As the end of the year approaches, it’s a great time to think about the year that was and some tax strategies to implement to finish the year with a bang. Of particular interest this year is the significant proposed change to the capital gains inclusion rate, taking effect on June 25, 2024, which makes its way into a number of the tips below. If year-end tax planning had a theme in 2024, the new capital gains rate would definitely be it. Let’s dive in.
#1 – Consider triggering capital gains (individuals and trusts)
Although not officially law yet since it has not passed Royal Asset, it was proposed that the capital gains inclusion rate increase from 50% to 66.7% as of June 25, 2024. There is an exemption for individuals of $250,000 annually (no exemption for corporations), whereby any gains realized below this amount will continue to be taxed at 50%. Given the significant tax advantages of the lower inclusion rate, taxpayers may want to consider realizing some gains in 2024 if they have not yet done so. Of course, there are more factors at play here, so be sure to discuss with your advisors before doing so. A trust could also trigger gains to be allocated to beneficiaries to use their exemption.
Note that the amount is not prorated in 2024 for the effective date, so taxpayers are allowed to claim the 50% inclusion rate on $250,000 of gains realized after June 25, 2024.
#2 – Consider use of capital losses
Capital losses can be very valuable and the decision to use them has never been more complex given the increase to the inclusion rate on capital gains referenced above. Capital losses are only applicable against capital gains and can be carried forward indefinitely. There is also an option to carry back losses up to three years for potential tax refunds. It may be better to use losses against gains realized post-June 24 or other gains taxed at the new 67% inclusion rate. More clarity from Finance Canada may be forthcoming in the coming months as these changes are ironed out and, luckily, there is some time before a decision needs to be made on this when the tax return is filed.
Generally, capital losses are worth more as a carry forward than carry back in the current environment of the higher inclusion rate. Collaboration between advisors ensures a well-timed and efficient approach, maximizing benefits such as tax-free CDA funds and minimizing corporate taxes when appropriate.
#3 – Consider timing of capital gains reserves
The Tax Act allows taxpayers to claim a capital gains reserve to defer tax on a sale of a capital asset up to a period of five years, as long as the proceeds are actually deferred and receivable over that five-year period. Generally, it is advisable to defer the gain as long as possible to time the taxes payable to CRA with the cash being received by the vendor.
Given the proposed increase to the capital gains inclusion rate in 2024 and future years, it may be advisable to recognize more of the reserve than is required to lock in the 50% inclusion rate, as opposed to the 67% inclusion rate that may otherwise apply in a future year.
#4 – Open a First Home Savings Account in 2024
The First Home Savings Account is a great new savings tool the government introduced in 2023, which combines the best of both RRSPs and TFSAs. If you qualify, it would be prudent to open an account in 2024 as the available contribution room of $8,000 per year only starts to accrue once an account has been opened with your financial institution.
#5 – Withdraw any TFSA money before year-end (but only if you have to)
Any amounts taken out of a TFSA are tax-free and are added back to the amount you are able to contribute. The only issue is that the contribution room is not added back until the subsequent year, such that taking money out in January for short term cash needs and re-contributing the same amount in April of the same year would result in an over contribution and some nasty tax consequences.
Therefore, if you expect you will need some of your TFSA funds on a short-term basis, it would be best to take the money out in 2024 so the contribution room resets for you in January. While it is generally recommended not to withdraw TFSA funds, there are, of course, situations where it makes sense to do so as the funds are needed.
#6 – Disposition and acquisition of capital assets
Selling a capital asset involves weighing the timing for potential tax advantages. Delaying the sale to a subsequent year may result in a tax deferral, providing the opportunity for full use of the proceeds until the new tax reporting period, even if the asset is sold the first day of the next year. Moreover, it will allow for another full year of capital cost allowance (CCA) to be claimed to reduce taxes otherwise payable.
Conversely, acquiring an asset in the latter half of the year entitles the purchaser to claim half-year capital cost allowance, offering a potential increased tax deduction in the initial year of acquisition. Further to this, there are currently special rules for enhanced CCA that you may qualify for.
