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Tax situation

Updated: January 1, 2020

Are you taking advantage of all the tax deductions and credits you are entitled to? Do you have deferred capital losses?

It is important to know all the different tax credits and tax deductions you are entitled to, because these things can reduce your tax bill. But first, do you know the difference between a tax deduction and a tax credit?

Deduction or credit

A deduction reduces your taxable income. Since our tax system uses progressive tax rates, a deduction represents a different benefit depending on the taxpayer's marginal tax rate. Here's a brief overview:

The chart below presents approximate marginal tax rates for individuals living in Quebec in 2020.

Tax bracket
Marginal tax rate1
$13,229 to $15,532 incl.
12.53%
$15,533 to $44,545 incl.
27.53%
$44,546 to $48,535 incl.
32.53%
$48,536 to $89,080 incl.
37.12%
$89,081 to $97,069 incl.
41.12%
$97,070 to $108,390 incl.
45.71%
$108,391 to $150,473 incl.
47.46%
$150,474 to $214,368 incl.
49.97%
more than $214,368
53.31%

1The rate that applies to each additional dollar of income.

For an individual with an annual taxable income of $30,000, a $100 deduction represents $27.53 in income tax savings, but for someone with an annual income of $60,000, the same deduction represents tax savings of $37.12.

Unlike deductions, tax credits directly reduce the amount of income tax that is payable. So a $100 tax credit represents a savings of $100. A tax credit has the same value for everyone, no matter what their income is. However, certain credits are reduced when the individual (or family) net income reaches specified tresholds.

There is a difference between refundable tax credits and non-refundable tax credits. Non-refundable tax credits, like deductions, lose their value if you have no income to pay that year. Some non-refundable credits can be transferred between spouses while others can be carried forward.

Here is a list of the main deductions that can be claimed:

  • Contributions to a registered pension plan or RRSP
  • Deductible business investment losses 
  • Annual union, professional, or like dues (at the federal level only; in Quebec, it is a tax credit)

In some cases, interest costs, support payments to a former spouse, moving costs, legal fees and some expenses for self-employed workers are deductible.

Capital losses are also 50% deductible, but they can usually only be deducted against taxable capital gains. When capital losses cannot be used in the year they are incurred, they can be transferred back three years against taxable capital gains, as long as the capital gains deduction was not used in the target year. If they cannot be used in the three prior years, they can be deferred indefinitely into the future.

Here is a list of the main non-refundable tax credits that were available in 2020:

Credit1
Federal (15%)2
Québec (15%)
Basic
$13,229
$15,532
Person living alone
N/A
$1,780
Single-parent family supplement
N/A $2,197
Eligible spouse or dependent
$13,229
N/A
Parental contribution for an adult child in post-secondary studies
N/A
$10,662
Post-secondary studies (per session), dependent minor (max. 2 sessions)
N/A
$2,983
Student loan interest
Eligible cost
Eligible cost
Caregiver amount    
Children under 18 years of age
$2,273 N/A
Other dependant 18 years of age or older
$7,276 N/A
Other dependent adult
N/A
$4,348
Employment amount
$1,245
N/A
Age amount
$7,637
$3,267
Amount for retirement income
$2,000
$2,902
Amount for a severe and prolonged impairment
$8,576
$3,449
Supplement for person under 18
$5,003
N/A

1The chart indicates the dollar amounts of the personal tax credits for 2020. The 15% federal and provincial rates are applied to the dollar amounts shown in the chart, to determine the value of the credit. At the federal level, the basic credit and the eligible spouse or dependent credit include an amount of $931, which is gradually reduced to zero when the individual has taxable income in the 4th tax bracket.

2Quebec residents do not pay the full federal income tax because of the 16.5% abatement. The actual value of the federal tax credits is therefore 12.53%.

 

Do you know the rules for pension income splitting?

Since the 2007 tax year, residents of Canada can split their pension income with a married or common law spouse in a lower tax bracket.

When they prepare their income tax return, retirees can decide to declare up to 50% of their eligible pension income on their spouse's tax return, if the spouse is in a lower tax bracket. This amount is then deducted from the retiree's income. The income taxes deducted at source are also transferred in the same proportions as the pension income.

This is not a real transfer of money between spouses, but a tax election made each year in their respective income tax returns by completing the required schedules (T1032 for the federal return and Schedule Q for Quebec).

