Every year, millions of Canadians gaze upon their Notice of Assessment with equal parts gratitude and mild panic. As your tax preparer or even your bank teller can tell you, Canada’s tax code is specifically designed to give you every opportunity to reduce your tax obligation legally – and everyone should take advantage of the opportunities the government puts in place that encourage saving for retirement, investing in one’s home, caring for one’s family, and supporting small businesses. Every dollar you save in taxes creates room for a dollar more in your pocket that can go towards paying down your mortgage or saving for retirement instead of being unnecessarily added to the government’s coffers.

Understanding Canada’s Tax System

Progressive Taxation

Canada has a progressive tax system, which means people with higher incomes pay a higher percentage of their income in taxes. Most people don’t realize that Canada’s progressive tax system doesn’t tax people’s entire incomes at the highest tax rate, however – only the portions of your income that fall into each of the tax brackets are taxed at those rates

You must also consider that the federal government and your province each have their own tax brackets, with the latter layering on top of the former. This is why you’ll find that a resident of Alberta will have a lower take-home pay for the same salary when compared to someone in Quebec.

Your Taxable Income

The Canada Revenue Agency (CRA) recognizes several categories of taxable income, which generally fall under the following headings:

• Employment income: Salaries and wages, employee benefits, and most other income earned as an employee reported on a T4 slip are fully taxable.
• Business income: The profits of a self-employed individual or an incorporated business are fully taxable.
• Investment income: Interest income and foreign income are fully taxable, while some types of investment income, such as dividends and capital gains, are subject to preferential rates.
• Rental income: Net rental income from the letting of property is fully taxable.
• Capital gains: Profit from the sale of investments, a second home, or other assets is subject to the capital gains tax rules for Canadian residents in respect of those assets.

Your Marginal Tax Rate Versus Your Average Tax Rate

Your marginal tax rate refers to the tax rate that applies to the additional dollar of income you earn; it’s the tax rate in whichever tax bracket you’re in. Your average tax rate, meanwhile, is your total tax bill divided by your total income – it will always be lower than your marginal tax rate, since only the additional portion of your income is taxed at the higher rates. People who are in higher tax brackets frequently fail to realize that extra income only earns the higher tax rate if it pushed them into the next tax bracket – it’s not taxed at the highest possible rate all of the sudden.

Tax Avoidance vs. Tax Evasion

It’s important that we clarify this distinction at this point. Tax planning or tax avoidance (using legitimate means allowed by the Income Tax Act) refers to reducing your tax liability by using the various provisions that the government puts in place to encourage you to, for example, put money into a retirement savings plan. 

Tax evasion, on the other hand, refers to actively cheating or defrauding the government. The CRA actively audits aggressive tax planning claims, so be aware that the CRA considers the following activities as tax evasion:

• Claiming expenses that you don’t actually have
• Claiming expenses not incurred in earning employment income

Failing to report employment income

If you’re found to have been involved in any type of tax evasion, you may be required to repay the taxes you illegally avoided, plus interest. Moreover, if the CRA finds that you acted with gross negligence when evading taxes, you could face penalties as high as 50% of the unpaid taxes. Tax evasion can even lead to criminal charges in egregious cases.

The Benefits of Tax Planning

Most people do very little tax planning aside from those months right before the end of the tax year, and even then, it’s mostly just filling in numbers. Strategic tax planning offers numerous benefits to individuals and businesses alike, including:

• Accelerated wealth accumulation: Income not paid to the CRA can be invested or saved for retirement. This allows you to grow your wealth faster and enjoy greater prosperity later in life.
• Increased retirement income: By contributing to your RRSP, you can reduce your taxable income and therefore increase the amount of income that you can shelter from taxes in retirement.
• Improved cash flow: By reducing your total tax bill, you can optimize the amount of income that goes into your bank account.
• Reduced investment taxes: By using certain tax shelters or investing in certain assets, you can reduce the amount of taxes payable on your investments.

A young professional contributes $5,000 to his RRSP each year for 20 years. Assuming he receives a 6% return on his contributions and pays about 25% income tax, he’ll likely end up with significantly more money in retirement due to the combination of the tax deduction and his average returns, even without factoring in the refund he could also receive on his contributions each year.

Maximizing Your RRSP

What Is an RRSP?

A Registered Retirement Savings Plan (RRSP) is a retirement savings plan that provides for tax-deferred growth (meaning that you don’t pay taxes on the investment income while it remains in the plan) and allows for contributions to be tax-deductible (with the ability to claim a deduction on your income tax return for the contribution that you make).

