Keyboard with a large key that says "fourth quarter" / jurgenfr

This article appears in the November 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

Tax planning should be a year-round process, but the fourth quarter is a critical time to ensure your clients’ tax strategies will deliver maximum benefits.

Three experts discuss strategies that taxpayers should consider, given the tumultuous year the markets have experienced.

Tax-loss harvesting

Clients with investments in non-registered accounts that have experienced an unrealized loss should consider tax-loss harvesting.

“Having a loss on paper is painful to look at on your account statement,” said Graeme Egan, president of CastleBay Wealth Management Inc. in Vancouver. “But if you want to get some financial benefit from it at the end of the year, realize the capital loss by selling the investment and get back a bit of a tax refund to soften the blow.” Capital losses realized in 2022 can be applied against any capital gains realized in 2022, carried back for three years or carried forward indefinitely.

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The tax savings for clients in the highest tax bracket can outweigh transaction and commission costs associated with realizing the loss.

“Despite only half of a capital loss or gain [being] taxable, given current tax laws, it’s like getting back a refund of about 25 cents on every dollar of loss,” Egan said.

He cautioned, however, that a client cannot repurchase the same investment within a 30-day period without triggering the superficial loss rules, which would prevent the client from deducting the loss.

Income splitting

With the Canada Revenue Agency’s prescribed rate at 3% for the fourth quarter, income splitting using family loans has become less viable than in previous years.

Gabriel Baron, tax partner with EY Canada’s private client services group in Toronto, said these arrangements involve a client lending money at the prescribed rate to a spouse or common-law partner in a lower tax bracket, or to a family trust. The borrower would then invest that money in hopes of earning a return higher than the interest rate. When done properly, the interest paid is deductible because the loan is for investment purposes.

Clients with existing income-splitting arrangements using a prescribed rate lower than 3% should take care to maintain those arrangements lest they lose access to the low interest rate.

For a prescribed-rate loan to remain valid, interest must be paid by Jan. 30 of the following year. Therefore, interest on a loan outstanding in 2022 must be paid by Jan. 30, 2023. Otherwise, income earned on an investment portfolio purchased with the borrowed funds will be attributed to the person who made the loan.

“That would completely defeat the purpose of the planning arrangement. So, it is very critical that people adhere to that repayment date,” Baron said.

Timing capital gains and income

Clients can arrange for a capital gains or income realization in 2022 if they believe they will be in a higher tax bracket next year.

Conversely, if they know they will be in a lower tax bracket in 2023, they can hold off on realizing gains or income until next year.

Ron Harvey, a senior financial advisor with Investment Planning Counsel Inc. in Ottawa, Ont., said these decisions are especially critical for people nearing retirement, many of whom will have less income after they stop working.

By Q4, many clients should be able to extrapolate their anticipated income for the remainder of the year and get an indication of their probable marginal tax bracket. If the tax bracket is higher than anticipated, they can consider ways to reduce their taxable income, such as through tax-loss harvesting, charitable donations or RRSP contributions.

Conversely, if the tax bracket is lower than anticipated or if the client is in the lower part of a tax bracket, the client could trigger income or capital gains this year if also appropriate from a financial planning perspective.

In-kind charitable donations

Another potential year-end tax strategy is to make a charitable donation to get a donation tax credit. If a taxpayer has a capital gain on an investment on paper, making an in-kind donation is more tax-effective than cash, as no capital gains tax is applicable when the investment is donated, Egan said.

“If, however, you donate an investment in a capital loss position, you don’t get to claim that loss,” Egan added. “So, it is more effective to sell the investment, create the loss, donate the cash and then use the capital loss and carry it back and get a tax refund from a previous year from the government.”

Donations must occur before Dec. 31 to use the credit in the 2022 tax year.

Keep an eye on key dates

Harvey advises clients planning to purchase mutual fund units in a non-registered account to check the distribution date of that fund, especially near the end of the year. If that date is, say, Dec. 15, he said, the client should make the purchase after that date, so the distribution is not added to their taxable income for this year.

“You don’t want to be owning an investment where you’re going to pay for an income gain that you didn’t experience,” Harvey said.

Conversely, if a client is planning to sell fund units, the most tax advantageous time to do so is immediately before the distribution.

Harvey reminds clients who turn 71 in 2022 that they have only until the end of the calendar year to make their last contribution to their RRSP before having to convert it to a RRIF or an annuity. They will not get the additional 60 days in 2023 to make a contribution for 2022 that other planholders are afforded.

Moreover, Harvey said, such clients should fill as much unused RRSP room as possible before contribution opportunities are lost forever: “This is your last shot at it.”

The final day to make trades that will settle in 2022 is Wed, Dec. 28.