Chapter 4
Using Tax
Concepts for
Planning
Copyright © 2012 Pearson Canada Inc.
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
8
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
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 30th of the following
year
• Self-employed individual have until June 15th to
file income tax returns, although taxes owing
must be paid by April 30th
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.
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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: 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
governments
• 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 noneligible 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: an item that can be deducted
from total income to determine taxable
income
27
Common deductions
• Registered Pension Plan (RPP) contributions
• RRSP contributions
• union/professional dues
• child care expenses
• support payments
• carrying charges
• moving expenses
• employment expenses
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Step 2: Subtract Deductions (cont’d)
• Net income: the amount remaining after
subtracting deductions from your total
income
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Step 2: Subtract Deductions (cont’d)
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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 nonrefundable
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)
38
Tax Credits(cont’d)
• Caregiver Amount
• Taxpayers may qualify for credit if they provided inhome 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)
46
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
48
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 noneligible
• 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)
51
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?
56
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Chapter 4 Using Tax Concepts for Planning