The information herein is general in nature, and while it has been obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed. Further, laws, regulations and circumstances can change. Individuals should not act on this information without first obtaining appropriate professional advice based on their particular situation.

ScotiaMcLeod does not offer tax advice. We are not tax advisors and we recommend that individuals consult with their professional tax advisor before taking action based upon any tax-related information.

Additional Information Booklets:

• How Investment Income is Taxed.
• Deductible Debt & Spousal Loans.