This is a guest post from Cleo Hamel, Senior Tax Analyst for H&R Block Canada
With the economy still uncertain, investing in the current market conditions can be challenging. And nothing is more discouraging than picking a winning investment only to be hit by a big tax bill. But there are investments that can be less painful at tax time but you need to plan ahead rather than waiting until you file your return.
Tax Free Savings Accounts
The ultimate in tax-friendly investments is the Tax Free Savings Account. You are allowed to contribute up to $5,000 per calendar year and you do not pay a penalty when you withdraw money. Unused contribution room is carried forward.
Investing the Child tax benefit
Another easy way to avoid the taxman is putting your Child Tax Benefit and Universal Child Care Benefit in a separate account in your child’s name. This means the income is taxed in their hands rather than yours.
Splitting investment income
Married or common-law couples with different income levels may be able to take advantage of the situation. For example, investments can be purchased by a lower-income spouse because they are taxed at a lower marginal tax rate. Higher-earning spouses can direct their money towards paying off the mortgage and other household expenses. But the higher-income spouse cannot simply give money to the other spouse. This triggers attribution rules and the higher-income spouse will have to report the investment earnings.
Attribution rules also mean you cannot simply put all your investments in a child’s name and avoid reporting the earnings on your tax return. However, spousal loans do avoid the attribution rules: the prescribed rate is only one per cent and interest must be paid within 30 days of the end of each year in which the loan is outstanding. One per cent is a very good interest rate, so your spouse might be a good lender.
Borrowing to invest
Also, you may want to consider a loan to purchase investments since you can claim interest on loans used to make investments. Depending on your situation, it may be better to pay off your mortgage and borrow money for investments. The courts have made this easier to claim, when they decided the direct use of the money determines whether or not the interest is deductible. So, if you have a personal line of credit, you can claim the interest on the money used for investments.
Tax efficient investment income
Since not all investment income is taxed the same, there are a few options for people who like to hold stocks. You can keep dividend stocks and stocks offering capital growth outside of a registered plan, so you get the preferred tax treatment. For example, only 50 per cent of your capital gain is taxed. And if you have capital losses from previous years, you can claim them against your gains. Dividends are also taxed at a lower rate.
If you have publicly-traded investments, you can use them to make charitable donations. By donating the stocks directly, you do not have to report the capital gains and you get a tax receipt for the entire amount of your donation.
And if someone tells you an investment is completely tax-free, it is not.