Each year at this time, the Canada Revenue Agency corresponds with millions of Canadians. The letters it sends -- known as notices of assessment -- contain the results of CRA's evaluation of 2014 income-tax returns. The arrival of your assessment notice is an excellent time to do some tax planning for the coming year. Acting now to arrange your finances in a more tax-efficient manner will mean a lower tax bill next April.
Estimating your marginal tax rate (the rate on your next dollar of income earned) in 2015 is a good place to start. Unless you expect major changes in income, your 2014 marginal rate is a reasonable proxy. It is based on your taxable income, which you can find on line 260 of your 2014 notice of assessment.
Your marginal tax rate depends on where you live because Canadians pay both federal and provincial/territorial income taxes, and the latter vary by jurisdiction. Canada has a progressive income-tax system, so tax rates rise with increasing income. The rate also depends on the type of income.
You can find your combined federal and provincial/territorial marginal tax rates by consulting Morningstar's Marginal Tax Calculator.
Consider the case of Angelina, an Ontario resident with a 2014 taxable income of $75,000. This income falls in the "over $72,064 to $81,847" tax bracket, which attracts a 32.98% marginal tax rate for regular income such as salary and interest. If Angelina lived in Alberta, her marginal tax rate would be 32%, and in Quebec it would clock in at 38.37%.
After tax, Angelina would have just 67 cents in her pocket (68 cents in Alberta and 62 cents in Quebec) for each additional dollar of regular income she earns above $75,000 until her income reaches the next tax bracket.
If Angelina expects more taxable income in 2015, say $85,000, another Ontario tax bracket (over $84,902 to $89,401) applies and her marginal tax rate increases to 39.41%. After paying the tax on her next dollar of regular income, she will take home just 61 cents. In Alberta, she still keeps 68 cents. In Quebec, a new tax bracket (over $83,865 up to $89,401) with a 42.37% marginal tax rate applies, leaving her just 58 cents after tax.
The Canadian tax collector is voracious, but there are various (legal) ways to leave more money in your pocket after tax.
Investors get a tax break on some investment-related income. Capital gains are taxed at 50% of the regular income rate. Eligible dividends paid by Canadian corporations are also taxed at a reduced rate, which varies by tax bracket. Note that the regular tax rate applies to dividends from foreign corporations.
If Angelina's taxable income remained at $75,000 in 2015, her marginal tax rate would be 32.98% for interest income, 16.49% for capital gains and 10.99% for eligible dividends. On her next dollar of income, depending on the income source, she could be left with as little as 67 cents or as much as 89 cents after tax. Clearly, planning the type of income you will earn in 2015 is one way to improve your after-tax returns.
Claiming all applicable tax deductions will reduce your tax bill. The self-employed can deduct business-related expenses. Contributions to RRSPs and pooled registered pension plans, employment-related union and professional dues, child-care expenses and certain investing expenses also qualify as tax deductions. Now is the time to identify potential tax deductions for 2015. To benefit, you may need to take action before the end of the year.
Tax deductions are subtracted from income. Consequently, the value of a deduction depends on your tax rate which, in turn, depends on your level of income. A deduction can provide additional tax savings if it reduces a taxpayer's marginal tax rate. In our previous example, if Angelina contributed $10,000 to her RRSP in 2015, her $85,000 taxable income would drop to $75,000 and a lower tax bracket. She would have six more cents in her pocket for every additional dollar earned until her income hits the next tax bracket.
Claiming all eligible tax credits is another route to keeping more money in your pocket after tax. Tax credits are subtracted from the amount of tax owed, so they are not income dependent.
Some credits, such as the federal Child Tax Benefit and the Quebec tax credit for home-support services for seniors, are refundable; you receive them if you qualify. Most are non-refundable, which means no refunds are issued if claimable credits exceed the tax owed.
Tax credits are wide-ranging and are often set to meet public-policy objectives such as improving access to post-secondary education, encouraging the use of public transit, recognizing volunteer firefighters and supporting children's fitness and art programs. Both federal and provincial/territorial tax credits are available.
Tax credits could significantly reduce the tax you pay. For example, first-time homebuyers may qualify for a $5,000 federal tax credit. A parent adopting a child under 18 can claim a federal tax credit of up to $15,000 for eligible adoption expenses.
As with tax deductions, now is the time to do your research and determine the tax credits which you could claim for the 2015 tax year. The Canada Revenue Agency's website provides a detailed rundown of existing tax credits as well as tax deductions.
Tax-reduction strategies extend well beyond the basics covered here. A tax accountant can advise on the various opportunites available to improve your after-tax returns.