madura ch4 tax

You Have to File a Return if• You have to pay tax for a calendar year • CRA sent you a request to file a return • You & spouse split pension income • You received working income tax bene

Chapter 4

Using Tax

Concepts for

Planning

Copyright © 2012 Pearson Canada Inc.

Edited by Laura Lamb, department of

economics, TRU

1

Chapter Objectives

• Explain the importance of taxes for personal financial

planning

• Explain when you have to file a tax return

• Outline the steps involved in completing a tax return

• Describe the major deductions available to a taxpayer

Chapter Objectives (cont’d)

• Show how tax credits can be used to lower tax payable

• Describe the difference among tax planning, tax evasion,

and tax avoidance

• Describe tax planning strategies that can be used to reduce

tax payable

3

The origin of the Canadian Income Tax

System

• Canada’s income tax system was implemented in 1917 to raise

funds to finance its efforts in World War I Since that time the system has evolved and become quite complicated with tax law presently consisting of about 2500 pages

• Taxes are the single largest expenditure for most families

• For this reason, knowledge and consideration of the tax

system is important to personal financial planning

5

The Federal and Provincial Income Tax

Structure

• The Canadian income tax system is progressive meaning that

the tax rate rises as income rises.

• Most income tax systems are progressive Why?

7

Consumption taxes

Background on Taxes

• Excise taxes: special taxes levied on certain consumer

products such as cigarettes, alcohol, and gasoline

• Taxes Paid on Capital Assets

• Capital asset: any asset that is acquired and

held for the purpose of generating income

9

You Have to File a Return if

• You have to pay tax for a calendar year

• CRA sent you a request to file a return

• You & spouse split pension income

• You received working income tax benefit(WITB)advance

payments

• You disposed of property or realized a taxable capital gain

• You have to repay any OAS or EI benefits

• You have not repaid withdrawals from RRSP, HBP , or LLP.

You Have to File a Return if

• You have to repay any Old Age Security (OAS) or Employment

Insurance (EI) benefits

• You have not repaid withdrawals from Registered Retirement

Savings Plan (RRSP), Home Buyers Plan (HBP) , or Lifelong

Learning Plan (LLP).

• You have to contribute to the Canada Pension Plan (CPP)

11

Why Students Should File Tax Returns

• You may be eligible for a refundable GST/HST credit

• Eligibility criteria:

• You are 19 years of age or older

• You have, or previously had, a spouse or common-law partner

• You are, or previously were, a parent and live, or previously lived, with your child

Do You Have to File a Return? (cont’d)

• If you do not have any tax payable, your tuition, education, and textbook tax credits can be:

• transferred to another taxpayer (a parent or

grandparent), or

• carried forward to another tax year

• You will create RRSP room for future

contributions

13

Do You Have to File a Return? (cont’d)

• Filing Your Return

• Tax year end is December 31 for federal income taxes

• Individual income taxes and tax returns must be paid and filed by April 30th of the following year

• Self-employed individual have until June 15th to file income tax returns, although taxes owing

must be paid by April 30

Background on Taxes (cont’d)

• Filing Your Return (cont’d)

• An interest penalty may be payable if any of these deadlines are missed

• Penalty (if taxes are owing)

15

Background on Taxes (cont’d)

• Filing Your Return (cont’d)

• Two ways to file a tax return: mail and e-mail

• Once your return is processed, you will receive a Notice of Assessment from the government

• Confirms your calculations or provides corrections

• Outlines your RRSP contribution limits for the following year

Overview: Completing an Income Tax

Return

17

Step 1: Calculate Total Income

• Total income: all reportable income from any source

Step 1: Calculate Total Income (cont’d)

• Wages and Salaries

• If you work full-time, probably your main

source of total income

• Self-Employment Income

• Consists of income from a business, a

profession, commissions, farming, or fishing

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Step 1: Calculate Total Income (cont’d)

• Individuals are considered self-employed if:

1 They have control over the work they do

2 They have taken on the financial risk and reward

that comes with being self-employed

3 Their job duties are independent of any employer

4 They provide and maintain their own tools and

equipment

Step 1: Calculate Total Income (cont’d)

• Interest income: interest earned from investments in

various types of savings accounts at financial institutions; from investments in debt securities such as term deposits, GICs, and CSBs; and from loans to other individuals,

companies, and governments

• Tax is due on interest in the year it is earned, not in the year it is received

21

Step 1: Calculate Total Income (cont’d)

Dividend income: income received from

corporations in the form of dividends paid on stock or on mutual funds that hold stock

• A dividend adjustment calculation reduces the income tax payable by shareholders

• Consists of a dividend gross-up and dividend tax

Step 1: Calculate Total Income (cont’d)

• Canadian Controlled Private Corporations

(CCPCs) are eligible for a small business

deduction on their active business income

• Dividends paid by large corporations are

referred to as eligible dividends; whereas

dividends paid by CCPCs are referred to as eligible dividends

non-• Eligible dividend income is eligible for an enhanced dividend tax credit (discussed later in this chapter)

23

Step 1: Calculate Total Income (cont’d)

• Capital gain: money earned when you sell an asset at a

higher price than you paid for it

• Capital loss: occurs when you sell an asset for a lower price

than you paid for it

• A taxable capital gain is currently equal to 50 percent of

the capital gain

Step 1: Calculate Total Income (cont’d)

• A taxable capital gain is currently equal to 50 percent of

the capital gain

• An allowable capital loss is currently equal to 50 percent of the capital loss

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Step 1: Calculate Total Income (cont’d)

Step 2: Subtract Deductions

• Deduction: an item that can be deducted from total income

to determine taxable income

27

Step 2: Subtract Deductions (cont’d)

