My son, Win, who is now in fifth grade, seems to have discovered the joy of educating his parents on all manner of new subject matter. I have to admit, he's taught me quite a bit this year, which leads me to wonder whether or not I am actually smarter than a fifth grader.
No, I'm not applying to appear on the TV show by the same name, lest I should embarrass myself. What's that? You think you're smarter than a fifth grader?
Okay, did you know that: The average Canadian goes bowling 207 times in a lifetime; the Swiss army keeps 20,000 carrier pigeons for emergency communication; Vermont maple is the type of wood used to make Scrabble letters; some Egyptian mummies wore dentures; and ostriches yawn in groups before they go to sleep? Not so easy, is it?
So, I decided to test my son's intelligence on investment issues. "Win, if someone earns eligible dividends and they live in B.C., how much can they earn in 2008 before they have to pay tax if they have no other source of income?"
"Dad, that's easy," he replied. "Seventy thousand dollars."
Whoa. Okay, so he's smarter than I thought. For those who didn't catch the significance of that last answer, let me share some tax tips.
THE RULES
You might recall that in 2005 the government of the day announced changes to the taxation of dividends. Basically, the changes reduced the tax rate that applies to "eligible dividends," which are generally dividends received from publicly traded companies (to simplify the definition). The tax rate was reduced by offering a greater dividend tax credit on these dividends.
In British Columbia, for example, a taxpayer with no other source of income could receive up to $70,000 of eligible dividends in 2008 before facing any tax on that income. In other provinces, the level of tax-free eligible dividends varies, but most provinces offer little or no taxation on approximately the first $38,000 of eligible dividends as a minimum.
It's interesting, but the marginal tax rate on eligible dividends is now lower than the rate on capital gains in most provinces at most income levels. In fact, at lower income levels, the marginal tax rate on eligible dividends is often negative. That is, adding more eligible dividend income to your tax return can actually reduce your overall tax bill.
Why? Because the dividend tax credit available will offset not only that dividend income, but the tax on other income as well. British Columbia has the deepest negative marginal tax rate in 2008 at negative 15.55 per cent for the lowest income earners. This means, for example, that if you live in B.C., are in the lowest tax bracket, and you add one dollar of eligible dividend income, you'll actually pay 15.55 cents less in tax than without the dividend. What a bargain.
THE PROBLEM
If your income is low enough, you may not have sufficient income to soak up the excess dividend tax credits that you're entitled to. If you're in the lowest tax bracket earning only eligible dividends, you could be entitled to approximately $5,600 of tax credits that you may never claim due to insufficient income.
THE SOLUTION
And so, tax planning going forward may be different than in the past. There are some strategies possible to avoid this wasting of tax credits. Consider the following ideas.
Transfer dividend income to the higher-income spouse. Although the higher-income spouse will have to report the eligible dividends, he or she may also be able to use the full dividend tax credit available, so those credits aren't wasted.
Consider increasing taxable income to avoid wasting the dividend tax credits. You might even consider withdrawing funds from your registered retirement savings plan if it can be done tax-free thanks to the dividend tax credit. You can always consider contributing those dollars to the new Tax-Free Savings Account (TFSA) starting in 2009.
Consider realizing taxable capital gains to increase income to use up the tax credits.
At tax-filing time, consider the following ideas to increase your ability to use up the dividend tax credits: Defer certain tax credits that can be claimed in a future year (such as donations or medical expenses), transfer eligible tax credits to your spouse, elect to split eligible pension income with your spouse, defer the claim of capital cost allowance against self-employment or rental income, defer RRSP deductions to a future year, defer losses that can be carried forward, or defer certain tax shelter deductions.
