Deduct, defer and divide

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?

Carol

Dear Carol,

Unfortunately, the more money you make the more tax you pay, thanks to the marginal tax rate system in Canada. Many people make financial decisions based on their gross incomes. However, from a planning perspective, it’s 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 guaranteed with taxation is that it is progressive. So, it continues to go up over time.

Just to give you an example – when RRSPs first came out in 1957, the highest marginal tax rate in Ontario was 11.5 per cent; now it is 53.5 per cent. Knowing your marginal tax rate is one part of understanding your net income. However, there are specific strategies 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.

Deduct: This would be a deduction or claim to reduce your taxable 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. Look for ways to lower your income through various expenses or income-splitting.

Defer: Deferring tax means you move the obligation to pay current taxes into future years. The advantages to deferring taxation works on the premise that it is better to pay the taxes 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).

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’re right. Dividing income can only be done with your partner. 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; or using partnerships or corporations to earn business income.

Tax planning is easier than you think. Try to utilize a TFSA (tax free savings account) as much as possible. If you were 18 or older as of Jan. 1, 2009, when TFSAs first started you can contribute up to $102,000 in the cumulated contribution room since inception.

Christine Ibbotson is an author, finance writer and national radio host, now appearing on CTV News across Canada and BNN Bloomberg across Canada and the U.S.A. Send her your money questions through her website at askthemoneylady.ca