Seven tips to reduce client tax burden

In the early pages of A Christmas Carol, a yet-to-be redeemed Ebenezer Scrooge is one of the classic meanies of literature. Dickens describes him as “hard and sharp as flint,” and when faced with the seasonal good humour of his nephew, he is grumpy and uncharitable to a fault. But when faced with the three portly gentlemen’s request that he contribute to a Christmas fund for the poor, he does hint at one of the home truths of the year end. “It’s enough for a man to understand his own business, and not to interfere with other people’s,” he tells his visitors before dismissing them.

No one would suggest being as obsessive about personal business and miserly as Scrooge was, but it’s important for your clients to remember that even though tax returns aren’t due until April 30, December is an important month for tax planning. In this column I want to cover some important tax planning measures that must be completed before the year end. And for our purposes, year end this year means December 30, since December 31, 2011 will fall on a Saturday.

Rebalancing with taxes in mind

The best way for your clients to begin their year-end tax planning is to evaluate their portfolios and consider rebalancing them. While it’s important to remember that the overall investment merits of a portfolio’s holdings trump tax considerations, there are tax questions that should come to mind.

If clients have investments with accrued gains, they may want to defer selling them until an appropriate time in 2012, the reason being that any tax on the capital gain isn’t going to be due until April 30 2013.

In cases where investments have accrued losses, it might make sense to sell them before the 2011 year end because the losses can be used to offset gains this year as well as being carried back to offset losses for the three prior years.

Attention to detail is helpful on this score. To establish a current year loss, the settlement date for a sale must fall in 2011. Since the final settlement date for 2011 is Friday, December 30, and trades typically take three business days to settle, the latest date that a trade can be executed to meet this deadline, allowing for statutory holidays, will be Friday, December 23. Your clients should also be aware of superficial loss rules that will deny a capital loss on “loss shares” if they are repurchased within 30 days of their sale.

Give like Scrooge

Your clients might want to consider being charitable in a manner that even Scrooge would appreciate. I’m talking about making a charitable donation of securities that have accrued gains rather than a cash donation. When individuals give cash, they receive a tax credit of 16% on the first $200 and 29% for additional amounts. If they give shares with accrued gains, they can claim the full value of the donation as a tax credit. Similarly, the gain realized on the donated shares will not be taxable.

There are two caveats on this score. The first is that donations will have to be made by December 31 in order to qualify for the tax credit. Second, tax benefits associated with donating flow-through shares were restricted by the federal budget of March 2011.

Don’t wait on RRSPs

It’s an obvious point to make, but one that bears repeating. Clients should not wait until the February 29 deadline next year to make their registered retirement savings plan contributions for 2011, simply because contributing sooner means the benefits of tax deferred saving will kick in sooner.

Having said that, there are a few tax-related points worth making for RRSP contributors who are 71 or over. A client turning 71 in 2011 has until the end of the year to make contributions to his or her RRSP. If this individual has no carry-forward RRSP room, but has income that will generate contribution room next year, it could be worthwhile to make an over-contribution in December before closing the RRSP.

The over-contribution strategy is this: The Canada Revenue Agency will impose a penalty of 1% a month on any contribution amount above $2,000, so there will be a one-month penalty. However, this has to be balanced against the potential tax savings benefit of making that over-contribution.

There is another option of those over 71. If they have unused RRSP room, these individuals can make contributions to a spousal RRSP, so long as the spouse in question is 71 or less.

Act on TFSAs

The same general point I made about RRSPs can be applied to tax free savings accounts. While contributions to these accounts are not tax deductible and unused contribution room can be carried forward, it still makes sense to contribute to them sooner rather than later in order to benefit from their the tax-free savings provision.

On the other hand, if a client wishes to withdraw from a TFSA, this person should do so before the 2011 year end because the amount of the withdrawal will be added to the contribution room for 2012. If this client doesn’t withdraw until 2012, the added contribution room won’t be available until 2013. And because TFSA earnings are tax free, there is no tax benefit from loaning money to a spouse to contribute to a TFSA.

Don’t forget RESPs

Registered Education Savings Plan contributions should be made before the year end in order to maximize the income deferral and to get the greatest benefit from the Canada Education Savings Grant. Grants tied to unused contributions can be carried forward, but it may make sense to maximize the grant sooner.

For clients making withdrawals from RESPs, timing is crucial from a tax standpoint. Because education assistance payments are taxed in the year they’re received, if the student in question is in a low tax bracket this year, it might make sense to make an EAP withdrawal before the year end. The withdrawal could be postponed until 2012 if the student is likely to remain in the same low tax bracket (tax on this withdrawal will not be payable until April 2013) or if the student’s tax rate is likely to be lower in 2012. The tax on a 2012 withdrawal will then be lower than it would be for this year, and, again, tax payable will be deferred until April 2013.

Income splitting’s finer points

Making loans to spouses or family members is one way your clients can engage in income splitting, effectively transferring income from a higher tax bracket family member to a spouse or child in a lower bracket. The proviso is that interest must be charged on the loan at the Canada Revenue Agency’s prescribed rate, which currently is set at 1%.

Once again, timing is important. If your client set up such a loan in 2011, remember that the interest on the loan will have to be paid by January 30, 2012 in order to avoid having the loan amount attributed to your client’s income. The prescribed rate, which is tied to the yield on Canada’s 90-day treasury bills, is reviewed quarterly. While market conditions suggest the prescribed rate is likely to remain low, it would still be wise to establish any new loans before the year end in order to take advantage of the current 1% interest rate.

Last reminders

At the risk of overwhelming clients with too much information, it’s important to remember that many tax creditable or deductible expenses must be paid by the year end. These include alimony and maintenance, child care expenses, investment counsel fees, professional dues, charitable donations, medical expenses and political contributions. It’s enough to elicit the odd “Bah, Humbug,” but that’s not so bad. It’s good to celebrate the season, but it doesn’t hurt to be a little bit like Scrooge and take care of business too.

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While the information provided may be intended to highlight various tax planning issues, it is general in nature. This information should not be relied upon or construed as tax advice. Readers should consult with their own advisors, lawyers and tax planning professionals for advice before employing any specific tax or investing strategy.

Views expressed regarding a particular company, security, industry or market sector are the views only of that individual as of the time expressed and do not necessarily represent the views of Fidelity or any other person in the Fidelity organization. Such views are subject to change at any time based upon markets and other conditions and Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice.