Textbook Notes (362,815)
Canada (158,059)
Finance (361)
FIN 502 (69)
Joan Lobo (33)
Chapter 8

CFIN502- Chapter 8- Income Tax Planning.docx

7 Pages
Unlock Document

Ryerson University
FIN 502
Joan Lobo

CFIN502- Chapter 8- Income Tax Planning  3 basic aspects of the nature of income taxation in Canada and most countries o Tax rates are progressive and the rate for each higher bracket applies only to the additional or marginal income o Government try to achieve several objectives at once with taxation laws  Raise revenues, promote social equity, encourage/ discourage certain financial actions, mange economic trends o Tax deferral often saves money because of the time value of money INCOME DEFERRAL  General principle—if you cant use the income for consumption purposes—you shouldn’t have to pay tax on it until you can use it  Invest the tax deferred income at a rate or return that is untaxed—get second advantage with faster compounding  Registered pension plan (RPP)- established by an employer to defer income payable to employees to provide retirement income for them o Key tax aspect—contributions to the plan are not taxed as income in the employees hands at the time they are put into the plan o Employer can deduct its own contributions for income tax purposes when they are paid o Employee pays tax on the pension as it is received  Contributions are deductible from taxable income and accumulated at the before-tax rate of return  Registered retirement savings plan (RRSP)- do-it-yourself pension plan o Contribution is deducted from income for tax purposes in the year it is paid into the fund and income on it accumulates tax-free o Withdraws it for spending purposes, the entire amount, principal and accrued earnings, is taxable  Treated as ordinary income o RRSP is primarily use as retirement savings—can use legally to defer income tax in shorted horizons o Make a withdraw in a year of low income (return to school, maternity leave)— benefit form low marginal tax return on the withdrawal than the tax rate you save when you contributed  Other uses of an RRSP o Lifelong learning plan (LLP)- allows you to withdraw up to $10000 in a year for education expenses for you or your spouse and up to $20000 total  Year after finish being a student—start repaying the loan from your RRSP by depositing at least 1/10 or the amount withdrawn each year o Home buyers plan (HBP)- allows you to withdraw up to $25000 to help buy the family’s first home nd  Start repaying the amount withdrawn 2 year after withdrawal—equal payments on 1/15  Capital gains deferral o No tax payable until realized o Portfolio of shares can increase in value at the before-tax rate of return if the return consists of capital gains instead of dividends  Invest in assets that will realize more of their rate of return from capital gains—can defer paying tax on the returns until you cash them in  Pay tax only on ½ of gain o 2 strong assumptions  Do not require the dividend or interest income from the portfolio for current consumption—people who are saving for the future  Can continue to hold the identical portfolio—may expose yourself to a lot of risk INCOME SPLITTING  Income splitting- legal allocation of income  Between spouses o Higher income—pay all expenses 1 CFIN502- Chapter 8- Income Tax Planning o Lower income—does all the saving and accumulates investment assets, whose income is taxed at a lower marginal rate o Gifts between spouses are presumed to occur at their adjusted cost base  Gift an income earning asset—income is attributed to the spouse who gave the gift you cant split income simply by giving investments to the lower income spouse o As long as investment asses transferred earns more than the market interest rate— some income is split  Not an efficient way to split income—risky  If the investment loses money—income split works in reverse lower income spouse will have less income o Income attribution does to apply to the compounding of earnings  Income earned on the gift is attributed back to the spouse who gave it every year  Income on that income on the second year is not attributed  High income spouse could give a bond to the lower income spouse  Lower income spouse deposits each coupon amount in a spate account— coupons will be taxed in the high-income spouses hand but earnings on the separate account will be taxed in the low-income spouse hands o Useful device—both splits and defers income tax spousal RRSP o Taxpayer may contribute to an RRSP for their spouse buy claim the tax deduction  Contributing spouse will be in a higher tax bracket at retirement—ultimate tax payable on the RRSP withdrawals will be lower  Important in a family where one spouse has spent most or all of potential earning years working in a household—has no pension o Spouse may not withdraw contributions until 2 years after elapsed without triggering attributions of the income back on the contributing spouse o Spousal RRSP has become much less important—significant recent change in taxation of pensions  May opt every year to split their eligible pension income between them up to 50%  o Eligible pension income is generally the total of the following amounts received by the pensioner in the year  Taxable part of life annuity payments from a superannuation or pension fund or plan  If they are received as a result of the death of a spouse or common law partner or if the pensioner is 65 years of age or older at the end of the year:  Annuity and registered retirement fund payments  Registered retirement savings plan annuity payments o Canada pension plan, old age security and guaranteed income supplement amounts are not eligible pension income  Between other family members o No analogue to spousal RRSP with other person o Higher-income person should pay all the living expenses—evident when a dependent child receives inheritances or gifts from other relatives  Amounts should be invested and the parents pay expenses as long as their marginal tax rates are higher o Income attribution rule doesn’t apply to children aged 18 and older o Parents can give a minor child a significant income with a gift of publicly traded common shares whose future return is mostly capital gains—pay little or not tax on attributions  Estate freezes o Freeze the value od a property in the hands of the original owner o Useful—family business or large investment o Original owner retain control of the asset during their lifetime or receive some income from it o Important—asses is the family business—original owner continues to manage it 2 CFIN502- Chapter 8- Income Tax Planning  Single parent families and marriage breakdowns o Parents who supports the children—claim one of them as equivalent-to-married— explained in schedule 6 of the general tax guide o Basic rule in Act governs how separation payments are taxed  Payments may be deducted by the payer and reported as income by the recipient if they meet all conditions 1. Spouses living apart as payments been made 2. Made under decree, court order, judgment, written agreement 3. Made for the maintenance of the recipient 4. Allowance to be paid periodically 5. Has discretion over how they are spent o Minimize income taxes  Spouse making payments does so as an allowance for spousal support if they are in the higher tax bracket  Allowance for child support or a lump-sum payment if they are in the lower income tax bracket o Correct choice reduced taxes more for the payer than it increases taxes for the recipient—1 will have more after-tax income to share  Weakness- risk that the payer will not make all periodic payments lump sum is better for the recipient even if it is less tax efficient INCOME SPREADING  Taxpayer who has highly variable income may want to spread income over several years to reduce marginal tax rates  This method of tax reduction doesn’t have may applications—difference between 2 ndand 3rd brackets is now quite small  Most people who earn relatively even streams of employment income and thus spreading income has no effect on their marginal rates  Irregular large contracts—may benefit from deferred compensation arrangements—require structured contracts  Substantial accrued capital gains—careful to realize them over several years rather than all at once—avoid higher tax brackets o Taxpayers in this situation are usually in the highest tax bracket anyways o Income spreading is of no value  Situation—many people can use occurs when a tax payer will be earning much less income for 1 or 2 years than in the years before or after o Person can withdraw part or all of the money in an RRSP for consumption and pay tax immediately—at a lower marginal rate than the original deduction provided o Sometimes the cheapest way of bridging a period of low income TAX SHELTERS  Taxpayers can arrange affairs so that tax shelters allow a lower or zero rate of tax—without any deferral or other sacrifice required  Many shelters are transitory relate to government attempts to affect the economy in some say  Tax-free savings account (TFSA) o Allows savings to accumulate tax free without creating any complications in later taxes and social assistance payment qualifications o Allows a person to contribute up to $5000 annually to be a registered TFSA account in a financial institution  Contribution is not tax-deductible—income in account is not taxable at any time  May withdraw any amount at any time—withdrawal is no taxable and is not added to income for tax purposes  Not affect eligibility for social assistance programs o Minor complication—withdrawals may also be replaced in the account not till next calendar year  Capital gains o Principal residence of a family is exempt from any capital gains tax 3 CFIN502- Chapter 8- Income Tax Planning o Long run trend of property values to increase—powerful incentive for a family to buy a home as early as possible and bend its saving efforts towards paying off the mortgage o Couples sells the home at retirement and moves to a smaller home or an apartment—capital gain can be split between the partners to provide income for both  Without income attribution even if one spouse paid most of the cost of buying the home  Dividends VS interest income o Want steady stream of income from investment assets—securities paying dividends or interest are preferred o Depending on relative pricing and your tax bracket  Preferred either dividends of interest and your preferences may change over time o Price paid on market will reflect some equilibrium average of all market participants marginal tax may be different  May be able to pay less tax by your choice
More Less

Related notes for FIN 502

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.