Tax Planning Strategies For Canadian Taxpayers

Income, Expenses, and Taxable Income for Marcus and Karla

The income for Marcus for the year is $72,000 plus the additional extra income of $16,800 (1,400x 12 months). This totals to $ 88,800. The expenses incurred in generating extra income include; costs of leasing the car used to travel to teach piano $ 400, insurance of $ 120, $ gas and operating expenses $ 110 and repairs and maintenance $85. This totals to $ 715, 30% of the cost is tax deductible ($ 214.5). Subtracting RRSP from the total income is $ 87,241.5 (88,585.5-1,344). Subjecting under the graduated scale;

First $ 49,090 x 15% = $ 7,363.5

The next (87,241.5 – 49,090) x 20.5% = $ 7,821.0575

Total tax = 7,363.5 + 7,821.0575= $ 15,184.5575

The income for Karla for the year is $ 84,000. Subtracting RRSP from the income (84,000 – 1872), the taxable income is $ 82,128. Subjecting under the graduated scale;

First $ 49,090 x 15% = $ 7,363.5

The next (82,128 – 49,090) x 20.5% = $ 6,772.79

Total tax =7,363.5 + 6,772.79 = $14,136.29

Karla should contribute to the retirement account of Marcus since her salary is higher. When the spouse contributes to a retirement account, the tax payable will reduce (Beattie, 2021). The couple could also consider opening a business so as to claim expenses relating to running the business hence reducing their tax liability. The couple should also increase investment in an RRSP, the contribution can be deducted from the taxable income, up to your annual RRSP deduction limit, thereby reducing the taxes you will have to pay (Wealth management.com). Marcus and Karla should also maximize tax credits and deductions available at their disposal. The couple should consider speaking to their employer concerning increasing the non-taxable benefit in an exchange for salary or any other benefit which is taxable. Marcus should consider deducting the expenses he incurs while traveling to teach piano so as to reduce his tax liability. The expense is allowable against the taxable income. The couple should start earlier in the year to undertake tax reduction measures.

Tax planning refers to a legal way of reducing the tax payer burden during a financial period. It enables the tax payer to take advantage of the various tax avenues offered by the authorities. (Franklintempletonindia.com).

It minimizes litigation: this involves solving disputes easily with the tax authorities. Therefore saving the tax payer from legal liabilities.

It reduces tax liabilities: tax planning enables the tax payer to take advantage of the various schemes that enables them to reduce their tax liability.

 It facilitates economic stability: tax planning ensures an effective flow of money in the economy which results to an economic growth.

It leads to flexibility in tax payment: tax planning provides individuals with the most flexible approach to payment of tax. This reduces the effect on personal finances (Arrowrootfamilyoffice.com).

According to Horton 2022, the following ways are applicable measures to decrease tax liability by a tax payer;

1. Contribution to a retirement account through either an employee individual registered savings account or a plan sponsored by the employer.
2. Adopting flexible spending plans so that part of earnings are absorbed by the some employer plans such as medical schemes
3. Opening health savings account which allow pre-tax income to be used to meet medical expenses later.

This is the total tax divided by the taxable income. It measures the respective tax burden of households showing the effect of tax on the ability of households to consume now or in the future (taxpolicycenter.org).

Graduated Scale and Total Tax Payable for Marcus and Karla

This refers to the incremental tax which is paid on additional income. It measures the extent to which tax might affect household decisions for example a decision whether to increase the savings, invest in a risk project or any other decision (prasadcpa.com).

This is a retirement savings plan created and registered by a couple so as to contribute to the plan as a family (Canada.ca, 2021). The contributions of RRSP that are deductible is used to reduce tax liability. Income arising from the plan is exempted from taxation given that the funds are kept in the plan. However any income received from the plan is subject to taxation.

According to Kagan 2020 (RESP) is a plan which facilitates parents invest into the education of their children at the university or college level. The contributions made earn a tax free earnings until the time of withdrawal. For children under the age of 18 years, their plan is supported by the government by contributing certain amount to the plan. Children with this plan can withdraw the money at a tax free rate. The Nagis family should consider this for their son Peter.

A tax-free savings account (TFSA) is a Canadian account where individual contributions, any interest or dividends earned can be withdrawn without any tax charge (Kagan, 2021). The account can hold investments such as mutual funds, bonds, cash and securities. The account can serve several purposes and can be opened by individuals of 18 years and above.

According to Golombek 2020, income splitting involves the transfer of income by a family member who is earning higher income to another family member earning a lower income in an aim to reduce the tax burden of the family. The Canadian tax system is based on a graduated scale hence by having the taxable income taxed on lower income earner’s the tax burden reduces. Therefore it’s a tax planning technique that facilitates shifting of income from a family member who is in the higher tax bracket to someone within the family in the lower tax bracket for example the child or spouse.

