It appears the U.S. Treasury Department is having a tough time controlling identity theft and tax fraud. According to the Miami Herald last fall, a Treasury report noted that more than $5.2-billion (U.S.) in tax refunds has been paid to fraudsters who filed 1.5 million fake returns using stolen identities. Evidently the IRS did manage to stop $2.5-billion of fraudulent refunds – almost half of which was claimed by two prison inmates.
I don't recommend the inmate strategy. A tax refund of a few hundred million dollars could raise a red flag with the taxman. There are definitely legitimate strategies, however, that could put more money back in your pocket. Let me share some ideas that investors will appreciate.
1. Transfer dividends when beneficial
If your spouse has received dividends from Canadian securities, but has little income, he may not benefit much, if at all, from the dividend tax credit that he's entitled to claim. It's possible in this situation to report the dividends on the tax return of the higher income spouse – that is, your tax return. Why bother? You'll be entitled to a higher spousal tax credit because your lower income spouse will now have less income to report (in fact, you can take advantage of this idea only where it's going to result in a higher spousal credit for you). In the end, you'll pay less tax as a couple.
2. Deduct all eligible interest
You're able to deduct interest when money has been borrowed for business or investment purposes. You'd be surprised, however, at how many tax preparers miss out on claiming certain interest costs.
In particular, interest on brokerage or margin accounts, or interest charged on Canada Savings Bond payroll purchase plans is often overlooked. To justify your interest deduction, make sure you're expecting income from your investments, which includes interest, dividends, rents or royalties. And don't forget: Where an investment has gone sour and is no longer held by you, a portion of the interest on money borrowed to acquire that investment might still be deductible.
3. Claim allowable business investment losses
If you own shares in or have lent money to a small business corporation, and the business has gone sour, there may be tax relief available in the form of an "allowable business investment loss" (ABIL). In many cases, your tax preparer may not even realize that you have made this type of investment, so be sure to make the fact known. An ABIL is calculated as 50 per cent of the money lost by you, and can generally be deducted against any type of income – not just capital gains – although some restrictions may apply where you've claimed the capital gains exemption in the past.
4. Track reinvested distributions
Don't forget that any reinvested distributions from your mutual funds held outside your registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) should be added to your adjusted cost base of the mutual funds. Keeping track of the new adjusted cost base each year will avoid a double-tax problem when you finally dispose of your mutual funds. Check the periodic statements you received from your financial adviser or mutual fund company for the amount of the reinvested distributions.
5. Consider deferring deductions
You'll want to avoid reducing your taxable income below $10,822 for the 2012 tax year. After all, there are no taxes to pay below this level thanks to the basic personal amount. If you have discretionary deductions available, such as RRSP deductions or capital cost allowance, these should generally be postponed to a future year if. You may even want to postpone the deduction if it's going to bring your income below $42,707, the level at which your marginal tax rate jumps up by about 10 percentage points, on average, due to the change in the federal tax brackets. By using the deduction against income over $42,707, you'll save more tax.
6. Avoid recurring losses
If you report business or rental losses for more than two or three years, you should expect the taxman to notice. If the taxman concludes your activity is more of a hobby, then you'll have to demonstrate that you have a reasonable expectation of earning a profit to be entitled to claim those losses. If your activity, on the other hand, is sufficiently commercial in nature, then losses should not be denied – so be prepared to defend your activities to avoid reassessment.