Some notable tax insights that could have widespread influence on Canadian taxpayers’ 2020 returns.
Since the delivery of a 2020 budget by Canada’s federal government was sidelined by the COVID-19 pandemic, tax rule changes that normally would have surfaced in response to the budget never materialized this year. And while some new tax measures have been delayed or are on hold until a budget is released, many taxpayers will have experienced some changes to their usual tax scenario as a result of the pandemic’s effect on the overall economy.
What won’t change is the quest of many individuals to reduce their annual tax bill using a variety of strategies and tactics. Here’s an overview of some areas of interest to taxpayers who wish to lower their 2020 tax bill.
Canada’s Income Tax Act says that a capital loss must be deducted against any capital gain in the current year. The excess, if any, may be carried back three years or carried forward indefinitely to reduce a taxable capital gain reported in the future. Therefore, consider realizing capital losses before the end of the calendar year.
The best strategy is to carry the losses back to the earliest year in which a capital gain was received, before it falls out of the three-year window. For example, 2017 is the earliest date allowed to carry back 2020 losses.
When selling an investment at a loss, in order for that capital loss to be available this year or in one of the last three years, the settlement date must occur in 2020. Because trades and fund settlements take one or two business days, trades should be completed by December 29 or 30, 2020, in order to realize the loss for the 2020 taxation year.
Someone who doesn’t have capital gains for this year or the previous three years can transfer capital losses to their spouse. First, the investment is sold to crystallize the capital loss. Immediately afterwards, the other spouse buys the exact same amount of the identical investment. That spouse then sells the investment after waiting at least 31 days. The capital loss realized on the sale will be denied under the superficial loss rules and, instead, added to the other spouse’s adjusted cost base, thereby transferring the capital loss.
A superficial loss is defined as a loss on the disposition of a property where a person affiliated with a taxpayer (such as a spouse, in this case) acquires the property or an identical property within the period beginning thirty days before and ending thirty days after the disposition, provided that the person affiliated with the taxpayer owns the property at the end of the period.
Tax-Free Savings Account (TFSA)
The annual TFSA contribution limit is currently $6,000 per year. The cumulative total since 2009, for those who never previously contributed, is $69,500 (including 2020). Overcontributions will be taxed at one per cent per month on the highest excess contribution at any time during the month. Any income attributable to deliberate overcontributions will be taxed at 100 per cent.
Withdrawals from a TFSA are not taxable, but keep in mind that amounts withdrawn are not added to allowable contribution room until the beginning of the next calendar year after the withdrawal. Therefore, consider withdrawing from a TFSA before year-end instead of early in 2021. It’s also important to know that the withdrawal of amounts related to deliberate overcontributions, prohibited investments, non-qualified investments and asset transfer transactions (and income related to those amounts) does not create additional TFSA contribution room. Unused contribution room can be carried forward indefinitely.
Registered Retirement Savings Plans (RRSPs)
Each person can decide when to take the deduction for their contributions. RRSP deductions can be carried forward indefinitely, even long after the RRSPs are closed, and can be spread out over several years to reduce taxable earnings throughout the retirement years. Unused RRSP contribution room can also be carried forward from prior years, and it may make sense to top up the RRSP to maximize its potential for tax-deferred growth. If there is less cash available than the amount of the RRSP contribution an individual wants to make, it may be appropriate to secure a loan for this purpose.
Withdrawals in low-income years
If a person’s income is lower than normal in a particular year, as may be the case for an unusually high number of people in 2020, then it could be wise to make an RRSP withdrawal by December 31. This strategy would generally make the most sense for those in the lowest tax bracket, although the income from the withdrawal could end up costing them some valuable tax credits and/or government benefits. Moreover, once a withdrawal has been made from an RRSP, that contribution room is depleted, unlike withdrawals from a TFSA. Future contributions can be made only to the extent to which there is available RRSP contribution room in the future.
Setting up a spousal RRSP is an effective income-splitting strategy, particularly where there is a sizable disparity in the estimated pension incomes between spouses. This strategy involves having the higher-income-earning spouse contribute to a spousal RRSP and obtain a tax deduction, while the lower-income recipient spouse is taxed on any withdrawals.
There is one important stipulation, however: income will be attributed back to the contributing spouse if the beneficiary spouse withdraws funds from any spousal RRSP within three years of any contribution being made to any spousal RRSP. The amount of the income attribution will be equal to the lesser of the amount contributed to any spousal RRSP in the current and prior two years, and the amount withdrawn by the annuitant (owner). Given that the three-year period is determined on a calendar year basis, contributing to a spousal RRSP before the end of the year, instead of early in 2021, will set back the attribution “clock” by one calendar year.