The spouse to whose return the income is added must give their written agreement for the year in question. Both spouses are equally responsible for the income taxes that arise from this election.

Eligible pension income

For individuals aged 65 or over, eligible pension income includes life annuity payments from a registered pension plan (RPP), payments from a registered retirement savings plan (RRSP) or a deferred profit-sharing plan (DPSP) and payments from a registered retirement income fund (RRIF) or from a life income fund (LIF).

For federal purposes only, eligible pension income for people under 65 includes life annuity payments from an RPP and some payments received following the death of a spouse or common law spouse.

No matter when during the year you turn 65, all pension income received that year is eligible. The age of the spouse to whom the income will be attributed does not matter, but each couple should analyse their tax situation carefully before splitting eligible pension income.

The greater the income gap between the spouses, the greater the tax savings. Some retirees may even be able to recover their Old Age Security (OAS) benefits using these rules. Make sure, though, that only one of the spouses repays the OAS because of high income.

In addition to the tax benefits of income splitting, couples can double their pension income tax credits. For people under 65, only pension plan annuities are eligible for this credit. For people 65 and over, all income on the eligible pension income list provides a pension income credit of up to $2000 on the federal level. In Quebec, the pension income credit can be obtained on a maximum pension of $2,902. Note that in Quebec only, age is not taken into consideration to determine eligibility for the credit for pension income.

 

Do you know what your average tax rate is? How about your marginal tax rate?

Canadians are taxed under a "progressive" system, which means that the tax rate increases as taxable income increases. We pay income taxes on income earned each year, not on our accumulated assets.

Marginal and average tax rates

The marginal tax rate is the rate that applies to the last dollar of taxable income.

The chart below shows the approximate marginal tax brackets of Quebec residents for 2020.

Tax bracket
Marginal tax rate1
$13,229 to $15,532 incl.
12.53%
$15,533 to $44,545 incl.
27.53%
$44,546 to $48,535 incl.
32.53%
$48,536 to $89,080 incl.
37.12%
$89,081 to $97,069 incl.
41.12%
$97,070 to $108,390 incl.
45.71%
$108,391 to $150,473 incl.
47.46%
$150,474 to $214,368 incl.
49.97%
more than $214,368
53.31%

1The rate that applies to each additional dollar of income.

The marginal tax rate is often used to evaluate the tax savings on an RRSP contribution or, inversely, the additional taxes resulting from additional income, or to evaluate the benefits of a couple splitting their income. Given existing social tax programs, especially in Quebec, it is a good idea to do a simulation at certain income levels.

The average or effective tax rate is the taxpayer's total taxes divided by total taxable income. For example, a taxpayer with taxable income of $50,000 in 2020 will pay about $10,116 in taxes, or an average tax rate of about 20%. This rate is used to evaluate total taxes on projected income, such as retirement income.

The chart below presents the average tax rates by taxable income bracket for Quebec residents in 2020.


2020 tax rates (Québec residents)


Taxable income

Total combined taxes


Tax rate1
Effective rate

Marginal rate

$13,229
$15,000
$20,000
$25,000
$ -
$222
$1,518
$2,895
0.00%
1.48%
7.59%
11.58%
12.53%
12.53%
27.53%
27.53%
$30,000
$35,000
$40,000
$45,000
$50,000
$4,271
$5,647
$7,023
$8,422
$10,116
14.24%
16.13%
17.56%
18.72%
20.23%
27.53%
27.53%
27.53%
32.53%
37.12%
$55,000
$60,000
$65,000
$70,000
$75,000
$11,972
$13,828
$15,683
$17,539
$19,395
21.77%
23.05%
24.13%
25.06%
25.86%
37.12%
37.12%
37.12%
37.12%
37.12%
$80,000
$85,000
$90,000
$95,000
$100,000
$21,251
$23,107
$25,000
$27,055
$29,246
26.56%
27.18%
27.78%
28.48%
29.25%
37.12%
37.12%
41.12%
41.12%
45.71%
$105,000
$110,000
$115,000
$120,000
$125,000
$31,531
$33,845
$36,218
$38,591
$40,964
30.03%
30.77%
31.49%
32.16%
32.77%
45.71%
47.46%
47.46%
47.46%
47.46%
$130,000
$135,000
$140,000
$43,337
$45,710
$48,083
33.34%
33.86%
34.35%
47.46%
47.46%
47.46%
1Maximum combined federal-provincial tax rates for single taxpayers
 

Are your debts structured to maximize interest deductibility?

