Tax Strategies and Considerations
This section provides a brief overview of several tax strategies and
other considerations that can help you and your Investment Advisor decide
where to place your investments for maximum tax efficiency:
Investment Income
Recognizing how gains from stocks, bonds, mutual funds and other
investment income (interest, dividend and foreign) are taxed differently is
key to optimizing your after-tax rate-of-return. While evaluating investments
based on their after-tax return is important, you should also consider such
factors as the investment’s risk, the opportunity for capital
appreciation, liquidity, and so on. It is also important to note that in most
cases, you will retain more after-tax income from capital gains than either
Canadian-sourced dividends or interest income.
Talk to your Investment Advisor about steps you can take to maximize
your after-tax investment income.
Borrowing to Invest
When interest rates are low, you may be attracted by the strategy
of borrowing to invest, also known as leveraged investing.
Unfortunately, when deciding whether to use leverage, many people
simply consider the current interest-rate environment and past
market performance without evaluating their complete financial
situation. Borrowing money to purchase investments is definitely not
a strategy for the faint of heart. It involves significant resolve as
well as various factors that should be considered and adhered to.
Discuss the benefits vs. the risks with your Investment Advisor
before deciding whether borrowing to invest is right for you.
Tax implications will depend on your individual situation and the type
of investment you choose.
Income Splitting
Income splitting is the reallocation of income among family members
(including spouse, minor and adult child) to reduce the total amount of
money paid by the family unit. A well-accepted tax-planning method,
shifting income from a family member in a high tax bracket to one in a
lower tax bracket can result in greater after-tax income. And although
income attribution rules restrict the number of income-splitting
opportunities available, there are still a number of effective ways
of splitting income with family members.
Note: To ensure the desired results are achieved, income-splitting
methods should be discussed with a qualified tax advisor prior
to implementation.
Funding a Child’s Education
There are two types of savings plans many investors consider when
putting aside money for a child’s post-secondary education:
- A Registered Education Savings Plan (RESP) is a tax-effective
method of saving as income earned in a RESP (and not withdrawn) is
tax deferred
- An In-Trust account offers a unique opportunity to split
investment income among family members and thus benefit from a
lower overall tax burden
Although income earned in a RESP is tax deferred until withdrawn,
annual contributions are limited and are not tax deductible. In
contrast, income earned in an In-Trust Account is taxable each year.
However, there are no limits to the amount of contributions, making it
a flexible alternative.
For more information on education savings plans, please speak with
your Investment Advisor.
Registered Investments
There are numerous types of registered investment vehicles available
to help you save on a tax-efficient basis: Retirement Savings Plans
(RSPs), Retirement Income Funds (RIFs), Locked-in Retirement Accounts
(LIRAs), Life Income Funds (LIFs), and Locked-In Retirement Income Funds
(LRIFs). Of the available registered vehicles, the RSP is by far the most
utilized tax-planning tool.
For details on RSPs, including benefits, strategies and more,
please see:
Tax Shelters
A tax shelter is an investment that provides significant deductions
against your other taxable income. By taking these deductions, you can reduce
your total taxable income and thereby reduce the amount of tax payable to the
Canada Revenue Agency.
Investors generally view the reduction in taxes payable as a tax savings,
but it is more accurately viewed as a tax deferral, since ultimately either
income derived from the investment or upon the sale of the investment will
incur a tax liability.
Many tax shelters are considered long-term investments, and most are
typically set up as either a limited partnership or as a flow-through share.
Tax shelters sometimes require large investments, present a bigger degree of
risk and may become subject to the Alternative Minimum Tax (AMT).
In addition, tax shelters are most appropriate for investors in the top
marginal tax bracket, since the value of any tax deduction is maximized.
Consult a qualified tax advisor prior to purchasing a tax shelter to
ensure it is appropriate in your situation.
Alternative Minimum Tax (AMT)
Alternative Minimum Tax (AMT) is designed to target high-income
individuals who have significant deductions such as write-offs from tax
shelters. Items that can lead to an AMT liability include stock option
deductions, limited partnerships losses and Capital Cost Allowance (CCA)
claimed on tax shelter investments.
Deductible interest expense and business losses can effectively reduce
your taxable income without triggering AMT. However, deductible interest
expenses related to tax shelters will affect the AMT calculation.
Investing through a Holding Company
As a result of changes to the Canadian tax system over the last several
years, the tax advantages associated with Canadian investment holding
companies have all but been eliminated. It is no longer possible to defer
taxes through an investment holding company and, in general, the combined
corporate/shareholder tax rates on investment income now exceeds the personal
taxes paid on the same income.
Despite the changes in the tax system, investing through an
investment holding company can still provide some benefits. For
example, an investment holding company can be used to:
- Split income with adult children -
Assets can be transferred into the holding company on a tax-deferred
basis and the adult children can subscribe for shares of the company.
Dividends can then be paid to the adult children and taxed in their
hands.
- Freeze an estate - The primary goal of an estate
freeze is to “freeze” a company’s share value for the
original shareholders, while ensuring that future increases in the fair
market value of the company pass to the next generation or to other desired
individuals. This way, the amount of income taxes at death and probate tax
can be minimized.
- U.S. Estate Taxes - Another reason for
using a bona fide Canadian investment holding company is to hold U.S. situs
investments in order to shelter a Canadian resident shareholder from U.S.
Estate Taxes. The pros and cons of this type of strategy are complex and you
should seek a professional tax consultant well versed in this area.
Investing in the U.S.
For many Canadians, investing in the United States presents an
opportunity for greater rewards and higher returns on their investments.
However, it is important to understand how investments in the U.S. can
affect your tax situation today and in the future.
Take the next step…talk to an advisor.
For information regarding U.S. taxation issues, please speak with
your Investment Advisor.
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