Contribution Limits and Carry Forward Rules

Your RRSP contribution limit generally refers to a percentage of the income earned in the previous tax year, less pension adjustments (if you have a pension). Unused contribution room carries forward indefinitely, but your limit for the current year specifically depends on your personal circumstances. You should consult your Notice of Assessment or CRA My Account to view your RRSP contribution limit for the current tax year.

Eligible Investments

Your RRSP can hold a variety of eligible investments, from stocks and bonds to mutual funds and GICs. Your RRSP itself isn’t an investment; it’s more like an account you use to hold your investments.

When to Contribute

You should always strive to make your RRSP contributions as early in the year as possible so you can maximize the amount of time your contributions are invested and therefore increase your potential returns. If you expect to be in a higher tax bracket in the following year, it may be a good idea to defer claiming your deduction to that year instead.

Withdrawals

RRSP withdrawals are fully taxable in the year you receive them, as the CRA withholds income tax from your withdrawals. There are two notable exceptions to this rule, however – the Home Buyers’ Plan (which allows you to withdraw up to $35,000 for a qualifying first home purchase, with repayment terms set out by the CRA) and the Lifelong Learning Plan (allows you to withdraw up to $10,000 per year for full-time education or training).

Maximizing Your TFSA

TFSA Tax-Free Investing

Unlike an RRSP, contributions to a Tax-Free Savings Account (TFSA) are not tax-deductible, but every aspect of a TFSA – from the contributions to the investment gains and withdrawals – is completely tax-free. TFSA withdrawals also do not affect your eligibility for income-tested benefits or credits, such as the Guaranteed Income Supplement and the GST/HST credit.

Eligible Investments

A TFSA can hold similar investments as an RRSP, with the exception of certain types of bonds.

Contribution and Re-contribution Rules

Contribution room is generated every year for every Canadian resident 18 years of age and older who has filed a tax return. Unused contribution room carries forward indefinitely, but amounts withdrawn from your TFSA can only be recontributed in the following calendar year. Many people fail to realize that withdrawing money from a TFSA and recontributing it in the same calendar year will result in an over-contribution.

TFSA Versus RRSP: When to Use Each

Generally speaking, if you have a lower income or if you want penalty-free access to your savings, a TFSA is a better option, while an RRSP is typically better for maximizing contributions and reducing your taxable income. Many people use both a TFSA and an RRSP, particularly those with higher incomes. If you’re unsure which account is right for your personal circumstances, you can consult a professional tax planner or a certified accountant.

Common Mistakes

• Recontributing a withdrawal in the same calendar year
• Keeping cash in a TFSA without investing it
• Day trading within a TFSA, which the CRA considers operating a business

Claim All Tax Credits for Which You Qualify

Tax credits allow you to reduce your tax liability directly, and Canadians routinely fail to claim tax credits that they’re entitled to receive. Tax credits typically come in two flavors: refundable and non-refundable. Refundable tax credits can provide you with a refund even if you don’t have any tax liability for the year, while non-refundable tax credits reduce the amount of taxes you owe but don’t give you a refund if you have no taxes owing.

Non-Refundable Tax Credits

Basic Personal Amount: Every Canadian resident is entitled to claim this amount, which means your income is partially tax-free. The main mistake people make in respect of the Basic Personal Amount relates to newcomers to Canada who have arrived in the country in the middle of the year. While you will be entitled to claim the full amount of the Basic Personal Amount for the year of your arrival, the amount is prorated for the year you depart.

Canada Employment Amount: This is a non-refundable tax credit designed to reimburse employees for work-related expenses incurred while earning employment income.

Tuition Tax Credit: Designed to reimburse students for post-secondary education expenses, this tax credit is transferable to a spouse or common-law partner if the student isn’t able to claim it for any reason. People often fail to realize that the tuition tax credit can be carried forward.

Disability Tax Credit: A generous, refundable tax credit for individuals with severe and prolonged physical or mental impairments who are certified as disabled by a qualified medical practitioner on Form T2201. Many eligible individuals fail to claim this tax credit due to a lack of awareness or misconceptions about the eligibility criteria.

Medical Expense Tax Credit: For medical expenses incurred by the taxpayer, their spouse, or their dependants that exceed a certain threshold, which is either 3% of the individual’s net income or a set amount, whichever is greater. One of the most common mistakes taxpayers make in respect of the medical expense tax credit is failing to aggregate expenses for the taxpayer’s spouse or common-law partner in order to claim the credit.

Charitable Donation Tax Credit: A generous, refundable tax credit for donations made to qualified donees, which typically increases by the amount of the donation. Donations by couples can often be claimed jointly in order to maximize this tax credit.