The basic tax principle of interest deductibility is as follows: a taxpayer can deduct interest paid or payable on money borrowed as long as the money is used to draw business or property income. So it is in your interest to prioritize the repayment of loans that do not give rise to this deduction, such as mortgage loans on family homes, car loans, or other debts incurred for personal use assets.

There is a tax technique called "cash damming" that consists of structuring the business of a self-employer worker or rental building owner to make the interest deductible on any loan indirectly incurred for personal purposes. How? By using gross self-employment or rental income to pay personal expenses and repay personal loans with non-deductible interest. All expenses related to the business or building upkeep are paid using a line of credit, probably secured by the mortgage, and used exclusively for the business or rental building. The interest payable on this line of credit is deductible, because the loan is incurred for the purpose of drawing property or business income. Certain conditions must be met to use this technique.

 

Do you know how much income tax to pay when you sell your rental buildings?

Capital gain

When you sell a rental building at a price higher than the purchase cost, you have to declare a capital gain. The capital gain is the difference between the sale price and the purchase price. Capital expenses reduce the capital gain, because they add to the purchase price. The taxable capital gain is 50% of the capital gain and is added to your annual income. You cannot realize a capital loss on the "building" portion, only on the "land" portion. This will be 50% deductible and applicable against a taxable capital gain only. For the "building" portion, a loss is deemed to be a terminal loss.

Recapture of depreciation

In addition to declaring a capital gain, you must also add the recapture of depreciation to your rental income in the year of the sale. Recapture of depreciation is the difference between the capital cost (purchase price of the building only, excluding the land) and the non-amortized portion of the building at the time of the sale (commonly called UCC, for undepreciated capital cost). The result is 100% taxable income in your income tax return for the year and represents all depreciation costs deducted during all the years you held that rental building.

Claiming depreciation expenses is a method of tax deferral. The point is to reduce your taxable rental income for all the years you own the building. It is even better if you can sell in a year when your marginal tax rate is low. The depreciation deduction is calculated, using a pre-established percentage, on the cost of the building excluding the land, because land is not a depreciable asset. Depreciation reduces your taxable rental income. Over the years, if you do major renovations or extensions to your buildings, these capital expenses are added to the UCC balance in the year they are incurred.

Terminal loss

If your building suffers a significant loss in value and you have not claimed much depreciation, you will probably be in a position of terminal loss, rather than recapture of depreciation. This terminal loss is deductible against all of your other income, not only against taxable capital gains.

As the land may be subject to a capital loss (50% deductible against taxable capital gains only) and the building subject to a terminal loss, it is important to divide your sale price between the land and the building when you calculate your capital gain or terminal loss.

 

If you are an entrepreneur or a self-employed professional… Do you know the advantages and disadvantages of incorporation?

A business (commercial activity) can be run under several different legal forms.

A corporation is a separate legal entity from its shareholders. It is responsible for paying all its own income taxes.

Corporate tax rates depend on the type of income the corporation earns.

The tax rates on the business income of active Canadian-controlled private corporations are as follows:

  • On the first $500,000 of active business income generated in Canada (divided among related corporations):
 
2019
2020
2021
Federal
9.0%
9.0%
9.0%
Québec
 6.0%
 5.0%
 4.0%
Total
15.0%
14.0%
13.0%
 
  • Amounts above the $500,000 limit:
 
2019
2020
Federal
15.0%
15.0%
Québec
11.6%
11.5%
Total
26.6%
26.5%

Since 2017, only corporations that pay at least 5,500 hours in a year are eligible for the reduced Quebec income tax rate.

For taxation years that begin after 2018, eligibility to the reduced income tax rate (both at the federal and at the Québec level) will decrease gradually when passive investment income exceeds $50,000, through a reduction of the $500,000 limit.

Individuals who incorporate a business or are shareholders of a Canadian-controlled private corporation can take advantage of significant tax deferrals if they are personally taxed at the highest marginal rate (in Quebec, 53.31%) and don't need all the income generated by the corporation.

The deferral is equal to the difference between the individual's tax rate and the corporation's effective tax rate.

