Tax Time

I'll call this the Tax special. Canadians (and others as well) are well into Tax season - everyone's favourite time of the year :) Some things to think of at this time ...

1. File early: I don't believe that I am unique in delaying filing my taxes simply because I am too lazy to get around to it. Canada Revenue Agency (CRA) is normally pretty good at grabbing your taxes through the year. So most of us file to get some back in the form of Tax refunds. And so if you are due to get a refund, better today than tomorrow. So get on it.

2. Slips and receipts: Make sure you have all your tax slips and receipts. Sometimes we change jobs a few times during the year or move accounts or actually move ourselves. Keep track of who owes you a T4 or T5 or RSP or Charitable Donation or other receipts. Businesses have until the end of Feb to mail out the slips. So if you have not received them by now, feel free to get in touch with them and find out what's happening. Worst case, call CRA and they will help you get your T4s.

3. Deductions: The Tax system offers a bunch of deductions ... even for us lowly employed folk. Make sure you use all of them that apply. Some common ones include RRSP, Child Care, Children's Fitness Tax Credits, Public Transit Credits, Medical Expenses, Relocation (if moving to be at least 40 kms closer to your job or school), Tuition credits (for students), Property Tax or Rent credits etc.

4. Save copies: Make sure you save yourself a copy of everything that you send to CRA. With online filing, a lot of us never send anything. But we also tend to get rid of stuff as soon as the refund cheque comes in. CRA send the refund cheques automatically assuming that your filing was accurate. They tend to take their time to decide if they need to look at your return closely and have upto 6 years (or is it 5) to request additional information or receipts. I normally advise people to keep their copy of the return and documents for upto 7 years. The analytical ones amongst us might want to store stuff even longer if they want to track their income patterns / tax payments etc. It can be fun :)

5. Carry forward amounts: Don't forget about your carry forward amounts. Tuition credits, unclaimed RRSP contributions, Capital losses, charitable donations etc can be carried forward. Make sure you do not forget about them.

Random tips:

• If you donate money to charitable organisations (and you should) remember that the first $200 each year only offer you a 15% deduction. Donations beyond the $200 mark offer you a much larger deduction. So if you only donate around $200 each year, it is a good idea to hang on to your receipts and claim them once every 5 years (you can carry forward your donations for 5 years). That way you get the maximum bang (tax-wise) for your charitable donations.

• All the govt support programs (child tax benefit, OAS, Disability, GIS, HST credits etc) are linked to your tax returns. What does that mean? It means that if you do not file, you won't get your benefits. So even if you have minuscule income, make sure you file your return.

• If possible get the highest income earner in your family to claim the deductions. This will get you the biggest refund for those deductions since the deductions are always at the marginal tax rate. Pension splitting lets you get the same for seniors. A number of credits can be transferred amongst family members. One example is the Tuition credit. Students get a credit based on the tuition fees paid. They can carry forward this credit themselves to future years when they start having income. Or they can transfer it to their parents. If you are studying to be a Doctor or in an MBA program or something similar which will allow you to land into a high paying job as soon as you graduate, it may make sense to keep your credits for yourself. If however your parents have income that is significantly higher than what you will have (which is true in most cases), let them take the deduction for a bigger refund.

• CRA doesn't complain too much if you are due a refund and you do not file your return. However if you owe, you absolutely must file by the April 30 deadline. Failure to file may result in penalties in addition to interest charges on the amounts owing. If you do not have the funds to send in a cheque along with your return, it is still a good idea to file your return. Call CRA and let them know of your situation. As long as you have filed your return, there won't be a penalty. And they may even be willing to waive the interest payments if you ask nicely.

• Made an honest mistake in your taxes and realized it after you filed - file a T1 Adjustment. Need to come clean on income you had that you didn't report - use the Voluntary Disclosure process to kill those tax audit nightmares. However this won't work if CRA has already started investigating you. So the sooner the better.

• Can't understand taxes and can't afford to pay someone to do them for you? If you are truly low income and have a simple tax situation (i.e. no business / investment income etc) you can avail yourself of the services of the volunteer tax preparers as part of the Community Volunteer Income Tax Program (CVITP

Any more you can think of? Please feel free to add in the comments.

Why is employing legal tax avoidance strategies a bad thing?

There is a tax code that all Canadians have agreed to (through their elected representatives who have voted on the various provisions and passed it into law come budget time). The Canada Revenue Agency enforces this tax code by making sure that everyone pays their fair share. But what is this "fair share". In my opinion, a "fair share" is what you must pay as per the tax code. You might think that I am just repeating myself. But there is a subtle difference.

Consider this scenario of 2 identical families with 2 adults and 2 children (say 5 and 9 years old). Both families have a single income and for the sake of simplicity let us assume that they both have employment income as their sole source of income. Both are neighbours living in the same kind of home as well so everything is identical between them. Again to keep things simple, neither has any RRSP deductions or any deductions for that matter except what I list below.

Family 1: 
Annual Income : $40,000
Charitable Donation deduction: $0
NET income after taxes, CPP & EI deductions: $35,073
Average tax rate: 12.32%
Net disposable income after accounting for Charitable Donation: $35,073

Family 2:
Annual Income : $61,600
Charitable Donation deduction: $21,600
NET income after taxes, CPP & EI deductions: $57,995
Average tax rate: 5.85%
Net disposable income after accounting for Charitable Donation: $36,395

As you can see above, Family 1 with a pre-tax income of $40,000 pays 12.32% of their income in taxes and takes home $35,073.

Family 2 on the other hand, in trying to be identical to Family 1, donates every dollar of their income that is in excess of their neighbour's income to charity. Their effective tax rate is 5.85% and after accounting for their charitable donation and taxes, they take home $36,395.

Most people will simply look at the tax rate and the pre-tax annual income and scream bloody murder.

How is it fair that a family making 50% more income pays taxes at a rate that is half that of the lower income family? And to add insult to injury, they end up with more money at the end of the year.

This is where all the "Occupy" folks are dead wrong. Family 2 is simply taking advantage of the tax code and coming out ahead. It is difficult to find fault with Family 2 in this example because they are giving away so much money to charity. So even the people who would normally have an issue with this case will likely hold back. But Family 2 could have very easily used other deductions to achieve similar results ex RRSPs, Dividend Investments, Capital gains, Public transit credits, Children's Activity credits, Medical expenses credits, tuition credits etc.

And I do not see anything wrong with that. They are simply paying their fair share of taxes and using the existing tax code to do what works best for them. If their effective tax rate turns out to be lower than their neighbours, its not their fault.

Millionaires and Billionaires like Warren Buffet likely use all these strategies and more to end up with an effective tax rate that is lower than what their chauffeur or secretary has.

So why do we frown on folks that follow the letter of the law and come out ahead?

Tax Rates

Here's an interesting article in the Globe and Mail talking about the why it is important to do a bit more thinking before making changes to laws and tax codes. The discussion stems from a proposal to hike the rates at which capital gains are taxes.

Here is the article.

A lot of people tend to take a simplistic view of things and tend to make snap judgements about whether something is a good idea or not. This if often coloured by their own situations, experiences, biases and political and financial affiliations. Something we all need to learn to do is to step back and take a "bigger picture" view of the situation.