Home Accessibility Tax Credit: Designed to reimburse homeowners for renovations made to their homes to improve accessibility for senior citizens, people with disabilities, and their family caregivers.

Refundable Tax Credits

Canada Workers Benefit (CWB): A generous refundable tax credit for low- and middle-income workers that has an option for automatic advance payments

GST/HST Credit: A quarterly tax-free payment made to low- and middle-income taxpayers and families for a portion of the GST/HST they’ve paid throughout the year. This is yet another reason why it’s important to file a tax return even if you have no income.

Canada Child Benefit (CCB): A tax-free monthly benefit for qualifying families with children that’s based on the number of children and the family’s level of income.

Climate Action Incentive / Canada Carbon Rebate: A quarterly payment designed to reimburse households for a portion of the costs associated with the federal carbon tax, for residents of provinces that have adopted the federal carbon tax. Eligibility and amounts vary depending on the province and the taxpayer’s family size. Be sure to check the website for the province where you reside, as the carbon tax and the rebate have undergone numerous changes recently.

In most cases, you must file a tax return in order to receive any of the refundable tax credits discussed above. Therefore, even if you have no income for the year, you may still need to file a tax return in order to receive any of the benefits discussed above. In fact, many low- and middle-income Canadians are surprised to find that they’re entitled to numerous tax credits for which they don’t claim.

Go through this list of tax credits every year and ensure that you’re claiming every tax credit available to you because tax credits are oftentimes changed or modified from one year to the next. Moreover, your eligibility for certain tax credits can change if your family situation changes, so be sure to take note of the eligibility criteria for the various tax credits.

Deduct Eligible Expenses

Eligible Deductions For Employees

As an employee, you have far fewer options when it comes to claiming deductions and expenses on your income tax return, but some of the most common deductions for employees include the following:

• Home office expenses: If you are required to work from home, you may be able to claim a deduction for a portion of your home that you use for work, up to a specified square footage, if your employer completes the required form.
• Travel expenses: Employees who regularly incur travel expenses as part of their job may be able to claim those expenses as a deduction, provided that they aren’t reimbursed for them by their employers.
• Supplies: Tools, materials, and other supplies bought for work may be claimed as a deduction if they are required for the job and you can’t receive reimbursement for them from your employer.
• Professional dues: Union fees and other professional fees may be claimed as a deduction for the year they were paid.

Eligible Deductions For The Self-Employed

Self-employed individuals and small business owners have a far wider range of eligible deductions, since most expenses that are “reasonable and necessary” in earning income may be claimed as a deduction on your income tax return. Some of the most common deductions for the self-employed and small business owners include the following:

• Home office: Similar to employees, self-employed individuals and small business owners may claim a deduction for a home office if they use it to earn income, though they’ll have to claim the percentage of the home that they use for business purposes.
• Internet: The business-use portion of your internet bill may be claimed as a deduction.
• Automobile: The business-use portion of your fuel costs, insurance costs, and car lease or loan payments may be claimed as a deduction – be sure to track your vehicle usage with a log in order to claim these expenses.
• Business insurance: Business insurance policies may generally be claimed as a deduction, as they’re considered to be reasonable and necessary expenses in earning business income.
• Advertising and marketing: Advertising and marketing expenses may generally be claimed as deductions, as they’re considered to be reasonable and necessary expenses in earning business income.
• Professional Fees: Accounting and legal fees may generally be claimed as deductions since they’re considered to be expenses incurred in earning business income.
• Equipment and Computer Hardware: Larger equipment purchases generally depreciate over time rather than being fully expensed in the year they’re purchased. The same rule generally applies to computer hardware as well, though some smaller purchases can be fully expensed.
• Meals and Entertainment: Expenses for meals and entertainment may generally be claimed for the business-use portion of the expenses, up to 50% of the amount for expenses that are directly related to earning business income.
• Travel: Business travel expenses may generally be claimed as deductions as well, for the business-use portion of the expenses.

A freelance graphic designer works from a spare bedroom that takes up 15% of the square footage of the home. That means they can claim 15% of eligible home costs as a deduction. In addition to that, the graphic designer can claim 100% of the software they purchase for use in their business. They can also claim the business-use portion of their vehicle expenses, based on the distance travelled for business purposes.

Common Mistakes

• Claiming 100% of home office costs, even when the home office is smaller than the minimum square footage
• Failing to keep records to support vehicle expenses
• Claiming personal meals as business expenses
• Claiming expenses that are paid for with the same bank account that you use for personal expenses

Income Splitting

Income splitting refers to a strategy wherein you transfer some income-earning activities to a lower-income family member so that you can reduce your overall tax liability as a family.

