I don't know if I can live on my income or not – the government won't let me try it.
~ Bob Thaves, “Frank & Ernest”
When I wrote about the 10 Steps to Fiscal Fitness, I may have overlooked one potentially huge factor that can affect your financial health, and that's taxes. Whether it's sales taxes, property taxes, provincial or federal income taxes, a pretty big chunk of our income goes to pay all sorts of levies. Strictly speaking, I guess taxes aren't really a step to financial security on their own, but good tax management can leave more money in your pocket.
Most of us don't even think about the total amount of taxes we pay, except maybe a few times of year when we look at the numbers, throw a small (or big) tantrum, suck it up, and write a cheque. This is one of those times. I just reluctantly started looking at our tax situation last week. It's going to be pretty complicated this year, so I've been putting it off. But the T-slips started arriving, and I decided that I'd better get a move on. Here are a few things to consider as you ponder the effects of taxes on your personal balance sheet:
10 Tax Tips for Canadians
1. Be Aware
Look at your pay cheque and really get a load of how much of it goes to taxes. Take a look at a basic tax calculator and put in your numbers and some higher and lower income amounts. It's interesting to see the effects of changes on the amount of taxes owing as you move up through the tax brackets. OK, I know. It would have to be a pretty snowy day to invest much time in this kind of exercise, but it can be pretty informative.
If you are self-employed or a commission employee, you will have a lot more flexibility on when and how you pay your taxes. You'll also have access to a lot of deductions that other employees don't. But you also have more work because you need to track things like mileage, business and home office expenses. These deductions are well worth the effort, as they can save you thousands on your tax bill.
2. Keep Up to Date
Tax laws change all the time, and the government periodically offers short term tax incentives like the recently expired home renovation tax credit. Watch the news and keep up to date on changes that might offer you an advantage. But be careful. Tax breaks can be like discount sales and coupons. You may end up spending money on, or worse, going into debt for, something you really can't afford just to get a tax credit. Saving $1000 on a kitchen renovation isn't worth it if you're going to pay more than that in interest to finance the total cost.
3. Property Taxes
Are your property taxes a lot higher than a friend's who lives just a few kilometers away? Would it be worth your while to lower your tax bill by moving? We happen to live in an area with very high tax rates compared to a town that's just a few blocks away. But I love my house, so we continue to pay. Still, I know of at least one neighbour of mine that did move to take advantage of lower property taxes (and better municipal services) in the town next door.
4. Income Splitting
If you are a commission employee or self-employed, your options are much greater here. I actually worked as a self-employed paid assistant to my husband for a number of years when he was in commission sales. It gave me income toward my RRSP limit, some CPP contributions, and reduced our overall tax bill as my salary was deducted from my husband's income.
Even if you have regular employment income, the new pension income splitting rules enacted in 2007 may be something for you to keep in mind as you decide how to allocate your retirement savings between vehicles like RRSPs, Spousal RRSPs, and other non-registered products. These new rules allow you to transfer up to 50% of your pension income to your spouse, with different rules if your spouse is under or over age 65. (Note: You cannot split OAS, CPP or QPP, or RRSP withdrawals other than annuity payments.)
5. Don't Cheat
The tax penalties levied by the CRA are far more onerous than the taxes themselves. It's not worth it to cheat. When I was earning self-employment income, I actually did do quite a bit of work for Mr. Cents, but we did get audited one year. I was the one who dealt with the CRA representative, so she knew that I really had been handling the bookkeeping. We did owe some money, but not much, and only as a result of some honest misinterpretations of the tax laws. They're not as clear as you'd like to think!
RRSPs are a tax tool as much as a retirement savings vehicle. In order to decide how much (if any) of your income you want to put under the RRSP umbrella, you need to do some math. How much tax savings will you receive if you contribute at a certain level? Again, play with the numbers. Is it worth it to contribute $10 000 to your RRSP for a tax savings of $4000? If you are in a lower bracket, your savings will be less. If you are carrying credit card debt, is the tax savings worth more than the ridiculous interest rate (usually around 19%) you're paying on your credit card?
7. Children & Taxes
There is a lot to be aware of in terms of how having children will affect your taxes from the Child Tax Benefit and RESPs to the fitness and transit credits and many more. H&R Block has a nice little run down of basic issues. Note also that if your child is under 18 and earns income, they may be able to claim a refund of taxes paid if their income is below the basic personal amount of $10320. Even if they won't get a refund, it's worth it to file a return for them as it will allow them to build RRSP contribution room.
8. Charitable Donations
Do some research on how charitable donations affect your taxes. Is it worth it to contribute over the threshold to get a greater tax credit? You get a 15% credit for donations up to $200, but you receive a 29% credit for any amount over $200 up to a limit of 75% of your net income. You can claim all or part of your eligible credits and it's usually worth it for the higher income earner to claim the credit if possible.
9. Medical Expenses
As with donations, you have some choice as to who claims the medical expenses. It's usually beneficial for the lower income partner to do so. Also, don't forget to claim premiums paid to private health plans.
Be aware of how taxes may affect your investment choices. As well as choosing between tax deferred (RRSP) and tax sheltered (TFSA) vehicles, be aware that investment income from interest, dividends, and capital gains is treated very differently, with interest carrying the highest tax burden. If you own funds, make sure they are tax efficient for your purposes.
These are just a few of the main issues to think about when you consider the bite that taxes take out of your balance sheet. Are there any others I could have included?