Every year people work hard to make enough money to satisfy their needs and wants. However, as time goes on and you start to earn more money through various means the tax liability corresponding to that income also begins to increase. With each coming tax year, people are always attempting to find new ways to pay fewer taxes through different tax strategies. Unfortunately, there are some easily accessible strategies that a lot of people don’t implement in their daily lives to lower their tax liability. Here are some basic strategies that you can follow to get the most of your paychecks and leave more money for you, your family, and your financial future.

1. Contributing to RRSPs

One way to reduce taxable income is  to maximize your Registered Retirement Savings Plan (RRSP) contribution each year. RRSP contributions are deducted from your income, this will in effect reduce your taxable income and as such reduce the amount of taxes you will have to pay. The magnitude of the tax savings depends on your marginal tax rate at which the taxable income is reduced. For example, if you are earning between $97,000 and $150,000 in Ontario, a marginal tax rate of approximately 43%, a $20,000 RRSP contribution would save you approximately $8,600 in tax.

Everyone can contribute up to their maximum contribution limit. The contribution limit is calculated based on prior year unused contribution room, your income (subject to some conditions) in the prior year, and any additional adjustments that may be required. You can find your current RRSP contribution limit through the CRA, looking at your prior year filings/assessments, or by speaking with your accountant. All investment income that is earned inside of the RRSP account is tax-free, however, any withdrawals made from the RRSP are taxable at the time of withdrawal. At retirement, RRSPs can be converted into steady income streams with predictable tax implications.

Another benefit of RRSPs is that first time home buyers can withdraw up to $25,000 in funds from their RRSP, not subject to any tax, with the expectation that the funds will be re-deposited into the RRSP over a period of time. This may be a good strategy to use to help maximize your down payment for your first time home purchase.

RRSPs may not be an optimal strategy for everyone, depending on their income, future projected income, and retirement plans.

2. The entrepreneur in you!

A lot of us have dreams of starting our own business or being able to work with our friends in a great new business venture. Having your own business has a variety of opportunities when trying to mitigate your taxes with the right strategies. Expenses that are related to operating a business can be deducted on your business income statement on your tax returns. This can include but is not limited to the use of your home office, car, and anything else incurred to earn the business income.

Many entrepreneurs start businesses or additional streams of income, and correctly report the income on their tax return, but forget to claim all allowable deductions and expenses. All expenses directly attributable to your business reduce the taxable income you earned and thus the tax liability corresponding to that stream of income.

Additionally, losses may be used to offset other streams of income, so even if your business is not currently profitable, you may be missing out on valuable tax savings by not correctly calculating its net loss.

3. Reducing Taxes using Employment Expenses

Another way to reduce taxable income is to claim eligible employment expenses. If you routinely work from home, use your personal vehicle for employment purposes, or are responsible for purchasing your own supplies, you may be able to reduce the taxable income to the extent these eligible expenses relate to employment.

For automotive expenses, this may include the business portion of expenses like repairs, insurance, parking fees and 407 charges. For home office expenses this may include the home office portion of any utilities, internet costs, maintenance, cell phone costs, rent, or property taxes and insurance under certain circumstances.

To claim employment related expenses, you will need to get your employer to sign a Declaration of Conditions of Employment (otherwise known as a T2200) to verify your situation that you are indeed required to incur these expenses for employment, and you have not been reimbursed.

4. Using a Tax-Free Savings Account

A more indirect way of reducing your taxes in Canada can be by purchasing investments through a tax-free savings account (TFSA). A tax-free savings account is a savings account that allows any investment income earned in the account to not be subjected to any income tax when it is earned or when funds are withdrawn from the account. The TFSA, similar to the RRSP, was created as an incentive for individuals to use tax sheltered accounts to save money.

A TFSA account differs from a registered retirement savings plan (RRSP) in that a TFSA does not reduce your taxable income. As such, you will not realize any immediate tax savings in the year of contribution. However, it does allow for good tax benefits and allows you to avoid paying income tax on income earned in the account.

Unlike an RRSP account, when amounts are withdrawn from the account, there are no tax implications. A TFSA can hold investments such as bonds, stocks, and other similar investments, however it is important to keep track of your allowable TFSA contribution room. If you overcontribute you can be subjected to a tax rate of 1 percent of the excess amount in that month. Your TFSA room increases annually by an amount designated by the government, $6000 in 2020. For individuals who have never contributed to their TFSA, you may have upto $69,500 in accrued contribution room.

5. Spousal Advantages

Marriage allows for some tax benefits that can reduce the taxes you pay in Canada. One of these includes income splitting eligible pension income with your spouse. Pension income splitting allows you to report some pension income on your spouse’s income tax return, which may be advantageous if your spouse is in a lower marginal tax bracket than you.

Another way that having a spouse allows you to reduce taxes is by utilizing prescribed rate loans to your spouse. Through complex income attribution rules, generally, income earned by a spouse on funds given to them by the other spouse, is taxed in the hands of the spouse who advanced the funds. By doing this, the CRA discourages higher rate taxpayers from transferring money to their lower marginal tax rate spouse, investing the money, and paying tax at a lower marginal rate on the investment income. However, an exception to this is if a taxpayer makes an interest-bearing loan to their spouse.

By doing this one can avoid the income being attributed back to the spouse advancing the funds. The lower tax rate spouse can put the loaned money towards investments, real estate, etc. and any income generated will be taxed at their marginal rate. For this strategy to work, all interest on the loan must be paid by the spouse to the spouse who made the loan by a certain date. If the profits generated on the investment (taxed at the lower spouse rate) are enough to offset the interest paid on the loan (taxed at the higher spouse rate), this can be an effective strategy.

When applied, these tips may help you to reduce taxable income on your statements. The strategies presented have been simplified for illustration purposes and may not apply in your particular circumstances. Please be sure to consult a tax professional before implementing any of the strategies outlined above. OR more questions regarding opportunities to minimize taxes on your income and create a plan that is custom tailored for your unique situation,

Frequently Asked Questions

How do you reduce your taxable income?

As mentioned above some notable ways on how to reduce taxable income include contributing to a RRSP. The RRSP can be used to lower the amount of taxes as RRSP contributions are deducted from your income, this will reduce your taxable income.

How can I lower my self-employment tax?

The easiest way to lower your self-employment tax is by increasing your business-related expenses. By claiming all eligible business-related expenses you can reduce your overall net income and in correlation reduce your self-employment tax.

How can I reduce my income tax in Canada?

The most commonly used way on how to pay less income tax in Canada is by maximizing your retirement savings. Putting money into a registered retirement savings plan (RRSP)  allows you to pay less income tax on withdrawals made from that account.