We are well into 2022 now -- but most taxpayers’ focus remains on tax matters related to last year. After all, the deadline is barely a month away for making an RRSP contribution that is deductible for 2021 tax purposes. And, soon after, it will be time to think about filing your 2021 income tax return.
But it’s unwise to postpone thinking about your tax situation. Wrapping your head around tax planning now can help you save taxes when you file your 2022 return a year from now – not to mention putting you on a solid long-term-planning course. Here are five broad tax-saving elements to consider before you get much further into the year.
1. Invest With an Eye on How Income and Gains Are Taxed
The main types of investment income (interest, dividends and capital gains) are taxed in different ways. So, over the long term – assuming you have made a sound investment that meets your risk tolerance and savings goals – it can really pay to consider how much tax you will pay on a particular deposit, bond, stock, mutual fund or real-estate holding.
The starting point is that capital gains generally are taxed at a lower rate than dividends and interest. But the discrepancies vary according to your tax bracket and province of residence.
If you are planning to make a big-ticket purchase like a more expensive home or a cottage, you may want to convert an equity investment to something liquid like a term deposit or short-term bond. As you near retirement, you need to begin shifting your focus to capital preservation – yet maintain enough growth in your portfolio to ensure you have enough income into your later years and/or to provide an inheritance to your heirs.
2. Make Full Use of Tax-Assisted Plans
While there are relatively few tax shelters available to the average individual Canadian, most people do have access to two valuable ones: the registered retirement savings plan (RRSP) and the tax-free saving account (TFSA).
The RRSP offers a combination of tax-deductible contributions and long-term tax deferral. Even though we are well into 2022, you are allowed to maximum contribution to an RRSP that is deductible in the 2021 taxation year during the first 60 days of the new year – for this year, March 2. If you already have done so, why not get a head start on your 2022 contribution, and thus create more savings that can grow free of immediate taxation sooner? The 2022 contribution limit increases to $29,210, up from $27,230 in 2021. Remember, any unused amounts in past years accumulate to create cumulative contribution room that you can use any time until you wrap up your plan no later than the end of the year in which you turn 71.
It is also key time for TFSA holders. Not only are you allowed to invest an additional $6,000 in your account – contribution room increases by that amount each Jan. 1 – any amounts withdrawn from your TFSA in 2021 can be reinvested in your account in 2022. This is because TFSA contribution room is restored to the extent of any withdrawals made.
There is a third attractive tax-assisted vehicle to consider if you are parents or grandparents of younger children: the registered education savings plan. The sooner you start an RESP, the greater the savings for a child’s eventual post-secondary education. There are several types of plans available, with varying degrees of investment options and flexibility as top how the savings eventually can be used.
3. If Feasible, Consider Tax-Deductible Debt
Interest paid on a home mortgage or a personal car loan is not deductible, unlike that which is paid on an investment loan or business-related debt. If you are planning to purchase securities or other investments this year, consider borrowing the money to do so and using the cash originally earmarked for investing to pay down a mortgage or personal loan. This way, the new interest will be deductible – and you will pay less non-deductible interest on the personal debt.
But be sure to seek expert advice before you act, as there are tight rules on investment loan eligibility. For other personal debt – such as when you carry a credit-card balance from month to month at exorbitant interest rates – make it a priority to pay off whatever you owe each month. If you must carry a balance, look into transferring the amount to a personal line of credit, which usually charges a significantly lower rate of interest.
However, be very careful, as this option is not for everyone. As Morningstar’s director of personal finance Christine Benz warns, “Borrowing money to invest might be something that some sophisticated traders may engage in, but generally speaking for more small investors managing their account it adds risk, complexity and costs - something I would advise against.”
4. Make Income a Family Affair
A practice known as income-splitting can provide substantial tax savings. Assuming there is a significant difference between spouses’ incomes, arrange to have more income received by the lower-income spouse (at a lower tax rate) that otherwise would be earned by the higher-income spouse.
The most basic form of income splitting is for mortgage payments and other household bills to be paid by the higher-income spouse, which allows new investments to be made by the lower income spouse and subsequently pay less tax on income and capital gains. If you have a family business, salaries can be paid to your spouse and children, as long as they are for legitimate work and the amounts are reasonable.
There are strict rules to observe, however. Bear in mind, though, that if you transfer existing investments to your spouse, any income or capital gains will be attributed back to you and taxed in your hands. If you sell an investment to your spouse at its fair market value, tax on the capital gain will be payable by you, but future gains or income from the investment will be taxed in your spouse’s hands. You can loan money to your spouse for an investment without triggering the attribution rules, as long as you charge realistic interest.
5. Pay Tax Installments on Time
Investors and self-employed individuals must heed a possible requirement to pay as the year progresses.
Most employed people pay income tax on payday as a deduction at source from gross income. But for many others -- including self-employed people, investors and for the most part anyone who does not have tax withheld at source -- tax may have to be paid four times a year in instalments.
If your net tax payable will be $3,000 or greater for 2022 as well as in either of 2021 or 2020, you will be required to pay instalments this year. (In Quebec, instalments are payable when federal or provincial tax-payable amounts, individually, are $1,800 or greater.)
Instalment payments are due on March 15, June 15, Sept. 15 and Dec. 15
Taxpayers identified by the CRA as probably having to pay instalments during 2022 will be sent a reminder notice in February for payments due in March and June. The amounts calculated by the tax department are based on your tax payable for 2020.
Another reminder is sent in August for September and December instalments, with amounts based on your tax liability during 2021.
You do not necessarily have to pay the amounts specified in the reminder notices – although if you do so you will not face a late-payment penalty if the amount owing turns out to be greater. Instead, you can opt to base the payments on either your estimated 2022 tax payable, or on what you paid for 2021. For details, consult the CRA website.
