Tax deferral is one of the key planning techniques available to individual Canadians, mostly through use of the registered retirement savings plan. An RRSP lets you invest money now and take a tax deduction for that investment, effectively deferring payment of income tax on that income. What's more, tax on income earned by that investment within the RRSP also is deferred. You pay tax on the capital gains and income only when money eventually is withdrawn from the RRSP.
However, there are times and situations when it is better to forego a tax deferral and pay tax on income in the year it's earned. Similarly, there are circumstances in which you may want to take money out of a tax-deferral plan early, or simply arrange to receive employment-related or investment income now instead of later.
Your income is lower than normal.
The most common reason not to defer is during a year in which your income is lower than your norm, and if you anticipate it will be higher in future years. In such cases, it might make sense to not contribute to your RRSP. Instead, you can bank the contribution room for use in a higher-income year. However, you wouldn't want to delay that contribution for more than a year or two, since you would lose the benefit of the tax-deferred investment growth. Similarly, consider withdrawing funds from your RRSP in a lower-income year and pay tax on the proceeds at a lower rate than in future higher-income years.
If you are self-employed and have some flexibility as to when you bill a client, consider in which year you should receive that income. If you've had a lower-income year and the invoice in question isn't for a large amount, ensure you send it out during December so you can take it as income during what presumably will be a lower-tax year than next year. Conversely, if you anticipate a slower year next year, delay sending the invoice until Jan. 1 or later.
You've made unclaimed donations.
If you have donations made in past years but for which you have not yet claimed a tax credit, try to arrange to receive income from employment or investment sources before the end of this year. "Donations can be carried forward for up to five years for tax-credit purposes," says Peter Megoudis, a tax partner with Deloitte in Canada. "You may want to consider accelerating income to this year so you can use any donations that otherwise would 'expire' due to the five-year window. This could result in significant tax savings."
RRSPs and donations are the straightforward stuff for tax planning. But there are a number of more complicated situations in which you may or may not want to report income this year or next.
You're eligible for shares from your employer.
If you are in a profit-sharing plan or other employment-compensation plan, there are some planning steps that can work in your tax favour. "If you take the shares now, you pay tax in this as income at your current rate and then pay capital-gains taxes in the future on any appreciation," said Megoudis. "Whereas if you wait two or three years to take those shares, you will defer paying tax on this income."
However, if the share price were to increase during that period, you would face tax on the higher amount at your future employment-tax rate, "in which case there would be an incentive to take the shares now and report the income and have the deferral of capital-gains tax as the shares appreciate over time," Megoudis said. "You'd then pay tax on the higher amount at the (lower) capital-gains rate in the future."
You've maxed out your CPP/QPP contribution.
Similarly, if you are retiring and can control when you receive extra compensation such as a bonus at work -- and if you have already made your maximum Canada Pension Plan/Quebec Pension Plan contribution for the year -- then it makes sense to take the income in the current year. That way you wouldn't have to pay the CPP/QPP premium on it.
However, if you are about to retire and won't be earning significant employment or other income in the new year, and you are able to decide whether to take a bonus in December or January, regardless of CPP contributions, you may want to wait until the new year because your income theoretically will be lower then, and thus attract less tax.
You want to avoid an OAS clawback.
Another issue is the income-related clawback of Old Age Security income and other social benefits. If you are about to retire, it might make sense to take the bonus this year, assuming your income already is high enough to result in a full elimination of these benefits for 2016. Taking the extra bonus money will thus have no effect on the clawback, and should improve your situation in this regard next year.
You're returning to Canada.
For those who have been working abroad and are returning next year to become a Canadian resident for tax purposes, it could be beneficial to withdraw from your RRSP before re-establishing Canadian residency, said Megoudis. By doing so, you'll pay a flat 25% withholding tax, as opposed to paying tax based on graduated rates after you become a Canadian resident again," he said. "You can also avoid Canadian taxes by receiving non-Canadian related bonuses or dividends before returning to Canada."
You're moving within Canada.
You also should consider comparative provincial tax rates if you will be moving from one province to another next year, Megoudis said. For example, if you are planning to move to Ontario from British Columbia, consider that the top marginal tax rate in B.C. is about 48%, compared with approximately 53% in Ontario. Such a move should be done before the end of the year, since provincial-tax exposure for the full year depends on which province you reside in on Dec. 31.
You're a dual-country taxpayer.
If you are a dual-country taxpayer, such as being potentially taxable in both Canada and the United States, Megoudis said be sure that income will be taxable in the same year in both countries, so as to use the foreign tax credit to avoid double taxation. "If the U.S. is definitely going to tax some of your income this year, but for Canadian purposes you have the ability to structure it differently so you could defer it, you may not want to do so," he said. "This is because Canada only allows a foreign tax credit for foreign taxes payable for the year in which the income is taxable in Canada. So you may want to accelerate Canadian income so you can be sure to use the credit."
