While April 30 is the tax-filing deadline for most clients, the end of the calendar year also is a significant date for many tax strategies, such as charitable giving and reporting capital losses. Here are tax tips to consider as 2021 draws to a close:
Offset capital gains
Managing capital gains to mitigate taxes payable is an important year-end consideration.
Clients who have already triggered capital gains due to robust stock-market appreciation during the first part of 2021 need to determine whether they can offset those gains with capital losses from investments that are now below purchase value, said Graeme Egan, president of CastleBay Wealth Management Inc. in Vancouver.
“That’s an annual exercise that we do for our clients as part of our ongoing wealth management services,” Egan said. “In late November or early December, we look at all portfolios to potentially sell any applicable investments that are in unrealized capital loss positions to offset, to the extent possible, capital gains triggered during the year.”
Timing also is important, said Gabriel Baron, tax partner with Ernst & Young LLP’s private client service in Toronto. “You want to make sure that your trades close inside the calendar year if you are going to realize a tax loss,” he said.
Baron noted that trades are settled on a T+2 basis: the settlement date for a trade is two business days after the transaction date. This year, Wed., Dec. 29 will be the last day on which a transaction settlement can be realized by Fri., Dec. 31.
An increase in the capital gains inclusion rate, to 75% from 50%, was proposed by the NDP in its 2021 federal election platform. With that party potentially holding the balance of power in the new minority Parliament, that measure could pass and significantly affect clients.
“None of us in the tax community wants to be alarmist,” Baron said, “but I think it’s important to at least sensitize people to the dialogue [about increasing the capital gains inclusion rate] so they start considering their plans.”
Review estate plans for business owners
Clients who own businesses and intend to pass them to an adult child should be made aware of Bill C-208, new legislation that facilitates such intergenerational transfers, said Michael Espinoza, senior manager of national tax for Grant Thornton LLP in Toronto.
The bill, which received royal assent in June, provides significant benefits for clients engaged in such intergenerational transfers as part of an estate plan, said Baron. In short, owners of family farms and fisheries can now pass their businesses to their children without triggering tax consequences that leave the original owners worse off than if they sold their business to an unrelated third party.
However, the federal government has indicated that amending legislation might tighten those rules on or after Nov. 1. The changes are intended to prevent “surplus stripping,” whereby shareholders or owner/managers take money out of their company and pay minimal taxes.
“What we’ve been trying to do with our clients,” Espinoza said, “is basically get out in front and have that conversation to say, ‘If you’re looking to transfer your business to your son or your daughter, this is what you need to understand about the new bill, and why you may want to consider this opportunity now, before the rules become more restrictive or complex.’”
Make charitable donations
In order for a charitable donation to be claimed as a tax credit for the current taxation year, it must be made on or prior to Dec. 31.
If your client does not have enough cash available to make a charitable donation, consider donating “in kind” to a charity by donating investments such as shares of a publicly listed company or ETF units. The client then avoids having to sell the investment, which would trigger capital gains taxes, in order to make a cash donation, Egan said.
A client who makes an in-kind donation will receive a charitable donation receipt for the value of the asset on the date of the donation, which can be claimed on their personal tax return as a donation tax credit, Egan added.
Use prescribed-rate loans
If you advise couples who are in different tax brackets, they can execute a tax strategy based on prescribed-rate loans.
The higher-income spouse can loan money to their lower-income spouse, who would invest that money. The lower-income spouse would pay lower taxes on the investment earnings than the higher-income spouse would have, and pay interest on that loan to the lending spouse at the prescribed rate. The strategy is predicated on the couple having excess cash to invest.
“The reason why this is a timely thing is that prescribed rates have been low for quite a while,” Espinoza said. “However, as the economic situation improves, rates may increase, resulting in a higher income inclusion for the higher-income spouse. The applicable rate would be the prescribed rate in effect when the loan is initially incurred, so establishing that loan now, while rates are still low, would result in a lower income inclusion than doing so when rates rise.”
If the lower-income spouse pays interest within 30 days of year-end, they will get a deduction for that loan interest, and the interest is included in the higher spouse’s income. But any dividends or capital gains would be realized within the lower-income spouse’s portfolio and taxed at their lower marginal rate.
The prescribed interest rate for the fourth quarter of 2021 is 1%.
Take advantage of self-employment deductions
Many people still work from home in Year 2 of the pandemic, and some of your clients may need to think about the related tax deductions available to them, said Dino Infanti, national leader for enterprise tax with KPMG LLP in Vancouver.
Infanti noted that individuals earning commission income now have a much broader range of deductions they can claim.
“Some examples of expenses that may be deductible include work space expenses such as electricity, heating and minor repairs, certain office supplies and a portion of an employee’s cellphone service plan, provided certain conditions are met,” Infanti said.
Independent contractors who are not employees can claim some home-office expenses such as home insurance, property taxes, mortgage interest and capital cost allowance, Infanti added.
Matters of principal
Given the real estate purchasing boom of 2021, some clients may need to review the rules governing the principal residence exemption, which frees up clients from paying taxes on the increase in value of the home realized when it is sold.
Clients need to complete Form T2091: Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust) to formally designate such a property on their tax return for the year of sale.
Use of the home for a business may, in certain circumstances, affect the principal residence exemption.
The Liberal Party proposed in its 2021 election platform the concept of an anti-flipping tax, whereby residential property — which could include a principal residence — sold within one year of purchase would be subject to taxes.
“This is a very relevant and important topic that’s being debated,” said Dino Infanti, national leader for enterprise tax with KPMG LLP in Vancouver. “A change to the taxation of a principal residence would be a significant and wholesale change to the Income Tax Act.”