You might recall the stories of Richard Goddard and David Winkelman who, 10 years ago, had their foreheads tattooed with "93 Rock" because they heard disc jockey Ben Stone of Iowa's KORB 93.5 FM "offer" $150,000 to anyone who would do it. Turns out Mr. Stone was joking. The two men sued the radio station - and lost. The moral of the story? If you're trying to line your pockets, do your homework first. Tax planning works the same way. Before trying an idea, make sure it's going to work. Here are some year-end tax ideas for investors that have stood the test of time.
1. Reassess your asset allocation and location.
Interest and foreign dividends are taxed at your full marginal tax rate while Canadian dividends and capital gains are taxed at lower rates. So, what difference has this made to your portfolio architecture? To the extent you hold highly taxed investments consider holding them in your RRSP or TFSA. For assets in taxable accounts, consider making changes to minimize interest income. This doesn't have to mean taking on more risk. There are money managers and strategies that can keep risk to lower levels while still providing tax efficiency.
2. Make your interest deductible.
If you have non-deductible interest and cash or investments on hand, consider using some of your cash or investments to pay down debt that comes with non-deductible interest, then borrow to replace that cash or those investments. If you borrow for the purpose of earning investment income (called "income from property") you'll generally be entitled to deduct your interest costs. Call this a "debt swap." It can cut your cost of borrowing significantly.
3. Time your investment in interest-bearing securities.
Since 1990 investors have been required to report (and pay tax on) interest income annually, on the anniversary date of an investment, even if the interest hasn't actually been received yet. Consider waiting until January, 2011, to purchase certain interest-bearing investments. For example, if you purchase a one-year GIC in 2010, the anniversary will fall in 2011 and you'll pay tax in 2011. But if you wait until January 2011 to make the investment, the anniversary will fall in 2012 and you won't face tax until 2012 - a year later.
4. Trigger capital gains before year end.
If you have little or no other income, or have capital losses to use up, consider triggering capital gains before year end by selling an investment that has appreciated in value, then reinvesting the proceeds (even in the same investment). It will cost you little or no tax, and will allow you to increase your adjusted cost base when you reinvest at the higher value. This will save tax later when you ultimately sell the investment. This makes good sense, for example, when you are investing in the name of a child who has little or no other income.
5. Trigger capital losses before year-end.
If you have capital gains this year (or in 2009, 2008 or 2007), consider selling an investment at a loss, which can then be offset against those capital gains this year, and then from prior years. You'll avoid taxes this year or recover taxes paid in the past.
6. Reinvest in a small business corporation.
If you have sold shares of a small business corporation this year and are due to pay some tax, consider reinvesting your sale proceeds in another small business corporation. You may be entitled to a tax-deferred rollover of those proceeds so that you may avoid tax in 2010 and not pay tax until you dispose of the newly acquired shares. Speak to a tax professional to see whether you qualify.
7. Utilize your lifetime capital gains exemption.
Every Canadian resident taxpayer is entitled to a $750,000 lifetime capital gains exemption to shelter gains on qualified small business corporation shares or on qualified farming or fishing property. There are ways to use up this exemption without having to sell or give up control of your company today. Speak to a tax professional about it, and to see if you qualify.
8. Delay investment in some mutual funds.
If you're thinking of investing in a particular mutual fund before year end, inquire as to whether there is going to be a significant taxable distribution reported in 2010. If so, consider waiting until January to make the investment to avoid paying tax on the distribution. Paying tax on the distribution when you weren't in the fund for most of 2010 really represents a prepayment of tax, but those dollars are better in your pocket than the taxman's.