The holiday season is upon us, and thoughts of the tax man are likely to be restricted to cash-register shock in the form of sales tax as we shop till we drop. But with only weeks remaining in 2012, it's worth considering income-tax matters as well. While there is little you can do to avoid sales taxes besides staying away from the stores, there may be some moves you can make to reduce your income-tax burden for 2012 -- and also to lighten your tax burden for 2013.
Though there are almost no tax-shelter investments available to individual investors, various types of investment income are taxed differently. So it's worth reviewing now what's on tap when you file your 2012 tax return next spring. Interest income is taxed in the same way as employment or net business income -- at your top marginal rate.
However, dividends and capital gains are taxed at lower rates, and thus you should ensure you are doing all you can -- within the bounds of your investment strategy, of course -- to ensure you will be able to take full advantage of the dividend tax credit and capital-gains rules come tax time.
Saving tax for 2012
So, what can you do now to reduce taxes on your investment income for 2012? Not much, unfortunately, in terms of interest and dividends. Any amounts coming your way will be paid or have already been paid to you according to the issuing company or institution's payment schedule. However, for capital gains, it's a different story, because you have control over when a capital gain -- or loss -- is realized and thus must be reported.
If you are thinking of cashing in on a stock, bond or other investment that has achieved a capital gain on paper, consider the impact this income will have on your 2012 tax bill. If it's been a low-income year for you, it might be a good time to realize this gain and bring it into income and possibly pay tax on this amount at a lower rate.
If you have an investment that has fallen in value since you purchased it and are ready to sell it, consider whether you should do so now, or next year. Capital losses can be used to offset capital gains during the current year, or during any of the three previous years.
If you've realized some healthy gains from other investments this year, selling any losers now will offset those gains, resulting in a smaller amount of capital gains being reported on your 2012 return.
Or, if you reported capital gains on your 2009 return, this is your last chance to trigger a capital loss and apply it back against the gains that were reported for that year, and thus be able to retroactively recover some previously paid tax dollars. Remember, one-half of losses can be applied against one-half of realized gains, as per the usual capital-gains taxation procedure.
However, for whatever reason you sell a capital investment, remember it must be sold soon enough so that the transaction is completed before the end of the year, in order to be reported as 2012 income. For securities listed on a Canadian exchange, the deadline is Dec. 24, because the Toronto Stock Exchange and other Canadian markets are closed on Boxing Day, Dec. 26. For securities listed on a U.S. exchange, the deadline is Dec. 26, because the New York Stock Exchange and other U.S. markets are open that day.
Note that you must really want to exit a particular losing investment, since there are "stop-loss" rules in place to prevent transactions executed purely for tax-saving purposes. A capital loss cannot be used to offset capital gains if the money-losing asset in question is reacquired within 30 days by you, your spouse or a corporation controlled by you or your spouse. Similarly, you cannot directly transfer an asset to your spouse or a corporation controlled by you or your spouse and use the capital loss to offset taxable capital gains.
If you are considering donating securities to a registered charity, as with cash donations you must do so before the end of the year in order to obtain a tax credit for 2012. In such a case, a security with an accrued capital gain is effectively not subject to tax. The full value of the security at the time it is transferred to the charity counts as a donation, and a receipt is issued to the donor for the full amount.
If you are contemplating buying a mutual find, consider waiting until the new year. Doing so will allow you to avoid the distributions that many funds make to unitholders during December, which in turn would boost your taxable income for 2012. These distributions, in many cases, represent all of a fund's income and capital gains earned and realized during the year, of which you'd receive a full share, even though you'd be a unitholder only during the final weeks of the year.
Planning for 2013 and future years
Looking ahead, as the year winds down and into January, it makes sense to review your portfolio to ensure you go into 2013 with the right mix of investment-income types. Actions to consider include:
- Delay purchasing a GIC until January, so that you won't have to report interest from that deposit until the 2014 taxation year.
- Review what types of income-producing investments are held in your RRSP or other registered plan, and which are held outside in a taxable account. For the most part, capital gains and dividends are more tax-efficient outside a registered account, while investments that pay interest and foreign-source dividends work better within it. (However, during the years well before retirement, you need such investments within an RRSP for the sake of long-term capital growth.)
- If you are considering making a withdrawal from your tax-free savings account (TFSA), do so before the end of the year. If you wait until the new year, the additional contribution room resulting from the withdrawal will not be added back to your account until 2014.
- Those with investments held within an RRSP that were deemed under 2011 legislation to be "prohibited" because the individual is too closely connected to that investment, must file a special form with the tax authorities so as to benefit from special transitional rules that provide some tax relief (until the end of this year) on such investments acquired after the new rules were announced. These prohibited investments are defined as a financial instrument that exists to fund a debt held by that person, or by a trust, corporation or partnership to which he or she has a significant interest (as defined by the tax man).