#7 – Stock option exercise
Similar to the new capital gains rules in point 1 above, there will also be a limit to the amount of stock options that will be entitled to the 50% deduction annually. This new limit will be the same $250,000 referenced in point 1, and the remainder of the stock option deduction will be reduced to 33% from 50%. Therefore, it may be wise to exercise some stock options where possible if there is a significant amount that will be over the annual exemption if exercised in one year.
#8 – Review compensation strategy for incorporated businesses
Compensation strategies for business owners is far from a one-size-fits-all approach. The overall tax rate, encompassing both corporate and personal aspects, remains relatively consistent whether opting for a salary or dividends. However, opportunities lie in strategic income distribution, especially to family members in lower tax brackets. However, the landscape has evolved, with Tax On Split Income (TOSI) rule changes adding complexity to the once straightforward decision-making process.
Salaries provide earned income, crucial for RRSP contributions, while dividends do not qualify for such contributions. Childcare costs add further consideration as the lower-income spouse can only claim expenses against earned income, potentially limiting benefits for those relying solely on dividends. The Canada Pension Plan also requires contributions through salary to ensure entitlement to benefits in retirement.
Relying solely on dividends may be advantageous for companies grappling with accumulated refundable taxes, offering potential savings, if executed strategically. Accrued bonuses, if paid out within six months, can be deducted as expenses, providing a means to shift tax burdens and optimize financial outcomes.
You may also want to consider hiring family members in the business as another form of income splitting, so long as you can justify their involvement to the tax man.
#9 – Consider new Alternative Minimum Tax (AMT) rules and their implications on you
The AMT rules were significantly updated in 2024 and will apply to a lot more people this year than in previous years. While the rules are complex, the general idea is that CRA wants everyone to pay a minimum level of tax, and these rules ensure that happens, no matter what kind of income someone has. At a high level, some of the main types of income and expenses that may give rise to AMT this year are interest expenses, capital gains at the 50% inclusion rate, capital losses, and stock option deductions and donations. If you have significant amounts in any of these categories, AMT may apply.
However, it’s not all bad news. The AMT can usually be viewed as a pre-payment of tax, and is available to reduce a future tax balance for up to seven years. This means taxpayers can potentially offset future regular taxes with the AMT prepayment. To leverage this, careful planning with financial planners and accountants is crucial to ensure the right type of income and taxable liability align with the AMT pre-payment.
#10 – Pay out CDA from company
The Capital Dividend Account (CDA) allows the non-taxable portion of gains from investment sales to be paid tax-free to shareholders through an election form. However, capital losses diminish this account balance, so their timing plays a pivotal role in optimizing CDA. You may wish to consider realizing capital losses in your company on assets, such as an investment portfolio, before year-end, to offset capital gains. While doing so can lower your overall tax bill, it would be wise to pay out your CDA balance first, with the appropriate elections forms, to preserve that CDA balance and not have it erode away by capital losses realized. This strategic move allows the offsetting of capital gains while preserving the tax-free nature of the CDA.
Bonus tip – Pay off any balance with CRA
Those making installment payments and other tax payments to CRA should note that late payments may incur non-deductible interest at a higher rate than what CRA pays on tax refunds. CRA interest charged on overdue balances has risen significantly over the last year on late payments, and is now 9%. As such, it would be best to pay the piper, so the speak, to minimize this cost.
As 2024 comes to a close, these ten tax and financial planning strategies offer individuals and business owners a valuable opportunity to maximize savings, minimize liabilities, and navigate the significant changes in this year’s tax landscape. From leveraging the favorable capital gains inclusion rate before it increases in mid-2024, to optimizing compensation strategies and understanding the implications of the new Alternative Minimum Tax rules, proactive planning with financial advisors is key. By implementing these tips, you can enter the new year with greater confidence in your financial footing and set the stage for long-term success.
