Tax Tips
These newsletters offer a range of advice on succeeding on Canada’s business economy. Check back for regular updates, or see below for ten of our top Tax Tips.
Ten Tax Tips
What is an RRSP?
An RRSP, or Registered Retirement Savings Plan, is a registered investment or savings account which allows you to defer paying income tax on funds deposited and on any income earned by your investments. The deferral of tax on your investment income allows your investments to grow more quickly since 100% of your investment income can be reinvested into your account.
Contributions to your RRSP are deductible from your taxable income in the year in which the contribution is made, but can also be carried forward and deducted in any future year before you reach the age of 71.
Your contribution limit is 18% of your earned income in the previous year, to a maximum $22,450 for 2011, plus any unused contribution room carried forward from previous years. Your current year’s contribution limit can be found on your previous year’s Notice of Assessment. It is important not to exceed your contribution limit as excess contributions are subject to a 1% penalty per month.
Since contributions to your RRSP are deductible from your taxable income, the higher your marginal tax rate, the greater your tax savings will be. Therefore, the benefits of deducting your RRSP contributions in the current year should be weighed against the benefit of carrying forward your RRSP contribution and deducting them in a future year when your marginal tax rate could be higher.
What is a Tax-Free Savings Account (TFSA)?
If you were 18 years of age or older in 2009, you were eligible to open a TFSA. If you were not 18 years of age in 2009, you become eligible to open a TFSA in the year in which you turn 18. In other words, if you were 18 in 2009 and have never contributed to a TFSA, you will be eligible to donate $15,000 to your TFSA in 2011.
You may contribute a maximum of $5,000 to your TFSA each year. However, any funds withdrawn from your TFSA cannot be reinvested until the subsequent year. For example, if you contributed $5,000 to your TFSA on January 1, 2011 and then withdrew $1,000 on June 15, 2011, you would not be able to top up your TFSA until January 1, 2012 at which point you could contribute $6,000. It is important to ensure that your total annual contributions do not exceed $5,000 (plus any withdrawals made in previous years) as excess contributions are subject to a 1% penalty per month.
TFSA particulars:
- Investment income (interest, dividends, trust distributions and capital gains) will accumulate tax-free
- Contributions are not tax-deductible
- Withdrawals are not taxable
- Capital losses are not tax-deductible
- Dividends will not be eligible for the dividend tax credit
What is a Guaranteed Income Supplement (GIS) for Canadian seniors, and the Allowance?
The Federal Guaranteed Income Supplement (GIS) is available to low-income seniors living in Canada, who are receiving (or are eligible to receive) the Old Age Security Pension (OAS). An application must be filed to receive this supplement - it is not done automatically when you file a tax return. Once a person is receiving GIS, it will be automatically adjusted each year after the income tax return is filed. For October to December 2010, the maximum combined payment from OAS plus GIS is $1,180.02 per month, for a single person. This maximum is reached if there is no income other than OAS and GIS.
Income from GIS is tax-free.
What are the Tax implications of owning a cottage or second home?
A cottage, or second home, is considered personal-use property, if it is used primarily for the personal use or enjoyment of
- the taxpayer,
- individuals related to the taxpayer, or
- where the taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary
There is no deemed disposition if a person moves into their cottage, so no tax will be payable as a result of this move. However, if the use of the property changes from personal use to being used for the purpose of gaining or producing income, such as a rental property, there is a deemed disposition.
When a cottage is sold, tax is payable on any capital gain, less any principal residence exemption. If there is a capital loss, the loss is not deductible; losses on personal-use property are not deductible. Where you own a vacation home it is important to always review the principal residence exemption when your home or cottage is sold.
Should you incorporate your small business?
When a business is started, it can be structured as a proprietorship, partnership, or corporation.
Proprietorship
A sole proprietorship is one person operating a business, without forming a corporation. The income of the business is then taxed in the hands of the owner (the proprietor), at personal income tax rates. The income is considered income from self-employment, and is included on the personal income tax return of the owner.
Partnership
A partnership is also an unincorporated business. It is similar to a proprietorship, except two or more entities are partners in the business. For partners who are individuals, the income from the partnership is taxed at personal income tax rates and a percentage of the income is included on the personal income tax return of each owner.
Corporation
A corporation is a separate legal entity, which is formed by application to either the federal government, or one of the provincial/territorial governments. The corporation issues shares to the owners, or shareholders. The funding of the corporation can be done through the issue of shares, or by borrowing. Instead of investing a large amount in shares, shareholders can lend money to the corporation, and invest only a minimal amount in the shares. This way, when the corporation has available cash, the shareholder loans can be repaid without attracting personal income tax.
Being a separate legal entity, a corporation pays corporate income tax, which is calculated separately from the owners' personal income tax. If the corporation pays wages to the shareholders, income tax, Canada Pension Plan contributions, and Employment Insurance premiums, must be deducted as applicable and remitted to Canada Revenue Agency.
Can Barter transactions result in taxable income and GST/HST payable?
Do you trade goods or services which you would normally sell in the course of your business?
