1) INTRODUCTION:
François Doyon La Rochelle: You’re listening to Capital Topics, episode #69!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In our podcast today we will review Year- End Tax Planning strategies highlighting the 2024 Federal Budget proposed changes on Capital Gains Tax.
Enjoy!
2) 2024 YEAR-END PLANNING:
François Doyon La Rochelle: Well, it’s that time of the year again to cover Year-end Tax Planning Strategies for Investors in Capital Market Securities. Our regular Listeners know this is an annual tradition on our Podcast to cover this topic at year-end. But this year the big tax planning challenge is that there is a lot of uncertainty surrounding capital gains tax rules. Most of our Listeners know that the 2024 Federal Budget introduced major changes with the New Capital Gains Tax rules. At the Personal tax level, The Capital Gains inclusion rate was increased from 50% taxable to 66 2/3% for gains realized over $250,000. The new rules for capital gains realized in corporations or a Trust are even harsher whereby all realized gains will be taxed at the higher 66 2/3% inclusion rate. These new rules completely upend the planning for investors with assets in their corporations and for estates. To make matters more complicated, the New Capital Gains Tax Legislation is delayed, and some are speculating it may not be passed before year-end. There is a lot to discuss, and as usual careful planning will be required. So, James, where would you like to start?
James Parkyn: Francois, to answer your question, I will tackle today’s topic in two parts. First, I will address the New Capital Gains tax rules and in Part Two I will cover the other year-end tax planning strategies.
But before I start, I want to remind our listeners that when we talk about Tax, we adopt the Optimizing Mindset which is a very different concept from minimizing your taxes. By Optimize we mean you need to think not just about the current tax year but how your assets will evolve over the longer term and how you will need to plan your current and/or future retirement income withdrawals tax effectively.
François Doyon La Rochelle: We want to remind our Listeners that the insights and advice we will be sharing will be general. We need a more detailed understanding of an investor’s tax and financial situation to give specific recommendations. Listeners should consult their tax advisors, portfolio managers, and financial planners for personal recommendations. So, James, what should taxpayers do about the new Capital Gains Tax Rules?
James Parkyn: Well, François, the political turmoil in the Federal Parliament has delayed the passage of the new capital gains tax legislation. As we record this Podcast, our thoughts and comments will reflect this reality.
But the question remains whether the capital gains inclusion rate increase will become law as some opposition parties have made it clear they would like to topple the government. There is a political risk that is difficult to assess at this point, but it could be that a delay or even a cancellation of the proposals could happen. The net effect would be to keep the current 50 percent inclusion rate.
François Doyon La Rochelle: If an election is called before the capital gains proposals are passed, my understanding is the bill will die with all others not voted on before Parliament is dissolved or prorogued. This begs the question of how should Canadian Taxpayers plan given this uncertainty.
James Parkyn: We have spoken with many tax professionals to answer that very question. Many Investors proactively planned by crystallizing gains before the June 25th deadline at the old 50% Inclusion rate, as if the proposals would become law.
François Doyon La Rochelle: James, is this usually the right thing to do?
James Parkyn: Yes, I think it is. The Canada Revenue Agency (CRA) is charged with administering the law, but the capital gains proposals are not yet law. Should they become law, they will be retroactively in force as of June 25, 2024.
François Doyon La Rochelle: Should taxpayers proactively file their tax returns as if these new rules were law?
James Parkyn: Well, François, tax specialists are saying that the CRA has no legal ability to assess affected tax returns on the basis that the capital gains proposals are law. In addition, the related tax forms and CRA-approved tax preparation software have not been updated or approved.
A recent Globe and Mail article highlights the challenges faced by private corporations and estates with financial year-ends on or after June 25, 2024. I will share with our Listeners some of the main points of the Article. And I quote:
“With the CRA stating that tax forms won’t be available until January 2025, taxpayers face these two main challenges:
Software providers can’t release updates until legislation is passed.
Filing and payment delays may result in interest and penalties for affected taxpayers.
