Taxes are a bane for just about everyone except but accountants, but they are an inevitable fact of life. The rules are constantly changing and it can seem like the deck is stacked against the honest taxpayer. Don't despair though; there are still simple ways for Canadians to limit their tax exposure. In this article, we will look at some of them.

Key Takeaways

  • Like most other places, if you live or earn income in Canada, you will have to pay income tax.
  • Canadian tax law allows for several ways to reduce your taxes owed if you know the current rules and can take advantage of them.
  • Contributing to a retirement plan, deducting interest, and small business credits can all help. Always check with a professional accountant when in doubt.

Borrow to Invest, Save to Buy

The days of debt-free living have pretty much come to an end and almost everyone in the country is carrying some type of debt. Surprisingly though, the right kind of debt can help make a small dent in your tax bill. A car loan or credit card debt incurred to buy that new sofa you've had your eye on, however, is not the right type of debt. A loan used to purchase an investment is. 

The reason is that the interest on loans taken out for the purpose of investing is tax deductible. The interest on anything else you assume to debt to buy is not. From a tax perspective, you're better off using cash or savings for these discretionary purchases and then borrowing to invest rather than the converse. However,as far as your personal finances go, no debt is the best kind of debt.

Max Out Your RRSP

Registered retirement savings plans (RRSPs) are the government's weak apology for its tax-gouging ways. You may as well take advantage of the bone they throw you and extract the most value from this tool. When talking about borrowing to invest, maxing out your RRSP is usually a sensible approach provided that you are able to service the loan in a reasonable period of time.

Taxes and Investments

Some investments - such as stocks - are accorded preferential tax breaks on dividends and capital gains, whereas other fixed-income investments aren't. Depending on your tax bill and the rate of inflation, holding your money in fixed-income investments that are taxable may actually cost you money. If you are holding a tax-protected retirement portfolio and an income portfolio, consider keeping a smaller percentage of your fixed-income investments in the taxable portfolio.

Marriage Maneuvers

Income splitting with your spouse or contributing to his/her retirement account will help reduce your tax bill, especially if there is a large gap between your incomes. However, this will require professional assistance to structure contributions in a way that will withstand an audit. 

Start a Business

Owning a business may allow you to write off your car, gas, home office, electricity, kids, and in some cases even cat food. This advice is often suggested as a way to reduce your taxes. While it is true that a side business can help you reduce your tax bill, it is not for everyone. For example, farmers enjoy some of the biggest tax breaks out there, but they rarely make enough money to truly enjoy the tax advantages. As with farming, creating a business that loses money will hurt your overall financial situation more than paying taxes does. If you have a business plan that suggests you'll generate a profit, go for it. If not, look for another strategy.

Keep Detailed Records

The tax code allows for a certain amount of back-filing in specific situations or when there has been a change to the rules. For example, if you're working on a side project that will create income in the future, you may not be able to claim write-offs as you incur them. By keeping detailed records, you will be able to back-file and protect more of the income by claiming the proper deductions in retrospect.

The Bottom Line

Keeping track of what write-offs apply to your situation can be difficult. For most people, finding the right accountant is the most important step in reducing your taxes. All of the aforementioned strategies are legal, but your accountant will be able to look at your finances and tell you which ones are viable. Look for an accountant through friends and colleagues whose tax profiles are similar to your own. Most importantly, keep up-to-date with your tax situation and keep an eye out for anything your account may have overlooked - accountants are still human. The more you understand about your own tax situation and the ways to reduce your exposure, the better prepared you will be to take full advantage of your accountant's expertise.