This refers to a situation where the tax payer delays the payment of tax to a later date in future. Taxes could be deferred indefinitely or taxed at lower rates in future. Another form of deferring taxes involves retention of corporate profits abroad. For individual tax payers deferring taxes on involves depositing money into a retirement account. In case the contributor is tempted to withdraw savings before the age of 59.5 years, he or she pays a 10% penalty of the amount. However withdrawal after the recommended age limit will enjoy a favourable tax rate (bankrate.com).

These are amounts that can be directly subtracted from the tax payer’s taxable income before calculating tax. The deductions for tax payer doing business are more compared to those who are employed. Some of the deductions in Canada are; support payments made to an ex-wife or husband and contributions to a registered savings plan (legalline.ca).

According to cooperators.ca, the major difference between RRSP and TFSA accounts is brought about by the tax implications. RRSPs offers a tax deduction while contributing however when withdrawing your money you pay tax. On the other hand TFSAs does not offer an up-front tax break, however no payment is made during withdrawals, which is inclusive of any growth.

Marcus supplements his income by teaching piano. He generates a monthly income of $ 1,400 a month. This income is taxable, and expenses incurred income during generation of this income are allowable expenses. The expenses include; costs of leasing the car used to travel to teach piano $ 400, insurance of $ 120, $ gas and operating expenses $ 110 and repairs and maintenance $85. This totals to $ 715, 30% of the cost is tax deductible ($ 214.5).

The Canada Pension Plan (CPP) retirement pension is a monthly, benefit that is subjected to tax received by individuals as an income to support individuals who qualify for the plan (canada.ca). The family of Nagis should contribute to the plan while still on employment so as to qualify for CPP upon retirement (cppinvestments.com).

OAS is designed to provide aging people with a monthly income to cover basic needs upon retirement (qtrade.ca). An individual qualifies upon attainment of 65 years of age. The Nagi’s family can apply OAS upon attaining the age of 65 years.

This is a plan to benefit the employee where the employer and employee contributes a certain amount on a monthly basis to a pool of funds that is set aside until retirement of the employee. The Nagi’s family should contribute to pension together with their employer so as to access the money when they retire.

According to Lamarche 2019, both (RRSP) and (TFSA) are good plans to invest for retirement savings. RRSPs work well for the Nagis since they do not allow them to make withdrawal of the funds until retirement. This will facilitate the family to realise their financial goals. On the other hand TFSAs is flexible and enables the family to access their savings when need arises. Both are therefore good for the Nagis.

References

A Complete Guide to Tax Planning Arrowroot Family Office. Retrieved from https://www.arrowrootfamilyoffice.com/services/tax-planning/

Beattie, A. (2021). Tax-Saving Tips For Canadian Taxpayers. Retrieved https://www.investopedia.com/articles/pf/07/canadian_tax.asp

Golombek, J. (2020). The Great Divide: Income Splitting Strategies Can Lower Your Family’sTaxes.Retrievedfrom

https://www.cibc.com/content/dam/personal_banking/advice_centre/taxsavings/income-splitting-strategies-en.pdf

Horton, M. (2022). What Are the Best Ways to Lower Taxable Income? Retrieved from

https://www.investopedia.com/ask/answers/012715/what-are-best-ways-lower-my-taxable-income.asp

https://www.legalline.ca/legal-answers/what-are-tax-credits-and-benefits/

https://www.canada.ca/en/revenue-agency/services/tax/individuals/frequently-asked-questions-individuals/canadian-income-tax-rates-individuals-current-previous-years.html

https://ca.rbcwealthmanagement.com/documents/10192/1395176/Tax+planning+for+high+income+earners_English.pdf/398cb480-23ae-4079-bba1-4c81cbffaa5e

https://www.taxpolicycenter.org/briefing-book/what-difference-between-marginal-and-average-tax-rates

https://www.prasadcpa.com/blog/how-to-reduce-income-tax-in-canada/

https://www.canada.ca/en/government/about.html

https://www.bankrate.com/glossary/t/tax-deferral/

https://www.rbcgam.com/en/ca/learn-plan/retirement-resources/rrsp-vs-tfsa/detail

https://www.insurancestrategiesva.com/tax-free-retirement-income

https://www.bmo.com/main/personal/investments/learning-centre/understanding-tfsa-the-basics/

https://www.investopedia.com/terms/t/tax-free-savings-account-tfsa.asp

https://dash.harvard.edu/bitstream/handle/1/31740606/67TaxLRev317.pdf?sequence=3&isAllowed=y

Kagan, J. (2020). Registered Education Savings Plan (RESP). Retrieved from https://www.investopedia.com/terms/r/resp.asp

Lamarche, L. (2019). Combining RRSPs and TFSAs to maximize retirement savings. Retrieved from

https://www.atb.com/personal/good-advice/saving-and-investing/combining-rrsps-and-tfsas-to-maximize-retirement-savings

Understanding TFSAs: What They Are and How You Can Use Them. Retrieved from

https://www6.royalbank.com/en/di/hubs/investing-academy/chapter/understanding-tfsas/ki58km35/ki58km3u