This quarter we have a two-pronged focus: Tax, and its impact on income and wealth maximization, and the power of Estate planning in reducing Tax and Estate expense erosion on assets. As with all other elements of the Natural Wealth® Process we will break the Tax and Estate discussion down into three areas: Person Tax and Estate, Portfolio Tax and Estate, and Possession Tax and Estate. Although Tax and Estate matters are inter-connected, for clarity sake we think it is only wise to discuss each category separately given the depth of the subject. This time around we will focus on Person Tax.
Working Person Income (income we earn while working) is some of the highest taxed income earned in a person’s lifetime. The fact remains that federal and provincial governments rely heavily for their annual revenues on the tax generated on wages, salaries, and net self-employed income. Outside of expenses incurred in generating self-employed income there are few actual methods for reducing tax paid on the income we generate from working. Two ways to reduce tax would be through investing in a Registered Retirement Savings Plan (RRSP), or by deducting education expenses paid for courses you enrolled in to improve your work skills and knowledge.
Retired Person Income (income earned from pensions) is eligible for income tax relief in certain situations through credits and deductions like the additional Age Credit and Pension Splitting in married households. As is the case with Working Person Income, Retired Person Income is, dollar for dollar, highly taxed relative to certain types of income earned on Portfolio Wealth. As such, it pays to be aware of the impact of tax on the income earned while working or retired to seek every opportunity to pay as little tax as necessary within the bounds of the Income Tax Act.
Awareness starts by defining your Person Income on your tax return. For those earning a salary or hourly wages your income is shown on a T4. If you are self-employed, Working Person Income is the net income you will pay tax on after deducting allowable expenses incurred in generating that income. These incomes are input on lines 101 and 104 or, in the case of unincorporated self-employment income, on lines 135,137, 139, 141, and 143.
These amounts are taxed as “ordinary” income with few additional deductions or tax credits. The trick to understanding the impact of income tax is to total the income in these boxes (some people earn salary / wages and operate a small business on the side) and then use a tax table to determine your marginal tax rate (the rate of tax you will pay on the net dollar earned). I have included a tax table in the below link which you can use for this purpose. Anything that can be done to “cap” earnings versus taking in a new dollar earned (e.g. deferring earnings or buying RRSP where appropriate) will save you that tax amount on each dollar. Conversely, any dollar deducted using legitimate methods will save you that rate of tax and possibly even create a tax refund where your tax has already been paid.
One method of reducing the overall level of tax on income earned by self-employed persons is to consider incorporating the business in situations where you do not need all the net income you are generating. Private corporations pay a lower rate of tax on net income generated on business income. Private corporations come with complexities and additional costs for legal and accounting work so it is wise to discuss the advisability of incorporation with a qualified tax planner.
In the case of Retired Person Income for retirees this income is normally reported on a T4A, or in the case of income drawn from a Registered Retirement Income Fund (RRIF) on a T4RIF. Certain methods exist for reducing tax paid on this income including the means-tested Age Tax Credit, the Pension Income Tax Credit, and where a person is married or in a common law relationship, the ability to split qualifying pension income and Canada Pension Plan payments received to reduce overall taxable income.
The trick to minimizing the amount of tax payable begins with understanding your marginal income tax bracket and the impact additional income or additional deductions can have on your overall tax bill. Use the attached worksheet along with your recently completed income tax return to determine your own individual marginal tax rate on Person Income.
If you would like us to review your 2017 Income Tax Return and look for possible opportunities to help you reduce the income tax you pay, please send us a copy of your completed income tax return along with your Income Tax Notice of Assessment.
David J. Luke, CFP, RFP, CLU, CH.F.C., CIM | Financial Advisor
360 Private Wealth Management | Manulife Securities Incorporated
Unit 1 – 25 Scurfield Boulevard, Winnipeg, MB R3Y 1G4
Main Office 204.925.5868 | Direct 204.925.2073| Fax 204.925.2263 | Toll Free 844.688.3656