Pay taxes like the rich by taking the long view

Being able to minimize your tax hit like the rich do may be less about having the money to afford a clever tax accountant and more about taking the long view.
Even if you can't afford champagne tastes, you may be able to take a page from the tax strategies of those who can by minimizing how much tax you pay over the long term. (Sunday Alamba/Associated Press)

Being able to minimize your tax hit like the rich do may be less about having the scratch to afford a clever tax accountant and more about taking the long view.

That applies even if you're on a low income — perhaps more so.

"You need to stay focused on your long-term goals and not get too distracted by your short-term goals," said Laura Wallace, vice-president and portfolio manager at Scotia Asset Management.

A study done in 2011 by Scotiabank suggested most affluent Canadians focus on minimizing tax over many years while the majority of middle- and low-income filers tend to pay more attention to getting the biggest refund.

"What we should all be watching is if our tax refund is too high, there's something not quite right," says Joanne Birtch, a senior director with Ufile, the tax preparation software firm.

"A smart taxpayer is going to make sure he's not paying any more tax than he has right from the get-go."

Refunds not always a good thing

While a refund might seem like a pleasant surprise at the time, it's actually a sign that you've lost some money, says Wallace.

"Getting a refund is a bad idea, because it means you've actually lent the government money and haven't earned any interest on it," she said.

"It means you paid too much in tax over the year, and they have to give it back to you. Unlike when you don't pay your taxes and the [Canada Revenue Agency] charges you interest on it, they don't pay you interest on the amount of over-contribution of tax that you made."

A refund is often the result of an employee failing to ask his or her employer to make payroll deductions reflecting such items as the number of dependent children or regular contributions to an RRSP or a registered charity.

Using a good tax software program is one way of ensuring that you're claiming all the deductions and credits you're entitled to — some of which have benefits even after tax season, says Birtch.

"Many of those, in particular in Manitoba and in Ontario, are credits that will come to you later throughout the year," she said. "If you don't file your tax return, you're not going to get those credits, and you're going to need those for your family, especially if you're in a low-income bracket."

That's one reason why Ufile — and some of its rivals — offers its online product free-of-charge to people on a low income, students, seniors, first-time filers and those with dependents.

Saving time is of value, too, Birtch says. Those on low income should take advantage of free tax preparation software to avoid making mistakes that can slow the processing of their refunds, she suggests.

"Math errors are probably the No. 1 error that the CRA has to cope with," Birtch said.

By Statistics Canada's reckoning, in 2010 there were about three million Canadians, or nine per cent of the population, whose after-tax income fell into the category considered low income, meaning they spend a disproportionate amount on necessities.

If your means are limited, it may seem obvious that you can't afford or even have the range of options to reduce the tax you end up paying that higher-income people do.

While Wallace admits there aren't a lot of options for minimizing tax for regularly salaried middle- and low income Canadians compared with the affluent, two of the best are registered retirement savings plans and tax-free savings accounts.

An RRSP provides a tax deduction for saving and tax deferment on capital gains — ideally to a time when you pay income tax at a lower rate — while the TFSA allows tax-free capital gains.

Incorporate life changes into tax strategy

Another example of taking the long-term view is to respond to major life changes. Be sure to claim dependent children, take advantage of the government matching funds gained by saving in a registered educational savings plan and investigate whether you qualify for a dependents deduction if you're looking after elderly parents.

Income splitting is another option if there's a wide gap between incomes earned by two spouses or between a parent and child.

The CRA allows the person with the higher income to lend cash or assets to the lower-income family member at the CRA's so-called prescribed interest rate (which is set each quarter and currently stands at one per cent) so that any income earned from that is taxed at the lower income rate. At the current one-per cent interest rate, if your spouse is in a lower tax bracket, the lent money has only to make a return greater than one per cent for the couple to end up with a lower overall tax bill. 

Just be sure to document the loan properly and ensure the lower-income spouse pays the interest every year or by Jan. 31 of the subsequent year.

Paying down debt also a priority

There may be times when borrowing to make an RRSP contribution if you're strapped for cash is worthwhile, especially given that if you skip just one contribution, you could reduce the final value of your RRSP by thousands of dollars given interest compounding.

Especially if you expect your income to rise in the coming year, it might make sense to borrow in February, make a contribution applicable to the tax return for the preceding year in order to lower your tax payable and use the refund to help pay back the loan as soon as possible.

But it's also important, Wallace says, to not let tax considerations drive all of your decisions.

A good example of that, she says, would be paying down your mortgage and especially higher-rate credit card debt.

Saving on interest payments, she says, "is a guaranteed rate of return."

"You know what interest you're paying and you know you're going to pay less," she said. "You need to look at your total financial picture and not just at tax-minimization strategies."