If a transaction will have tax implications if money changes hands, it will have the same tax implications if it is a barter transaction. These transactions may result in taxable income or tax-deductible expenses. They may be considered dispositions of capital property, eligible capital property, personal-use property, listed personal property, or inventory, each of which has a different tax treatment.
A barter transaction occurs when two people or entities agree to trade goods or services without any money changing hands. When this occurs between people dealing with each other at arm's length, the value of the goods or services is deemed to be the value that would have been obtained for those goods or services in a regular cash transaction.
When a person provides bartered goods or services which would normally be sold in the course of business, the value of those services must be included in income. If the person is a GST registrant, then GST would have to be remitted on the income. The value of the bartered services is included in income when determining if the person has reached the threshold of income to become a GST registrant.
When a person receives bartered goods or services which would normally be purchased in the course of business, the value of those services can be claimed as costs to the business. If the person is a GST registrant, then an input tax credit could be claimed.
Property rental - What expenses can be deducted from income?
If you rent out one or more rooms in your home, or if you own a rental property, there are many expenses that can be deducted in calculating your net rental income. These expenses include mortgage interest (but not principal), property taxes, utility costs, house insurance, maintenance costs, advertising, and property management fees. Rental income and expenses are recorded using the accrual basis of accounting. Rental losses can generally be used to reduce income from other sources. If the rental loss exceeds income from other sources, and cannot be deducted on the current year tax return, it becomes a non-capital loss, which can be carried back or forward to reduce taxable income in other years.
If you rent out only a portion of your home, you would only be able to deduct a portion of the costs. If you rent a room to a friend or relative at less than fair market value and this results in a rental loss, you would not be able to deduct the rental loss.
Capital cost allowance (CCA) may be claimed based on the purchase price of the building, furniture and fixtures, etc., but not the land, and may not be used to create or increase a rental loss. If you only rent a portion of your home, then you would only be able to claim a portion of the CCA. However, you need to be aware that if CCA is claimed on your home, you can lose your principal residence exemption when you eventually sell your home. The claiming of CCA will probably result in a recapture of the CCA when the property is sold. This will happen if the selling price of the building is greater than the remaining undepreciated capital cost (UCC) at the time of sale. The difference between the original cost and the UCC will be added back to income. If the selling price is greater than the original cost of the building, then the difference between the selling price and the original cost will be a capital gain. When purchasing or selling a rental property, it is important to break down the purchase or sale price between buildings and land.
A change in use of your home from personal residence to rental property, or from rental property to personal residence, can result in a deemed disposition for tax purposes. This means that you will be considered to have sold your home and repurchased it immediately thereafter for fair market value. There are many factors which affect this, and professional advice is recommended.
Net rental income or loss is reported on line 126 of your personal tax return. This net income is included in "earned income" for purposes of calculating your allowable RRSP deduction limit for the following year.
Canada Revenue Agency (CRA) has a Rental Income Guide (T4036) which goes into detail about deductible expenses, capital cost allowance, deemed dispositions, and most issues regarding property rental.
What books and records must be kept for a business?
Any person (individual, partnership, corporation, trust, etc.) carrying on a business must keep books of accounts and records which provide the ability to calculate taxes payable. These books and records must be supported by "source documents" which substantiate the amounts in the books of account. Source documents include (but are not limited to) invoices for purchases and sales, deposit slips, cheques, and contracts. These books and records are used to prepare financial statements of the business, which must be prepared according to generally accepted accounting principles (GAAP).
For purposes of income tax, many books of accounts, records, and source documents have to be retained for a minimum of six years after the end of the last tax year to which they relate. In the case of records regarding capital purchases, the last tax year to which they relate would be much later than the acquisition date; it would be the tax year in which a disposal of the capital property occurred, because the purchase records would be required to calculate the gain or loss on disposal. Thus, records regarding capital property should normally be kept until six years after the end of the tax year in which the capital property was sold.
Some books and records of the business of a person (other than a corporation) must be retained until six years after the tax year in which the business ceased.
What is the underground economy and why should I be concerned?
The underground economy typically involves commercial activity that is unreported for tax purposes. It is of concern to the CRA, as well as all provincial, territorial and municipal jurisdictions, and all law-abiding businesses and individuals across the country.
Why you should not support those who participate in the underground economy:
The underground economy hurts all Canadians. Those who participate in the underground economy avoid their tax responsibilities at your expense, and place an unfair burden on all law-abiding taxpayers. Unpaid taxes mean less money for programs, such as health care, childcare, employment insurance and pensions.
The underground economy also undermines the competitiveness of businesses and individuals because it offers an unfair, illegal advantage to those who fail to comply with Canada's tax laws. It undermines the integrity of our tax system.
Find out more on the CRA website.
Why should I pay my installments if my return isn’t due until the next filing season?
Instalments are periodic income tax payments that individuals have to pay to the Canada Revenue Agency (CRA) on certain dates, to cover tax that they would otherwise have to pay in a lump sum on April 30 of the following year. Installments are not paid in advance; they are paid throughout the calendar year in which you are earning the taxable income. If you do not pay your required instalment, you will be assessed non-deductible interest charges. We generally suggest that you borrow on your line of credit rather than paying interest on unpaid installments.