François Doyon La Rochelle: What should taxpayers do in the meantime, James?
James Parkyn: The CRA recently provided some guidance via CPA Canada, the governing body that regulates professional accountants. The CRA encourages taxpayers to file affected returns based on the proposed legislation using a variety of different options.
Estimate and pay tax using the new 66.67% inclusion rate to avoid interest on the additional tax.
File the tax return on time, even if uncertain, to avoid late filing penalties.
Monitor developments for possible legislative changes before year-end.
Work with advisers to prepare returns manually, when necessary.
Amend the return later if the legislation doesn't pass.
Tax lawyer Kim Moody writing in the National Post recently stated “I have reviewed the CRA’s suggestions, and they make logical sense. In today’s high-interest rate environment, you would generally want to ensure that probable tax liabilities are timely paid to avoid possible costly interest charges. Currently, that rate is nine percent.”
François Doyon La Rochelle: But what if the opposite happens James? In other words, if you follow the CRA recommendations and proactively file and pay tax based on the proposed legislation, but the new proposed rules never get passed?
James Parkyn: In that case, you would need to file an amended return to adjust for the correct amount of taxable capital gains and request a refund for the overpaid tax. The CRA would also pay interest on such overpayments, but, of course, at a rate lower than the current nine percent for liabilities. That refund rate is currently seven percent for non-corporate taxpayers and five percent for corporations.
François Doyon La Rochelle: I stated at the beginning of today’s Podcast that these new rules completely upend the planning for investors with assets in their corporations and for estates. If these new rules come to be voted into law what will be the long-term impact for investors?
James Parkyn: According to me, François, the impact for investors would be to ask themselves whether it is still valid to hold long-term investments in their company. At a minimum, investors should determine whether it would be advantageous to withdraw amounts from their company to personally benefit from the 50% inclusion rate on the first 250,000 dollars of annual capital gains, or if they should simply leave those amounts in the company for the long-term.
This question requires careful planning with a tax accountant. To put things into context, I will summarize the taxation of passive investment income in a corporation. When you earn passive investment income within your company, it is taxed at a single marginal rate (in Ontario and Quebec, this rate is 50.17%). There are no progressive rates. The tax on corporate investment income results in a potential refundable tax. When your company pays dividends, it generally recovers this refundable tax. Once you have paid the tax on the dividends received personally, you can retain the net proceeds (after the tax paid in the corporation and the tax paid personally) from the investment income that was initially earned by your company. For most investors, tax experts believe that it is still very advantageous, both short-term and long-term, to invest through their corporation.
François Doyon La Rochelle: This sounds complicated and counterintuitive as the first $250,000 is taxed at the 50% inclusion rate personally and in the corporation, it is taxed at 66 2/3%. Can you clarify this, James?
James Parkyn: When business income that’s earned in your corporation is used as investment capital, you may have a lot more cash left over inside your corporation to invest than you would have if you paid yourself out a taxable dividend and then made personal investments. This is due to the lower tax rates on corporate business income. Even though the tax inclusion rate for corporate capital gains is quite a bit higher than the tax on personal capital gains earned personally that are taxed at 50% below $250,000. The extra corporate investment income more than outweighs the higher corporate tax.
François Doyon La Rochelle: Can you give some examples of what would be the net benefit for investors?
James Parkyn: Jamie Golombek, CIBC’s resident tax expert has produced a Report that illustrates the net benefit for an Ontario resident. He estimates that if the corporation is taxed at the General Corporate Income Tax Rate it would represent about 39% more accumulated after 30 years. When the estimate is based on the corporation being taxed at the Small Business Deduction Tax Rate, he projects there would be almost 60% more accumulated after 30 years.
François Doyon La Rochelle: This is significant James. We will include a link for our Listeners to this CIBC Report. Some of our Listeners may be asking themselves, will the new rules impact a business owner’s decision to take money out of their corporation and contribute to their TFSA and their RRSP?
