Title: Time to sharpen up your tax planning

Sub-title: Acquiring technical knowledge and getting good advice are not enough for you to minimize the taxes you pay. For maximum results you also need to plan well.


During the next couple of weeks Canadiansí mailboxes will be filling up with the T4s, T5s and other tax receipts that employers, financial institutions and charities send out each year. Many taxpayers will simply stick those receipts into a shoebox and keep them there until just before the filing deadline.


Smarter taxpayers will prepare early by reading up on tax literature and securing the best advice. But the brightest ones are already thinking proactively about next yearsí tax moves.  Thatís because tax planning is big business. Do it right, and you can save thousands and sometimes tens of thousands of dollars. When looked at over the course of a lifetime the savings can be staggering.


Getting in early: Tax Free Savings Accounts

There are few better examples of the importance of effective tax planning than the recently introduced Tax Free Savings Accounts. Starting on January 1rst of this year, Canadians over the age of 18 will be allowed to contribute up to $5,000 per year of cash, stocks, bonds or other assets into these accounts and any interest they earn on them will be tax free. Unlike RRSPs, taxpayers will not be allowed to deduct their contributions. However withdrawals will not be taxed either.


With interest rates currently running quite low and the stock market in the doldrums, on the face of it, the new initiative seems lame. For example a TFSA owner who invested $5,000 on January 1rst in a GIC that pays an interest rate of 1.6 percent this year will reap a lousy $80. If he is in one of the higher tax brackets (of say 50 percent) signing up for a TFSA will save him just $40.


However after a while, those $5,000 per year contributions can add up. Furthermore interest rates on fixed income securities havenít always been this low. Historically, interest rates of 5 percent and even higher on many bonds have been common. In good years double-digit returns in the stock market are also far from uncommon.


In short, over the longer term, the tax savings in a TFSA can be quite impressive. For example a TFSA holder in the 50 percent tax bracket who has socked away $100,000 and earns 6 percent a year (or $6,000) on his portfolio, could save as much as $3,000 a year in taxes. Thatís the after-tax equivalent of getting a $120 per week raise. However to accumulate those kinds of savings you need to start early. That requires proper planning.


Your often lazy and greedy partner

Planning oneís tax moves may seem obvious, but it is not. Entrepreneurs grasp almost immediately that when they go into business, they are burdened with a lazy partner, whose overall contribution is questionable and who grabs an inordinate share of profits. That partner is government. Canadaís federal, provincial and municipal governments tax away just about half of the countryís economic output each year.


Savvy businessmen and wealthier individuals devote considerable resources toward making sure that they pay as few taxes as possible. Individuals who learn the ropes of the tax game can benefit substantially too. And one of the first rules that most Canadians need to learn is to mimic what successful entrepreneurs do, which is to plan their tax moves effectively.


Among the more common tax planning strategies:


File your tax returns. This may seem obvious. But many Canadians donít even bother to file their returns. The reasons vary from inattention, to lack of time. Many low income earners simply believe that if they donít need to pay taxes they donít need to file a return. However completing your returns is a good way to make sure that you donít owe taxes and minimizes the chances that youíll expose yourself to penalties and interest on the unpaid balances. Low income Canadians who file returns may also find that they are eligible for certain refundable tax credits.


Pay taxes on time. Canadians who pay their taxes late, expose themselves to an immediate 5 percent penalty on their unpaid balance, plus a 1 percent penalty for each month they are late. If you were already charged penalties in previous years, those amounts rise to 10 percent, plus 2 percent for each month the payment is overdue. These are quasi-usurious penalties, whose effects are magnified because they paid in after-tax dollars.


Get good advice. Canadaís tax code is unbelievably complex. The code itself runs thousands of pages of clauses, sub-clauses, annexes and regulations. That does not include the thousands of pages of Canada Revenue Agency-issued interpretation bulletins and circulars, nor the legal jurisprudence that forms an integral part of taxation literature. In many ways, the politicians, lawyers, accountants and academics who have prepared this incomprehensible legislation, have done so intentionally in order to make themselves indispensable and they have succeeded. If you want to optimize your tax position youíll need to pay the piper.


Stay informed on your own. However donít assume that just because you are paying for tax advice that your role ends there. Most tax experts will only see you for a short time and if the chemistry is not perfect between the two of you, they may not be able to get all the information from you that theyíll need. So youíll need to steer them in the right direction. For example if your tax advisor is unaware that your kids play sports, he may forget to inform you that you may qualify for the Child Fitness Tax Credit.


Sad as it may be, even if you have access to the best tax advice, youíll need to take a personal interest in your own tax position to at least be aware of issues that may affect you. Youíll need to be aware of what the difference is between a tax deduction and a tax credit. Youíll also need to figure out whether you are best off investing in an RSP or paying down your mortgage, or how the new Tax Free Savings Accounts, mentioned above, will affect your need to invest in Registered Education Savings Plan to finance your kids college education. 


Hard to start

Of course starting to tackle your tax challenges proactively is easier said than done. In fact, a cynic would say that the system is designed that way. Some have likened the modern taxation establishment to the equivalent of courtiers in early kingdoms; a crowd of useless parasites, who communicate only in jargon and references that are understood only by each other and not by the general public and who have gotten rich by drawing slowly each year on the wealth of the economy. 


Whether or not you agree that Canadaís accountants, tax officials, lawyers and the lobbyists who fight all attempts to make the tax code comprehensible to the common man, are adding value to the system, is irrelevant.


What is certain is that if you donít learn to play their game according to their rules, it is pretty clear who the loser is going to be.


Peter Diekmeyer (peter@peterdiekmeyer.com) is Bankrate.caís Quebec correspondent.






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