Taking opportunities

(June 2006) Batina and Armand Milo live very comfortably in Vancouver with their two teenage children. Batina is an ad exec who earns $180,000 annually. Armand left the business world a few years ago to pursue his real love, sculpture; and he’s now earning about $25,000 annually as an artist.

They’ve been good savers and have managed to accumulate a non-registered investment portfolio currently worth about $250,000 (2/3 in equities paying decent dividends and 1/3 in bonds paying interest), and registered savings of about $550,000 (40% equity and 60% fixed income). Their stocks have appreciated significantly over the last three years. Batina maximizes her RRSP contributions and they generally donate between $15,000 and $20,000 each year to two or three favourite charities.

They’ve heard about the tax relief proposed in the most recent federal budget and want to know how these measures will affect them from a dollars and cents perspective, and what they can do to tweak their holdings to take advantage of any available benefits.

First, the reduction in the basic personal amount and the increase in the lowest marginal tax rate (from 2005 amounts) will add about $200 to their tax bill for 2006 (and another $200 for 2007). However, the reduction in tax rates on dividends and the elimination of capital gains on the donation of listed securities could offer them significant tax savings that will far outweigh the rate increase.

Currently Batina earns about $1,000 in Canadian dividends, $500 of interest, and anticipates realizing about $7,000 of capital gains on the sale of stock this year. Armand’s investment income is comprised of about $4,000 in dividends and $3,000 of interest.

A preliminary calculation based on pre-budget tax rules shows the family’s total income tax bill for 2006 would have been $54,000 ($50,000 for Batina and $4,000 for Armand). If we apply the 2006 proposals including rate changes and the new dividend gross-up and credit rules for large corporation dividends, we see a $600 tax reduction (going on the assumption that British Columbia will apply its current dividend tax credit rate to the new 45% gross-up amount). To reduce the tax bill further, Batina should donate some of the shares she’s planning to sell instead of making a cash donation to her charities. That will effectively eliminate tax on that $7,000 capital gain and result in an additional savings of $1,600. So far, the Milos’ tax bill has been reduced from $54,000 to $52,000.

Then, I would suggest Batina and Armand swap some investments between their registered and non-registered accounts. They can move their bond holdings into their RRSPs in exchange for stocks of equal value that are currently held in their registered plans. The accrued gains on the bonds are nominal, so there are no concerns about taxable gains.

And, of course, there is no tax in the RRSP on the accrued gains on the shares that are coming out of those plans. If, as their tax advisor, I assume the dividend income on the shares coming out of the plans will be about 60% of the interest income on the bonds that are being transferred to the RRSP, then the total family tax can be reduced to about $51,000.

So, with the new budget measures and a little tax planning, the Milos’ tax bill for 2006 can be reduced from $54,200 to $51,000; or about 5.5%. The savings can go toward the new plasma screen TV they’ve been thinking about and they’ll save an extra 1% on that purchase if they wait for the GST reduction to take effect July 1.

Now, if only the Conservatives were to move on the capital gains deferral election promise (it wasn’t mentioned in the 2006 budget). This would result in even further savings for Batina, Armand, and many other Canadian investors.

This article originally appeared in Advisor’s Edge Magazine. Gena Katz, CA, CFP, is a senior principal with Ernst & Young’s National Tax Practice in Toronto. “Tax Break” appears monthly.

(06/16/06)