An advantage to this strategy is the opportunity for income splitting at any age that is not limited to 50 per cent. Also, clients over the age of 71 who have available contribution room can contribute to a spousal RRSP if their spouse is under 72 and then claim the deduction on their tax return whenever it’s most advantageous.
In the year of death, or within 60 days after that year-end, a legal representative may contribute to a spouse’s RRSP under the normal rules. This contribution will be deductible on the contributor’s final tax return.
Pension income splitting
Spouses can agree to divide up to 50 per cent of qualified retirement income with their spouse or common-law partner. This can result in a reduction of family taxes and can also minimize the impact on income-tested tax credits and benefits.
For individuals aged 65 or older, income from any of the following qualifies for pension income splitting:
- A pension plan
- Other registered plans such as registered retirement income funds (RRIFs)
- Annuities purchased from RRSPs and deferred profit-sharing plans (DPSPs)
- Annuities including a Guaranteed Interest Contract (GIC) from a life insurance company
For those under 65, only income received directly from a pension plan, or received from other registered plans or an annuity because of the death of a spouse or common-law partner, qualifies for pension income splitting.
Other income-splitting options are available with Canada Pension Plan (CPP) and Quebec Pension Plan (QPP). CPP/QPP allows spouses who are at least 60 years of age to share up to 50 per cent of the benefits earned while they were living together.
Sooner is better than later
A variety of expenses can be claimed as a deduction or credit on a tax return only if the amount is paid by the end of the calendar year. If someone wants to take advantage of the tax savings sooner, paying the amount in 2020 will give them the benefit of the tax deduction or tax credit on this year’s tax return. When it comes to taxes, timing can make a big difference.
Lowering an annual tax bill is something everyone would like to do, but they may not be sure how it can or should be done. Without handing everything over to an accountant to wade through the paperwork, clients can benefit from critical information from their advisors with respect to minimizing the amount of taxes owed at the end of each year.
Some special 2020 circumstances
RRSPs and the Canadian Emergency Response Benefit (CERB)
The economic measures implemented by the federal government to counterbalance the effect of business closures and spiking unemployment early in 2020 included the distribution of CERB program payments to millions of Canadians. These CERB payments did not have a withholding tax applied, creating a potential tax bill that could be offset by an RRSP deduction. Also, consider the following:
- A lengthy period of unemployment may result in less income and thus lower-than-usual RRSP contributions.
- CERB payments will not factor into the calculation of next year’s RRSP room, which may therefore be lower than average for some people. As a result, future automatic contributions may need to be revisited and revised.
- Lower-than-expected deductions, such as for child care, could facilitate an increase in RRSP contributions.
Working from home during the pandemic
The tax rules related to the deductibility of work-from-home expenses may be too restrictive to apply to the enlarged cohort of people who began working from home during the pandemic. However, if the Canada Revenue Agency eases the criteria, workers could stand to benefit.
Generally, employees who wish to deduct work-from-home expenses would be responsible for submitting their receipts and documentation if their contract of employment requires them to pay expenses that are not reimbursable by the employer. Employees should also understand that not every expense is deductible, although the more common deduction requests include a portion of expenses related to heat, electricity and maintenance. If the home is rented, a reasonable portion of the rent may be deducted. Mortgage interest and capital cost allowance are not deductible.
FOR ADVISOR USE ONLY.
© 2020 Manulife. As one of Canada’s largest integrated financial services providers, Manulife offers a variety of products and services including insurance, living benefits, segregated fund contracts, mutual funds, annuities and guaranteed interest contracts. The persons and situations depicted are fictional and their resemblance to anyone living or dead is purely coincidental. This media is for information purposes only and is not intended to provide specific financial, tax, legal, accounting or other advice and should not be relied upon in that regard. Many of the issues discussed will vary by province. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. E & O E. Manulife Mutual Funds and Manulife Exchange‑Traded Funds (ETFs) are managed by Manulife Investment Management (formerly named Manulife Asset Management Limited). Manulife Investment Management is a trade name of Manulife Investment Management Limited. A division of Manulife Asset Management Limited. Commissions, trailing commissions, management fees and expenses all may be associated with investments in the Manulife Mutual Funds and Manulife ETFs. Please read the ETF facts/fund facts as well as the prospectus before investing. The Manulife Mutual Funds and Manulife ETFs are not guaranteed, their values change frequently and past performance may not be repeated. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. Manulife, Manulife & Stylized M Design, and Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.