Tax Season Speedway 2025:

With the anticipated increase in the capital gains inclusion rate from 50 per cent to 66.67 per cent effective June 25, 2024, it is recommended to assess your investment portfolio before year-end. Under the proposed rules, individuals will have a limit where the first $250,000 of capital gains incurred in 2024 after the proposed effective date of June 25, 2024, will still be eligible for the current 50 per cent inclusion rate. You might consider the below strategies.

It is important to note that the proposed increase to the capital gains inclusion rate is still a proposal, and there is no guarantee that the proposed legislation will be passed into law. This should be considered before undertaking any of the strategies below.

Realize Gains Up to $250,000:

If your capital gains for 2024 post June 24, 2024, are expected to be under $250,000, consider crystallizing additional gains to fully capitalize on the lower inclusion rate. Crystallizing gains today ensures your cumulative gains are taxed at the current lower rate, while the step-up in cost base reduces future taxable gains. This strategy can be especially advantageous if, in future years, your capital gains are expected to exceed $250,000 and will be subject to the higher 66.67 per cent inclusion rate in a future year. This approach works particularly well for publicly-traded shares, as they can be easily sold and reacquired at a similar price.

When considering crystallizing additional gains, it’s important to take into account the time value of money, as this option results in immediate taxes payable in early 2025 and the tax deferral opportunity on unrealized gains is lost. It’s also prudent to factor in the impact on your marginal tax rate, as realizing these capital gains could put you in a higher tax bracket for 2024.

Offset Gains with Losses:

If your capital gains post June 24, 2024, will exceed $250,000, look for opportunities to offset these capital gains with capital losses. This can include losses carried forward from previous years or by selling underperforming investments you no longer wish to hold. When selling investments, it is important to be mindful of the stop-loss rules, which disallow a capital loss in the current year if the same or identical property is purchased (or repurchased) within 30 days before or after the sale.

If you have cash available and are considering additional investments, utilizing registered accounts can provide tax savings and/or a tax deferral opportunity. Consider the following registered account options.

First Home Savings Account (FHSA)

If you are a first-time homebuyer who is a resident of Canada and at least 18 years of age, the FHSA allows you to save on a tax-free basis toward the purchase of a home. Contributions to an FHSA are tax-deductible, and withdrawals for a qualifying home purchase are tax-free.

From the year you open an FHSA, you can contribute up to $8,000 annually, with the option to carry forward a maximum of $8,000 of unused contribution room to the following year. There is, however, a life-time contribution limit of $40,000. If you qualify, it is advisable to open an FHSA by December 31 of any given year, even if you are not ready to contribute that same year. Doing so allows you to accumulate contribution room ahead of time and, if desired, contribute up to $16,000 the following year, providing an opportunity for a deduction against your income during a high-earning year. 

Registered Retirement Savings Plan (RRSP)

The RRSP is another effective way to manage your taxable income. Contributions to an RRSP are tax-deductible, making it especially advantageous if you are in a higher tax bracket. Investments grow tax-free in the account; however, withdrawals are taxable. The plan is primarily to accumulate retirement savings, presumably when you will be in a lower tax bracket, but can also be used to fund the purchase of a first home through the Home Buyers’ Plan. You can also achieve income-splitting by contributing to a spousal RRSP. 

Your contribution room can be found on your CRA My Account or on your 2023 Notice of Assessment. It is essential to check your contribution room to ensure you do not exceed the limit, as over-contributions are subject to penalties. 

Tax-Free Savings Account (TFSA) and Registered Education Savings Plan (RESP)

TFSAs allow Canadians to earn investment income tax-free. Although contributions are not tax-deductible, withdrawals are tax-free. It’s a flexible investment tool, ideal for years during which income is low or when other plans, like RRSPs, have been maximized. Your contribution room can be found on your CRA My Account, but be mindful of overcontributions, as they are subject to significant penalties.

The RESP is ideal for parents saving for a child’s education. Investment income grows tax-free within the plan, and contributions may qualify for government grants. While there is no annual contribution limit, the lifetime contribution limit for any beneficiary is $50,000. If used for education, withdrawals from the RESP are taxable to the student beneficiary. The portion of the withdrawal that represents prior contributions is not taxable. Students usually have little or no income, so they will likely pay a lower tax rate on withdrawals.

Utilizing registered accounts like the FHSA, RRSP, TFSA, or RESP can grow your investments in a tax-efficient manner, and planning your contributions strategically will ensure you make the most of these opportunities.

TFSA contribution room generated from a withdrawal is restored at the start of the following calendar year, so it is important to time withdrawals wisely. If you withdraw funds in early 2025, you won't regain the equivalent contribution room until 2026. Re-contributing the funds in the same year could result in over-contribution, leading to penalties on the excess amount. Consider making the withdrawal by December 31, 2024, to ensure that the contribution room is reinstated at the beginning of 2025, provided that the withdrawal is not made to correct an over-contribution. If you intend to transfer TFSA funds to another registered account, a direct transfer between financial institutions is recommended to avoid exceeding your contribution limits.

The Alternative Minimum Tax (AMT) is often applicable when an individual claims preferential deductions, exemptions or credits against their income. Its purpose is to ensure that individuals pay a baseline minimum amount of tax. AMT is, however, effectively a prepayment of income taxes, as any AMT paid can generally be carried forward for up to 7 years and used as a credit to offset “regular” income tax payable in a future year. Be mindful that if you do not pay enough regular income tax to recover the AMT within the 7-year carryforward period, the AMT will become an unrecoverable permanent tax cost.

There will be a shift in the AMT system starting in 2024, which may affect taxpayers claiming certain deductions or credits on their 2024 personal income tax returns. The new AMT landscape may reduce the benefits of certain tax optimization strategies that have been used in the past.

Effectively managing the timing and mix of your income can lead to significant tax savings, especially if financial circumstances are expected to change. For example, if your income is lower in 2024, it may be advantageous to withdraw funds from your business this year to take advantage of lower personal marginal tax rates. On the other hand, if you anticipate a lower tax rate in 2025, deferring distributions from your business, where cash flow permits, could help reduce your overall tax liability.

Salaries and dividends are the two most common forms of withdrawing funds from your corporation, each with distinct tax implications. For example, withdrawing income as salary would generally create RRSP contribution and childcare deduction room, while dividends may be taxed at a lower rate.