• Net income: the amount remaining after subtracting

deductions from your total income

29

Step 2: Subtract Deductions (cont’d)

Step 3: Calculate Taxable Income

• Taxable income:

= net income – some additional deductions

• Net income is used to make adjustments to certain benefits

• Taxable income is used to calculate net federal and

provincial income tax

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Step 4: Calculate Net Federal Tax Payable

• Marginal tax rate: the percentage of tax you pay on your

next dollar of taxable income

• Average tax rate: the amount of tax you pay as a

percentage of your total income

Step 4: Calculate Net Federal Tax Payable

(cont’d)

33

Tax Credits

• Tax credits: specific amounts used directly to reduce tax

liability

• Refundable tax credit: the portion of the credit that is not

needed to reduce your tax liability may be paid to you (e.g GST credit)

Tax Credits (cont’d)

• Non-refundable tax credit: the portion of the credit that is

not needed to reduce your tax liability will not be paid to you and cannot be carried forward to reduce your tax

liability in the future

• Most tax credits are considered non-refundable

35

Tax Credits(cont’d)

• Examples of non-refundable tax credits:

• Basic Personal Amount

• Spousal or Common-Law Partner Amount

Tax Credits(cont’d)

• Age Amount

• May be claimed by a taxpayer who was 65 or older on December 31 of the tax year in question

• Clawback: used to reduce a particular government

benefit provided to taxpayers who have income that exceeds a certain threshold amount

Tax Credits(cont’d)

Tax Credits(cont’d)

• Caregiver Amount

• Taxpayers may qualify for credit if they provided home care to a parent of grandparent 65-plus years

in-of age, or to infirm adult relatives

• Infirm Dependent Amount

• Pension Income Amount

• Claim a credit on the first $2000 of eligible pension

or annuity income

39

Tax Credits(cont’d)

• Canada Employment Amount

• Employees are eligible to claim this non-refundable tax credit

• CPP/QPP Contributions

• Claim the amount shown in boxes 16 and 17 of your T4 slip

• EI Premiums

Tax Credits(cont’d)

• Public Transit Passes Amount

• Interest Paid on Your Student Loans

• Interest must have been paid on a student loan

made to you under the Canada Student Loans Act,

the Canada Student Financial Assistance Act, or

similar provincial or territorial government laws for post-secondary education

41

Tax Credits(cont’d)

• Tuition, Education, and Textbook Amount

• Claim the amount you paid for full-time tuition

• Full-time students: claim an education amount of

$400, and a textbook amount of $65 for each month

of full-time enrolment in a qualifying education

program

• Part-time students: claim an education amount of

$120, and a textbook amount of $20 for each month

of full-time enrolment in a qualifying education

Tax Credits (cont’d)

• Medical Expenses Amount

• To qualify, total medical expenses must be greater than either 3 percent of your net income of $2024, whichever is less

• In general:

• net federal tax = tax payable – non-refundable tax credits

43

Tax Credits (cont’d)

• Transferable tax credits are credits that can be transferred

to other individuals

• Transferable Tax Credits:

• Tuition, education, and textbook amount

• Pension income amount

• Age amount

• Disability amount

Tax Credits (cont’d)

• Certain tax credits may be carried forward by the taxpayer

• Tax Credits Eligible for Carry Forward:

• Medical expenses amount

• Tuition, education, and textbook amount

• Charitable contribution amount

45

Tax Credits (cont’d)

Step 8: Refund or Balance Owing

• Tax refund : amount of total tax payable is less than the amount of total tax already paid

• Tax owing: amount of total tax payable is greater than the

amount of total tax already paid

47

Reducing Your Taxes

• Focus on Ethics: Reducing Your Taxes

• Tax planning : involves activities and

transactions that reduce or eliminate tax

• Tax avoidance: a term used to describe the

process of legally applying tax law to reduce or eliminate taxes payable in ways that the CRA

considers potentially abusive of the spirit of the

Income Tax Act

Reducing Your Taxes (cont’d)

• Tax evasion: occurs when taxpayers attempt to deceive the CRA by knowingly reporting less tax payable than what the law obligates them to

pay

49

Tax Planning Strategies

• Types of Income

• Interest income is earned on investments such

as savings accounts, term deposits, GICs, and CSBs

• Dividends are classified as eligible or

non-eligible

• Tax payable on eligible dividend income is reduced through an enhanced dividend gross-up and dividend tax credit

Tax Planning Strategies (cont’d)

51

Tax Planning Strategies (cont’d)

Tax Planning Strategies (cont’d)

• Sources of Income

• Tax-free savings account (TFSA): a registered

investment account that allows you to purchase investments, with after-tax dollars, without

attracting any tax payable on your investment growth

• Contributions are not tax deductible

• Contributions and any growth can be withdrawn free

tax-• Unused contribution room is carried forward

53

Tax Planning Strategies (cont’d)

• Any money you withdraw, contributions plus growth,

is added back to your contribution room for the

following calendar year

• Proceeds can be used for any purpose

• RRSP Contributions

• Tax deduction is based on your highest marginal tax bracket

Tax Planning Strategies (cont’d)

• Record Keeping

• Maintain a record of the purchase transaction for capital assets, such as stock, in order to make the future calculation of capital gains or losses easier

• Maintain a record of the non-refundable tax credits that can be carried forward: the medical expenses amount, the tuition, education, and textbook

amount, and the charitable contribution amount

• At minimum, retain copies of your completed tax forms along with receipts for a period of seven years

55

Tax Planning Strategies (cont’d)

• Are Big Refunds a Good Thing?