Pension income splitting: You and your spouse or common-law partner can split your eligible pension income, reducing the higher-income spouse’s pension income and increasing the lower-income spouse’s pension income for the purposes of calculating taxes owing. You don’t actually have to transfer any funds from one spouse to the other – this is strictly a tax reporting issue on your joint tax return.

Spousal RRSP: Your higher-income spouse can make contributions to a spousal RRSP using their RRSP contribution room, and any withdrawals from the spousal RRSP will be included in the lower-income spouse’s income. There are restrictions and conditions around spousal RRSPs, however, including rules around the timing of withdrawals and attribution of income, so it’s important to understand how they work before attempting to use them.

Hiring family members: You can deduct salaries paid to family members who work in your business, assuming that the compensation is reasonable for the work performed and that the work itself is genuine. The income earned by the family members would be included in their income as well, so this can be a great way to reduce overall taxes owing by shifting some income-earning activity to a lower-income family member, particularly if they qualify for other deductions or credits.

Attribution rules: Gifts and loans between spouses are generally subject to attribution rules, meaning that any income or gains earned on the gifted amount will be reported by the person who made the gift rather than the recipient, with a few notable exceptions. This is particularly important for loans between family members, as interest charges must be calculated according to strict CRA guidelines, or the loan may be considered to be a gift for tax purposes.

Scenario: A business owner pays her spouse a salary for bookkeeping services she performs for the business. The salary is reasonable for the work performed and is fully deductible to the business, and the spouse pays taxes on the income at her lower income tax rate, reducing the overall amount of taxes owed by the married couple.

Capital Gains Strategies

Understanding the Inclusion Rate

When you dispose of a capital asset, only a portion of the gain is included in your income as income from capital gains. This inclusion rate was changed in recent years for certain gains, so confirm the current rate directly with the CRA.

Considerations Regarding Timing and Losses

The most important thing to note about timing and losses is that you can carry forward capital losses to future tax years in order to reduce the amount of taxes you owe on capital gains in those years. Losses can also be carried back up to three years in order to reduce taxes owing in previous years.

In the future, when you sell your business or your investment property, be sure to consider the Lifetime Capital Gains Exemption. You may also be able to make use of various strategies to help you reduce the amount of capital gains you report on your investment property.

You may want to sell an investment in the year in which you expect to have the lowest income, in order to reduce the amount of taxes you’ll owe on the gains from the sale. Moreover, if you’re considering buying a business or an investment property, consider selling it in the year in which you expect to have the lowest income as well, since it may allow you to reduce the amount of taxes you’ll owe on the gains from the sale in the future.

Homeownership Tax Benefits

Principal Residence Exemption

Your gain from the sale of your principal residence is generally exempt from income tax, provided that it was your principal residence for every year that you owned it. Be sure to designate the property as your principal residence in the year that you sold it.

Home Buyers’ Amount

A non-refundable tax credit designed for first-time home buyers (or qualifying home buyers with disabilities).

First Home Savings Account (FHSA)

A registered account that offers the best of both worlds – contributions are tax-deductible (like an RRSP), and withdrawals to buy a qualifying first home are completely tax-free (like a TFSA). It has its own contribution rules, however, so ensure that you understand them before making any contributions.

Home Office Deductions

Covered above in Eligible Deductions for Employees and Eligible Deductions for The Self-Employed.

Rental Properties

Eligible expenses on rental properties can be claimed as deductions, even if the property was your principal residence at one point. The ability to claim the Capital Cost Allowance (CCA) on a rental property usually prevents you from being able to claim the principal residence exemption on the property in the future, if it was rented out at any point.

Renovations

Various federal and provincial programs offer rebates and tax credits for certain types of renovations, including energy-efficient renovations and renovations made to improve the accessibility of a home for senior citizens and people with disabilities. These programs change frequently, so consult the relevant websites for more information before making any renovations.

“Lowering your taxes in Canada often comes down to utilizing the various tax shelters and incentives that the government puts in place. The strategies and considerations outlined in this guide can potentially reduce your tax liability significantly, with many people realizing the benefits for decades to come, particularly when it comes to maximizing one’s RRSP and TFSA contributions and claiming the various tax credits for which one is eligible. It’s important that you keep up with the latest changes to these programs, as the CRA frequently updates contribution limits, eligibility requirements, and more. Consult a qualified tax agent or CPA for information specific to your personal circumstances.”