With the extensive increases in personal tax rates in Ontario and across the country, it is essential to be mindful of the various tax credits and deductions that are available to you as a taxpayer. Access to various credits / deductions is dependent on your sources of income. As a self-employed individual incurring expenses to earn income, you generally have the greatest access to deductions against income; an expense is deductible if incurred to earn income, provided that the Act does not specifically disallow the expense. By way of contrast, a deduction may only be claimed against employment or investment income if authorized by the Act- such expenses are narrow in scope.
With the significant number of potential credits / deductions, it is not possible to list all of them here. Instead, we will concentrate on the specific elements of two key deductions/credits: RRSP deductions and Charitable Donation credits.
We are often approached by clients with large RRSP contribution limits accumulated over a number of years. For one reason or another, they are now in a position to deposit a large amount to their RRSP. Their first instinct is often to deposit the whole amount and deduct it on their current year’s return to offset income and generate a refund. There can be a better outcome.
The key to this planning is determining if all of the RRSP deduction offsets high rate income in the current year. We have graduated tax brackets such that the rate of tax increases as taxable income increases – the top tax bracket is reached at taxable income of $220,000 wherein the combined federal / Ontario tax rate is 53.5%. By way of contrast, income up to approximately $41,000 is taxed at a rate of 20%. The preceding has a direct correlation with respect to tax saved by virtue of an RRSP deduction. This can be illustrated as follows:
- An RRSP deduction of $10,000 which offsets taxable income in the top tax bracket saves $5,350 of tax; and
- An RRSP deduction of $10,000 which offsets taxable income in the lowest tax bracket saves $2,000 of tax.
We are not saying do not make the contribution. We are saying it is prudent to evaluate the tax savings that arise by virtue of an RRSP deduction. You must consider the merits of postponing some or all of an RRSP deduction to a future year when the RRSP deduction will generate more tax savings. Remember that the RRSP deduction limit sets the maximum that can be contributed to an RRSP, however the decision to deduct the RRSP contribution is discretionary.
You should know the following about the charitable donation tax credit:
- For federal purposes, the first $200 of donations leads to a tax credit at a 15% rate, above $200 a credit is earned at a 29% rate, except for a taxpayer with income in excess of $200,000 where the donation credit is at a 33% rate.
- Ontario follows a similar framework such that the combined value of a donation tax credit, for an Ontario taxpayer, is a low of 20% and a high of 50%.
- An annual limit is imposed on donations such that the amount claimed cannot exceed 75% of net income. Charitable donations can be deducted in the year of donation or carried forward five years.
- Gifting eligible property to a charity is beneficial because the underlying gain with respect to the disposition is not subject to tax. Eligible property includes securities such as shares and bonds listed on a prescribed stock exchange. Based on this, the after tax advantages associated with a gift of eligible property vs. cash can be significant
The purpose of this article is to display the ability to slightly alter an otherwise good tax planning strategy to make it great.