Income Tax Planning

Income Tax Planning

Income Tax Planning is a part of the whole process of financial planning. It is essential not only for financial planners, but also for everyone to have a good understanding of how income tax works. There are many different types of income and expenses that have to be determined properly in order for income tax to be estimated. Government of Canada collects taxes on personal income to cover the costs of the services provided by the Government. The Government uses the tax system to achieve different social and economic goals.

Everyone needs to know how to fill out a tax form for his/her personal income.

The tax form consists of several parts:

Ø Identification

Ø Goods and Services Tax Credit Application

Ø Total Income

Ø Net Income

Ø Taxable Income

Ø Non-refundable Tax Credits

Ø Refund or Balance Owing

Ø Provincial Income Tax

Identification gives information about the individual, whose income is a subject to tax. It also gives information about some personal data, (i.e. address and marital status).

Goods and Services Tax Credit applies to all individuals who were residents of Canada at the end of the year. GST Credit can be claimed for the spouse and every child less than 19 years of age if not married.

The Total Income includes every income an individual received through the year. The total income is the sum of employment income, commissions, other employment income, old age security, different types of benefits, taxable amounts of benefits, interests and other investment income, net partnership income, rental income, taxable capital gains, RRSP income and etc. Every type of income has specific features that should be known and understood properly. The aim of the financial planner is to consider the different types of income, create deductions, and tax credits to reduce the total income tax that has to be paid.

Net Income is the difference between the total income and the adjustment amounts from Registered Pension Plans, RRSPs, annual union dues, child care expenses, moving expenses, etc.

Taxable income is the difference between the net income and various tax deductions. Tax deductions are amounts that are not subject to tax. The process of financial planning is most powerful at this stage of income tax planning.

Non-Refundable Tax Credits are amounts that are deducted from the income tax, but they are not payable if the non-refundable tax credit exceeds the tax. There is a basic personal amount of $7634 for 2001 that is not taxable. A spousal amount to a maximum of $6140 can also be added to the personal amount if the spouse’s net income is less than the base amount. CPP contributions and EI premiums are also included in the non-refundable deductions. Tuition fees paid by the person or his/her children or grandchildren for attending a university, college, or other educational institution in Canada can be deducted as well. Additional education amounts (different for full time and part time students) are available as deductions. If the tuition fees and educational amounts cannot be used by the student it can be transferred to a spouse, parents, or grandparents. Medical expenses to a specified amount can also be claimed as a deduction. The consideration of non-refundable tax credits allows the financial planner to structure the payable taxes payable in a way to reduce them.

Refund or Balance Owing is the final result from the income tax estimation. It is either the tax that has to be paid to the Government or the money that has to be refunded to the individual. It is not uncommon for an individual to overpay the CPP or the EI. In an event like that Canada Customs and Revenue Agency will refund the amount or reduce the owing balance.

Provincial Income Tax differs for different provinces. It has recently been changed for many provinces. Instead of applying a single provincial tax rate to the basic federal tax, the Government allows some provinces to levy provincial income tax as tax on income. The tax on income is applied directly on the taxable income rather than as a portion of the basic federal tax.

The purpose of Tax planning is to provide basic understanding of the Canadian Income Tax System and possible ways to reduce the taxes on the personal income.