Many of the best tax tips fall under a group of tax strategies known as the three D’s of tax planning – deduct, defer and divide. In this article, we introduce each concept and provide examples of some of the more common strategies Canadians can utilize.

 

Three D’s of Tax Planning – Deduct, Defer and Divide

 

There’s an old adage in personal finance – “It’s not what you earn, it’s what you keep”.

That saying is especially relevant for Canadians, who are subject to some of the highest combined tax rates among developed countries. Let’s face it – we pay a lot in taxes! To get ahead and improve your personal finances, it’s essential to take full advantage of all available tax tips and strategies that can help you reduce your overall tax bill.

Many of these available tax tips fall under a group of strategies commonly referred to as the three D’s of tax planning – deduct, defer and divide. Let’s examine each strategy further to see how you may benefit when filing your next tax return.

 

Deduct

Deductions are amounts that reduce income dollar for dollar. Their impact on the tax return depends on your income level since Canada has a “progressive” tax system which imposes lower rates of tax on low incomes and progressively higher rates of tax on higher incomes. Deductions save tax at a rate applicable to the taxpayer’s marginal tax bracket and are generally more valuable for taxpayers in higher tax brackets.

The most common deductions include:

Pension plan contributions

RRSP/PRPP contributions

Employment expenses

Moving expenses

Union dues and/or Professional membership dues

Support payments for a former spouse or common-law partner

Carrying charges and Interest expenses

Child care expenses

Certain legal fees

Some financial advisors will also include charitable donations and medical expenses as eligible deductions. In reality, these are tax credits – not deductions. While deductions are amounts that reduce income dollar for dollar, credits are amounts that reduce taxes owing. Taxpayers may claim a non-refundable tax credit for qualifying medical expenses and charitable donations.

Both tax deductions and tax credits offer some of the easiest routes to save money in taxes. However, there are detailed rules that govern the eligibility of each item. Make sure you speak with your tax professional each year to confirm you are taking advantage of all available deductions and credits.

 

Defer

A deferral strategy involves delaying or deferring the payment of taxes to some future period. This is often accomplished with some form of investment or retirement account. Registered Retirement Savings Plans (RRSPs) and Registered Education Savings Plans (RESPs) are the most common vehicles for tax deferral for the average Canadian.

Tax deferrals offer two primary advantages:

Due to inflation and the time value of money concept, we know that a dollar today is worth more than a dollar at some point in the future. The longer the money stays with you – rather than the Canada Revenue Agency – the longer you can put that money to work earning income.

Secondly, tax deferral gives you more control over when you pay your taxes. Ideally, you should defer any tax payments into a future period when you are generating less income and therefore subject to a lower tax rate.

 

Divide

Dividing income to reduce taxes is often called income splitting. It involves taking advantage of Canada’s progressive tax system by moving income from the hands of one family member paying tax at a higher rate to another household member who will pay tax at a lower rate. Using this strategy, the overall tax burden of the household will be lowered.

Common strategies to divide income within the rules of the CRA include the following:

Using spousal Registered Retirement Savings Plans (RRSPs) to split income in retirement

Splitting CPP retirement benefits with your spouse

Pension income splitting

Investing non-registered savings in the name of the lower-income spouse

Higher-income spouse makes a loan (at the prescribed interest rate) to the lower-income spouse, who in turn invests the funds

Gifts or interest-free loans to eligible family members to generate income from a business

Capital gains from property transferred to minor children are taxed in their hands

Investing Canada Child Benefit payments in your child’s name

Utilizing Registered Education Savings Plans (RESPs)

Utilizing Registered Disability Savings Plans (RDSPs)

Salaries or wages paid to family members (through a business)

Use of partnerships or corporations to earn business income

Utilizing either inter-vivo or testamentary trusts

As with deductions, there are several rules that must be followed to utilize these strategies. And taxpayers must be extra careful when combining family members and businesses for tax deductions. If you are confused about all the different rules and regulations, then seek the help of a qualified tax professional.