With the end of the year fast approaching, the window for taking steps to claim certain deductions, and for planning to minimize your 2023 tax liability, is closing.
There are several things that can be done before January 1 to help control your ultimate tax payment, or maximize your tax refund, in April 2024. Below are some of the more common planning considerations which are relevant at this time of year.
Tax loss harvesting
If you have realized capital gains in 2023, one common way to mitigate the associated tax liability is tax loss harvesting. Essentially, this consists of selling investments with accrued losses to offset the taxable gains.
For example, if you sold a capital asset in 2023 and realized a gain of $10,000, one-half of that gain would be included in your income and subject to tax. If you also had, say, portfolio investments sitting with an accrued loss of $10,000, you could sell those investments in 2023 and realize that loss.
Capital losses are automatically set off against capital gains in the same year, so the “taxable capital gain” of $10,000 would be wiped out by the “allowable capital loss” of $10,000. Thus, no tax liability would arise in respect of the gain.
The concept is fairly simple, but there are a few important timing points to be aware of.
First, any loss needs to happen in 2023, meaning that the underlying shares need to be actually sold in 2023. For publicly traded shares in Canada, “settlement” of a trade is normally 2 business days after the trade, and December 30-31 are on the weekend this year. Therefore, you likely have to complete the sale by December 27, 2023. (Certain securities can settle in 1 business day; check with your broker.)
(If you don’t complete the sale until 2024, you still may be able to carry back half of the loss (a “net capital loss”) to 2023 to offset against the taxable capital gain, but only when you file your 2024 return in spring 2025.)
Secondly, the “superficial loss rules” in the Income Tax Act, prevent you from realizing a loss on the sale of an asset, if you, or someone “affiliated” with you (most commonly your spouse or a company you or your spouse control) buys the same or identical property in the period beginning 30 days before the sale and ending 30 days after the sale.
If this is the case, and that person still holds the property 30 days after the sale, the capital loss will be denied. Instead, the cost of the acquired identical property will be increased, meaning that the loss will only be taken into account when the acquired property is sold in the future.
Capital losses are first offset against capital gains arising in the same year. Any excess losses can be carried forward to future years or can be carried back to any of the previous three tax years, but still only against capital gains. Therefore, you may be able to obtain a refund for some tax already paid. They cannot be used against other kinds of income.
Also, if you have capital gains and your spouse has assets sitting at a loss (or vice versa), it is possible in certain circumstances to transfer the assets with an accrued loss to the other spouse to sell and offset their gain. This takes some planning and you should consult with your advisor before taking such action.
Tax loss harvesting can be done by a company also. However, before doing so, it is worthwhile checking whether there is any balance in the company’s capital dividend account (which can be paid out to shareholders tax-free) as any losses created would reduce this tax-free balance. It may be best to pay out capital dividends before triggering losses.
At this time of year, it may be worth speaking to your financial advisor to get an idea of the capital gains you have triggered in 2023, as well as an indication of any potential assets which may be suitable to sell to create a capital loss to offset those gains.
Timing of income and expenses
Towards the end of the year, it is often possible to delay certain events until the next year, or to bring those events forward. Depending on your anticipated tax liability for 2023, doing one of these may be beneficial.
For example, if you are due to sell a capital asset, it may be beneficial to delay the sale until the new year if this is practicable. By doing so, any capital gain would arise in 2024, and tax wouldn’t be due until April 2025, giving you a whole extra year of the benefit of the money used to eventually pay the tax.
Similarly, it may be beneficial to incur certain expenses before the year-end, if these expenses can be deducted from your 2023 income. Doing so can reduce your 2023 tax liability.
Outlays such as medical expenses, charitable donations, political contributions, student loan interest, childcare expenses and professional dues are all eligible for either a tax credit or an outright deduction, subject to various rules.
Charitable donations
Any donations made to registered charities by December 31, 2023 should be eligible for a charitable donations tax credit, which will reduce your 2023 tax liability.
The federal credit is equal to 15% of the first $200 donated for the year, plus 29% of all donations above this level (33% if you are in the highest tax bracket). There are similar provincial credits available too. A helpful credit calculator can be found here.
The value of donations in respect of which you can claim a credit is limited to 75% of your “net income” for the year. (Net income is a defined amount, calculated after certain deductions, but before others that are allowed in computing “taxable income”.) Any donations not claimed can be carried forward and claimed in any of the following 5 years.
Charitable-donations made by a couple can be claimed by either spouse, and tax return software will usually automatically calculate the most beneficial allocation between spouses to maximize the benefit received.
As well as donating money, you can also donate shares to charity. This is actually a very tax-efficient method of donating if the shares are publicly-traded shares with accrued gains. The main reason for this is that, although you are disposing of the shares, you do not have to pay tax on the gains.
You also maximize your tax credit through a direct share donation because you are donating the entire value of the shares. If you instead sold the shares and donated the after-tax proceeds, the amount donated (and the credit) would be less due to having to pay tax on the gain.
The value of the donation eligible for the tax credit is the market value of the shares at the time of the donation.
For both cash and share donations, the charity must be a “qualifying donee” in order for any donation to qualify for the tax credit, and you must ensure that you receive a donation receipt, and that you keep this for at least six years, in case the CRA ask to see proof of the donation.
The CRA provides a searchable database of qualifying donees here.
