Tax planning in a pandemic: How to adjust for 2021
From devastating health effects to massive financial impacts, the pandemic has affected so many people in so many ways.
2020 was different, and your financial strategy going forward could look very different too. If your income has been affected by the COVID-19 pandemic, here are some ways to lay the groundwork for some stability in 2021.
1. Plan for the taxes you’ll owe on COVID-19 support.
If you received money from any of the following government support programs, be sure you understand what’s taxable, when it is taxable, and whether tax was withheld.
- Canada Emergency Response Benefit (CERB): Taxes were not withheld, so you could have a tax amount owing for 2020, due in April 2021.
- Canada Emergency Wage Subsidy (CEWS): The CEWS is generally taxable in the fiscal year accrued/received. Taxes were not withheld.
- Canada Emergency Business Account (CEBA): If you aim to qualify for the loan forgiveness, the deadline for principal repayment is still two years away. The loan forgiveness amount is taxable, so set aside money for that. As a repayable loan, the rest of the CEBA is not taxable.
Talk to your tax advisor to estimate how much tax you’ll owe for 2020, and make sure you set the amount aside to pay the CRA later.
2. Revisit your tax instalment payments for next year.
Tax instalment payments can be recalculated at any time. If your income is significantly less than in the previous year, it makes sense to recalculate. Try to estimate your taxable income and, from there, your taxes payable for the year. You can then reduce your tax instalments as appropriate. Corporate instalments are payable monthly, while personal instalments are quarterly.
3. Offset capital losses with capital gains.
Capital losses realized in 2020 can be used to offset capital gains realized in 2020. Capital losses realized in 2020 can also be carried back to any of the three previous years where you had capital gains to partially or fully offset these gains and recover taxes paid in prior years. If there are no capital gains in the latest year or three previous years, then capital losses can be carried forward indefinitely to be used to offset capital gains realized in the future.
4. Review your compensation strategy.
If you are incorporated and have experienced a severe income reduction, review your compensation strategy with your accountant and MD Advisor* to coordinate portfolio and tax considerations.
5. Rethink your RRSP strategy.
If your personal income dropped drastically in 2020 due to COVID-19, then you may choose to not deduct contributions made in the current year and instead wait to deduct them in a future year when your income is higher and so a deduction might provide a larger tax benefit. You should seek advice on whether it makes sense to use your tax deduction in a future year when it will be more valuable and instead direct this year’s cash flow to another short-term priority.
6. Adjust your longer-term goals.
Given the potential long-term impact of the pandemic, you may need to adjust your retirement plan. Your MD Advisor can help you run the numbers again and get you back on track. It could mean making changes to your savings contributions; your mix of stocks, bonds, etc. (asset allocation) and whether you hold them in registered, non-registered or corporate accounts (asset location); the amount you contribute to a particular account; or how income is split in your household.
7. Consider a prescribed rate loan.
If you have a relatively higher income compared with your family members and a large personal portfolio, talk to your MD Advisor about income splitting using a prescribed rate loan. It’s a type of income-splitting strategy in which a high-income family member lends cash to a lower-income family member or to a family trust. This way, any income earned on the borrowed funds is taxed at the borrower’s low tax rate, instead of the lender’s high tax rate. The lender collects the interest and must pay tax on it, but since July 1, 2020, the interest rate for prescribed rate loans is just 1%, which is the lowest it can be.1
*MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 The calculation formula is set out in regulations that accompany the Income Tax Act. The formula takes the simple average of interest rates paid for three-month Treasury bills in effect for the first month of the preceding quarter, rounded up to the next highest whole number — meaning 1% is the lowest possible rate.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.