Be prepared: Year-end tax tips

For all of us, December is just about the busiest month of the year. For your high-net worth clients there are also tax issues that should be dealt with despite the seasonal distractions. As an advisor, you are uniquely positioned to help clients minimize their 2009 tax bills. The following are some of the key considerations you will want to raise with them.

Paying the right amount

December 15th is the deadline for the year’s final quarterly tax installment payment, and it’s important that your clients pay just the right amount. The Canada Revenue Agency provides them with a payment schedule based on their prior years’ income but this year’s income is what counts. If your clients’ income is heavily dependent on investments, for example, they may see a drop in the overall total for the year. To avoid over-paying, it’s advisable to carefully estimate 2009 income and then make a final payment based on the result. The only caveat in this respect is if the estimate is incorrect and a client underpays income taxes for the year, he or she may also be charged interest and penalties. Nevertheless, it is worth making the estimate to avoid overpaying. Although a tax refund is always appreciated, a large refund hardly constitutes good tax planning.

Balancing capital gains and losses

December may also be the time to rebalance portfolios in order to smooth the effects of capital gains and losses. If clients have realized capital gains in the year, they may want to offset the associated tax liability by selling securities with accrued losses before the end of the year. Your role as advisor is to help them decide whether the investments they intend to sell remain good fits for their portfolios.

Remember too that there’s a time constraint when implementing this strategy. A trade must be settled in the 2009 calendar year to be considered a 2009 disposition. Assuming a normal three-day settlement, a transaction would have to be initiated by December 24 this year in order to actually settle in 2009. This is because the Boxing Day Holiday falls on Monday, December 28th in 2009 in lieu of Saturday, the 26th.

One final caveat: clients should be aware of superficial loss rules that will deny a loss if they repurchase the “loss shares” within 30 days before or after the original sale.

Carrying forward and carrying back

Your clients can also minimize taxes depending on the timing of realized capital gains. If, for example, they currently have unrealized capital gains, they may want to defer them until 2010. The reason for deferring is taxes on realized capital gains are due by April 30 of the year following that in which they were realized. So if a gain is realized during 2009, the tax will be due by April 30, 2010. By waiting until 2010 to realize capital gains, your clients defer payment of the tax until April 30, 2011.

If clients make installment tax payments on a quarterly basis, their savings may be lower because the amount that can be deferred is less. Still, if a client is likely to have a lower marginal tax rate next year, the eventual tax on the deferred capital gain will be lower.

Capital losses, on the other hand, can be carried back to offset capital gains of prior years. The proviso is that the current year’s capital losses must first be applied to this year’s capital gains before being carried back to a maximum of three years. So, 2009 losses would first be applied to 2009 capital gains before being carried back to offset gains in the years 2006 through 2008. This is the last year that capital losses can offset capital gains from 2006. In other words, if capital gains were realized in 2006 then 2009 is the last year to carry back losses to offset those gains and recoup the tax thereon. As an advisor, your role is to help clients decide whether deferments or carry backs have investment merit.

Paying expenses before the year end

A number of expenses must be paid before December 31, 2009 if clients want to deduct them from their 2009 tax returns. These include interest expense, investment counsel fees, child care expenses, safety deposit box fees, accounting fees and professional dues. Similarly, expenses that will be claimed as tax credits for 2009 must be paid by the end of the year. These include charitable donations, political contributions, children’s sports and fitness program costs, tuition fees and medical expenses. Depending on anticipated income in 2010, your clients might want to pay these expenses by December 31 to benefit from the tax deduction or credit in 2009 rather than waiting until next year.

Donating securities

If a client wants to make a charitable donation, he or she should consider donating publicly listed securities in-kind instead of cash. The virtue of donating securities is that the client can claim the full value of the gift as a donation credit. The accrued gain on the securities being donated is not a taxable capital gain and is not included in taxable income.

Clients who want to claim the donation credit on their 2009 returns must make donations by December 31. Because the administrative process for donating securities in-kind can take a while, it’s best to begin well in advance of the year end to ensure that donation receipts have 2009 dates.

RRSP strategies

Normally, you have 60 days after the calendar year to make a registered retirement savings plan contribution that qualifies for a tax deduction in the current year. This is one of the staples of year-end tax planning. However, if a client is 71 at the end of the year, that person has to make a final RRSP contribution no later than December 31. Similarly, that person’s RRSP must be matured by the end of the calendar year.

There are a couple of ways clients can benefit from this age-imposed financial transition. If the person is turning 71 in the current year, it is possible to make an RRSP contribution for the following year before maturing the RRSP but while the person may have earned income in the current year, the next year’s RRSP contribution room will not be created until January 1. And the rule is that 71-year-olds cannot hold RRSPs after December 31.

However, there’s nothing to stop a client from making a contribution for 2010 in 2009 before maturing the RRSP, based on a reasonable estimate of the room that will be available. While an over-contribution to the RRSP will have occurred, thus subject to a penalty of 1% per month, the tax savings generated by making the contribution in the first place should more than offset it.

A second approach for those turning 71 is to take advantage of unused contribution room by contributing to a spousal RRSP so long as the partner is 71 or younger.

RESP options

Registered education savings plans allow people to save for the post secondary education of children or grandchildren on a tax sheltered basis while reducing taxable income. There are, of course, other advantages to RESPs. With an RESP contribution of $2,500 per child, the federal government will contribute $500 in the form of the Canada Education Savings Grant to the RESP. If a client has prior non-contributory years, the annual Grant can be as much as $1,000 in respect of a $5,000 contribution. Clients should try to contribute to their RESPs on or before December 31st in order to maximize the income deferral and benefit from this Grant.

Making use of TFSAs

With the introduction of Tax Free Savings Accounts on January 1st, 2009, 26 million Canadians aged 18 or more received $5,000 in tax-free contribution room from the federal government. On January 1st, 2010, an additional $5,000 in tax-free contribution room will be added to each account. In the manner of RRSPs, Tax Free Savings Accounts are bound to become staple financial vehicles for investors and given the flexibility these accounts offer, they provide advisors with additional opportunities to deliver the tailored, tax-saving strategies that are so highly valued by affluent clients. Now is an excellent time to discuss clients’ options for making the most of this new contribution room.Making the most of the season

As you can see, clients have a host of year-end tax planning issues to deal with, along with all the other seasonal considerations. It’s worth it to do as much as you can to alert them to the tax saving possibilities. Indeed, a little planning now could result in some substantial “gifts” from the tax man in the New Year and beyond.