For example, suppose Marc-André incorporates his business (corporate tax rate of 14%) and his own marginal tax rate is 53.31%. He could take advantage of an income tax deferral of 39.31% (53.31% - 14%) on profits he leaves in the corporation. Marc-André's profits will be taxed when they are paid out in dividends. Combined taxes (corporate and personal) would have been slightly less if Marc-André hadn’t incorporated his business, but incorporation will give the corporation access to liquid assets which it could use to reduce its debts or make capital and portfolio investments. 

Incorporation entails some advantages but also some disadvantages:

Advantages

  • The corporation is a separate entity from the shareholder
  • Possibility of limiting liability, depending on profession and type of activity
  • Business income taxed at a lower tax rate than individual income
  • Possibility of using capital gains exemption on the sale of corporate shares, if they qualify as eligible small business shares
  • Choice of compensation: salary or dividends
  • Possibility of setting up an IPP
  • Possibility of splitting income with family members (spouse and adult children), in certain circumstances
  • Possibility of paying expenses through the corporation
  • Longevity of the corporation

Disadvantages

  • Incorporation fees
  • Corporate maintenance costs
  • Potential double taxation
  • Cost of social benefits
  • More complicated structure

Incorporation allows you to defer taxes payable on active business income. To determine whether incorporation would be beneficial, it is important to consider both the individual's income and the individual's cost of living.

 

Have you set up a business succession plan?

Entrepreneurs are often actively concerned about the future of their company when it is young and in the early stages of its life cycle. But once the business is well established, with strong and growing profits, they often forget to take the time to plan for the company's succession.

It's not that they're not interested in their company's future, but they rarely take the time to establish a solid plan. An entrepreneur may take up to 80,000 hours to build the company, and then just 6 to 10 hours to plan its succession.

This unfortunately means that 70% of family businesses do not survive into the second generation, and 90% do not make it to the third. Of the survivors, only 1% still have a family member on board.

Succession

Almost 50% of entrepreneurs would want their company to stay in the family, but nearly all of them feel isolated in their attempts to achieve this.

These are entrepreneurs' four main concerns with regard to the division or sale of their company:

  • Being fair to all the children
  • The reaction of senior executives who are not family members
  • Family conflicts
  • Taxation

Fewer than 10% of entrepreneurs have a written plan for the preparation of their succession. Most of the time, they stick to the technical issues (estate freeze, estate balance sheet, will, taxation, fair market value of the company, holding companies, life insurance, etc.).

The role of the financial planner

Although entrepreneurs want to plan their business succession, they often feel powerless to plan properly and so their results are disappointing. Entrepreneurs should not hesitate to ask for help from a competent advisor who understands their wishes, the expectations of the heirs, the needs of the company and the role of the senior executives. They should look for an advisor with the expertise to work with external experts (accountants, tax experts, legal advisors, insurers, organizational psychologists) to establish the appropriate conditions of sale, business structure and legal agreements.

Financial planners are in a good position to help entrepreneurs coordinate their efforts to establish a sound succession plan for the business, especially with regard to:

  • Reorganization of share capital (estate freeze, crystallization of capital gains)
  • Shareholders' agreement, buy-sell agreement
  • Life and disability insurance
  • Will
  • Protection mandate (or mandate in case of incapacity)

 

Do you know about the capital gains deduction?

In 2020, capital gains realized on the sale of eligible small business shares and farming or fishing property give rise to a capital gains deduction of up to $441,692 ($883,3841 × 50%) for qualified small business corporation shares and $1,000,000 for qualified farm or fishing property. This ceiling is the lifetime deduction limit for each person. 

Eligible small business shares

The eligible shares are for Canadian-controlled private corporations. Several criteria must be met, including criteria regarding share ownership and use of assets.

Share ownership

The shares cannot have belonged to anyone other than the taxpayer (or a person or partnership related to the taxpayer) for the entire 24-month period prior to disposition.

Use of assets

The corporation's assets must meet the two following criteria:

1. Throughout the 24-month period mentioned above, over 50% of the fair market value of the corporation's assets must have been used in an active business carried on primarily in Canada.

2. At the time of disposition, all or almost all (that is, according to the CRA, 90% or more) of the fair market value of the assets must have been used in an active business carried on primarily in Canada.

Certain other restrictions may reduce or even eliminate the capital gains deduction, such as the prior realization of investment losses or the balance of the cumulative net investment loss account. Furthermore, it is possible for the deduction to trigger alternate minimum tax (AMT), a tax that can be recovered in subsequent tax years.

1Indexed annually

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