James Parkyn: Francois, this is a great question. We have always favored accumulating assets in three buckets: Corporations, personal accounts, and RRSP’s. Some business owners preferred to not take money out of their corporations in the past. I suspect many who had previously favored investing in their corporations may now choose to withdraw income from their corporations to invest personally.
François Doyon La Rochelle: James, how will Capital Losses be treated under the new Capital Gains Tax rules?
James Parkyn: Capital losses carried forward from prior years will be worth more if you apply those losses against capital gains subject to the new inclusion rate. Capital losses realized in 2024 must be used against any capital gains in 2024. Excess losses can be carried forward. However, capital losses carried forward from 2023 or earlier years can be applied against any future capital gains. So, if you realized capital gains this year that will be taxed at the lower one-half inclusion rate you may be best to hold onto your capital losses carried forward to apply them against gains taxed at the higher inclusion rate in the future.
François Doyon La Rochelle: So, James if I understand correctly, Investors should claim capital losses against the right gains. And, where possible sell your losers before year-end.
James Parkyn: Exactly Francois, if you realized capital gains this year that will be taxed at the higher two-thirds inclusion rate, you should see if any securities have declined in value and consider selling these before year-end to offset the capital gains. Any capital losses realized in 2024 that can’t be used to offset gains this year can be carried forward indefinitely to offset capital gains in the future. Alternatively, they can be carried back to 2023, 2022, or 2021 to offset gains in those years. Carrying losses back could recover some taxes paid in those years, but the savings won’t be as great as using the losses against capital gains taxed at the higher inclusion rate in the future.
François Doyon La Rochelle: If you’re selling a loser, the settlement date must fall in 2024, which means placing your trade on or before Monday, Dec. 30 for publicly traded securities that settle one day after the trade – which became the norm on May 27, 2024.
As year-end approaches, clients may also consider making in-kind donations of appreciated publicly traded securities. For high-net-worth clients with gains above $250,000 in a year, the strategy must be very attractive.
James Parkyn: Yes, it is François. If you donate publicly traded securities or mutual funds to charity, you’ll receive not only a donation receipt for the fair market value of the gift but any capital gain on the security will be subject to a zero inclusion rate, eliminating the tax on the capital gain.
François Doyon La Rochelle: In Summary James, we don’t have to pay the tax on the capital gain, and we still get our charitable donation receipt to use on our tax return.
James Parkyn: That’s exactly right Francois.
François Doyon La Rochelle: OK so let’s tackle Part 2. What are the other Year-end Tax Planning strategies our Listeners should know about and what actions should they take before December 31, 2024, regarding the registered accounts: RRSPs, TFSAs, RESPs, and the new FHSA?
James Parkyn: First off, much of the content of last year’s Podcast on Year-End Tax Planning is still very relevant this year. I recommend that our Listeners go back to Podcast #58 and listen to it.
To answer your question, François, I will start with RRSP’s.
The current year's maximum RRSP contribution room is $31,560. Listeners can find their RRSP room on their 2023 Federal Notice of Assessment (NOA). This number will include unused contribution rooms carried forward from prior years.
The 2025 maximum RRSP contribution room will be $32,490. For those Listeners who like to make early bird contributions in January.
For Business Owners consider declaring a T4 salary of at least $180,500 by December 31, 2024. This will create the maximum RRSP contribution room of $32,490 in 2025.
If you have turned 71 in 2024, you must convert your RRSP to a RRIF and you have until December 31 to do so. But don’t forget to make any final contributions to your RRSP before converting it.
François Doyon La Rochelle: What do you have to share about TFSA’s James?
James Parkyn: For TFSA there are a lot of planning points:
The TFSA dollar limit for 2024 is $7,000 but there is no deadline for making a TFSA contribution. The unused contribution room is carried forward.
The CRA has announced the limit for 2025 will NOT be increased and will remain at $7,000. Best to make your contribution as early as possible in January 2025.
