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tax matters

The world of social media has given tax authorities a new method of identifying tax cheaters. Consider the example of Florida resident Rashia Wilson, who was caught by the U.S. Internal Revenue Service for tax fraud. According to Forbes, Ms. Wilson wrote a Facebook post that read: "I'm Rashia, the queen of IRS tax fraud. … I'm a millionaire for the record. So if you think that indicting me will be easy, it won't. I promise you." In the end, Ms. Wilson was thrown in jail in part thanks to her Facebook post. The moral of the story? Don't cheat on your taxes. And if you do, don't brag about it on Facebook.

A better approach is to reduce your tax burden through proper planning, and there's no better time than now to take final steps to reduce your taxes for 2013 and set yourself up for "tax success" in 2014. Today, I want to speak to investors about year-end tax strategies.

Restructure your portfolio

Taxes can be a huge drag on the performance of your portfolio if you're investing outside of a registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or tax-free savings account (TFSA). Since interest income is the most highly taxed type of income, consider holding your interest-bearing investments inside a registered plan to the extent possible. Also, consider how much in eligible dividends you're earning. Eligible dividends provide a dividend tax credit, which can fully offset the tax owing on those dividends – and then some. Specifically, if your income is low enough (generally under about $40,000), then the tax credit on eligible dividends might offset not only the tax owing on those dividends but might shelter other income from tax as well.

Manage TFSA before year-end

Setting up a TFSA should be a no-brainer. Any income earned inside the TFSA will be sheltered from tax, so consider holding your highly taxed fixed income investments there. Make this change before year-end to save tax in 2014. And if you're thinking of making a withdrawal from your TFSA in the near-term, consider doing this before Dec. 31 since amounts withdrawn are not added to your TFSA contribution room until the calendar year following the withdrawal. So, if you make a withdrawal on or before Dec. 31, you could recontribute those dollars as early as Jan. 1, 2014, but it you wait until Jan. 1 to make the withdrawal, you won't be able to recontribute until 2015.

Consider a holding company for your portfolio

There are three common situations where investing inside a holding company makes sense:

Where the cash is already in the corporation (perhaps because it was earned inside the corporation or was paid up to the holding company as dividends from an active operating business).

Where you have significant U.S. securities and want to avoid U.S. estate tax (see my article from last week for more on this topic.)

You live in Ontario, have a high income, and want to take advantage of the slightly lower tax rates on investment income inside a corporation than you'd pay personally (other provinces don't provide the same opportunity and there may be a tax cost if you invest inside a corporation elsewhere).

Increase tax relief for interest costs

Interest can be deducted if it's reasonable in amount and was incurred for the purpose of earning income from a business or property (including your portfolio). Consider paying off your high-rate non-deductible interest first, use cash for personal purchases (rather than debt) and borrow for business or investment purposes if you're going to borrow at all. Also, consider using existing cash or selling securities to raise the cash to pay off non-deductible debt. Then, reborrow to re-invest if you'd like. The interest should be deductible since you'll be borrowing to earn income. Set this up today for some tax savings this year, and into the future.

Donate securities to charity

If you have a desire to donate to charity before year-end, you'll save more tax by donating securities that have appreciated in value than donating cash or selling the securities to donate cash. The reason? Any capital gain triggered when you directly donate securities is eliminated under tax law, and you'll receive a donation tax credit to boot. If you don't have securities with accrued gains, you can donate your losers as well; you'll be entitled to claim the capital loss and a donation tax credit for the value.

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