Plan ahead to reduce your taxes

Hey there, time traveller!
This article was published 17/11/2021 (1489 days ago), so information in it may no longer be current.

Dear Money Lady,

I know it’s not tax season, but have you got any tips on how to reduce the amount of taxes I pay every year?

Carolina

Dear Carolina,

I think the timing is perfect for this question, since many Canadians will soon be determining how much income they made in 2021 as we approach year end. Many people make financial decisions based on their gross income, however, from a planning perspective, it is not good enough to know how much money you make, but rather to know how much money you keep. Making a dollar today doesn’t mean you can count on spending that dollar tomorrow.

We all have two layers of taxation in Canada — federal and provincial.  The one thing that is guaranteed with taxation is that it is progressive. So, over time it continues to go up, something that a lot of economists believe will continue for many decades to come, owing to COVID relief efforts.
Knowing your marginal tax rate is one part of understanding your net income, however, there are specific strategies that you can utilize to help minimize the taxes you pay.

The three best ways are to deduct, defer and divide.  

Let’s talk about each method.

1) Deduct — This would be a deduction or claim to reduce your taxable income. This is a great way to reduce your income taxes and to ultimately keep more after-tax income.  The best way to do this is to have a home-based business, be an independent contractor or be a self-employed entrepreneur to write off expenses against your gross taxable income. For the rest of us, here are some common deductions, (this list will vary in each province and/or territory):
• Pension plan contributions;
• RRSP contributions;
• Safety deposit box fees;
• Interest expenses;
• Union/professional dues;
• Alimony/maintenance payments;
• Employment expenses;
• Moving expenses;
• Professional fees;
• Child-care expenses.

2) Defer — Deferring tax means you move the obligation to pay current taxes into your future years. The advantages to deferring taxation works on the premise that it is better to pay in the future, perhaps when your income is much lower, than to pay it today, when your income is in a higher marginal tax bracket. This can be done through registered pension plans (RPP and PRPP), registered retirement savings plans (RRSP and RRIF), registered education savings plans (RESP), and registered disability savings plans (RDSP).

3) Divide — Income splitting is the best way to divide your income and lower taxation. Now I know that many of you who are single will say that this is not relevant — and you are right. Dividing income can only be done with your partne. Here are some of the ways you can split income:
• Spousal RRSPs;
• Sharing CPP benefits;
• Paying wages to family members through a business;
• Using trusts;
• Using partnerships or corporations to earn business income.

Tax planning is easier than you think. It is not just about filing your taxes every year, it is about finding ways to keep more of your money in your pocket. COVID-19 has forced us all to reconsider our careers, life plans, and future wants. Many people have written to me saying they no longer desire the same things they did before the pandemic. Many are using this world economic change to create a more minimalist lifestyle — one that is more freeing, rather than living just to work and pay taxes.