For listeners who have not maximized their TFSA since 2009, you should check online with the CRA website to confirm your contribution room. The maximum room since 2009 is $95,000 in 2024 if you haven’t previously contributed to a TFSA.
Be careful, however, if you have withdrawn funds from your TFSA in 2024, you must wait until the next year 2025 to recontribute the amount withdrawn.
If you are planning a TFSA withdrawal in early 2025, consider withdrawing the funds before December 31st, 2024, so you would not have to wait until 2026 to re-contribute.
François Doyon La Rochelle: Next up is the new First Home Savings Account. We covered this topic in detail in our Podcast #52 published in 2023.
James Parkyn: First off you must verify if you qualify to open an FHSA. You can visit the CRA’s online website to make sure you meet the requirements.
In 2024, your contribution cannot exceed $8,000 if this is the first year you make a contribution to your FHSA. If this is your second year and you contributed the maximum $8,000 in 2023 then you can contribute another $8,000.
You can claim a tax deduction for contributions within this limit, in 2024 (or in a future year if not claimed previously). Unlike RRSPs, contributions you make within the first 60 days of 2025 cannot be deducted in 2024.
François Doyon La Rochelle: The new FHSA rules are complicated. The 2024 Contribution must be made before December 31 to be deductible in 2024. It is best to seek out expert advice. Now let’s talk about RESP’s James.
James Parkyn: I will summarize the key end-of-year RESP planning strategies.
RESP contributions are subject to a $5,000 limit or $2,500 for the current year and $2,500 for one catch-up year, to generate the maximum grants. If you have less than seven years before your beneficiary child turns 17 and haven’t maximized RESP contributions, consider contributing by December 31 because otherwise, you will not be able to claim the maximum of $7,200 in Federal government grants.
For RESP withdrawals, the maximum Education Assistance Payments (EAP) that can be taken in the first 13 weeks of post-secondary education is $8,000 for full-time students and $4,000 for part-time students.
If your child is a RESP beneficiary and stopped attending a post-secondary educational institution in 2024, EAPs can only be paid out for up to six months after the student has left the school. You may, therefore, wish to consider making a final EAP withdrawal for that beneficiary before year-end especially as they may have to pay much higher taxes in 2025 with a full year of employment income.
François Doyon La Rochelle: Do you have any other year-end suggestions for our Listeners?
James Parkyn: Yes, I have a few:
Pay investment expenses to claim a tax deduction or credit in 2024. This includes interest paid on money borrowed for investing and investment counseling fees incurred for managing non-registered accounts.
For our Retiree listeners, the dreaded OAS clawback is always a big concern. You need to make sure that your income does not exceed the recovery thresholds. Taxpayers must repay their OAS at the rate of 15% of 2024 net income of more than $90,997. The entire OAS amount must be repaid if a taxpayer has a net income of more than $148,451 for taxpayers between ages 65 to 74 or if a taxpayer has a net income of more than $154,196 and is age 75 and over. This is a means test that also amounts to a form of double taxation. Because OAS is an individual benefit, it is not impacted by family income but instead is clawed back based on an individual’s taxable income.
François Doyon La Rochelle: Anything else to add James?
James Parkyn: Yes, I do Francois, as we have said many times before in our Podcast, Tax Planning should be done all year long. Do not wait until year-end to optimize your taxes.
François Doyon La Rochelle: Indeed James, and I hope they do. I believe we have covered a lot of ground and hopefully, our Listeners will find this update very useful. I also want to remind our Listeners that our comments and Advice on this Podcast are generic in nature and all our Listeners should consult their tax and financial advisors.
3) CONCLUSION
François Doyon La Rochelle:
Thank you, James Parkyn: for sharing your expertise and your knowledge again today.
James Parkyn: My pleasure. François.
François Doyon La Rochelle: That’s it for episode #69 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: capitaltopics@pwlcapital.com
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Again, thank you for tuning in and please join us for our next episode to be released on December 18th . In the meantime, make sure to consult the Capital Topics website for our latest blog posts.
See you soon.