Misleading tax advice needs to be avoided at all costs.
I worry about misleading tax advice circulating on the web. Tax advice has a direct impact on people’s financial welfare, but unfortunately, sometimes, tax tips are not thoroughly vetted. Here are some of the most common misleading tax advice for Canadians that I’d like to debunk today.
1. You should maximize your RRSP contribution every year
This is another very common piece of tax advice that is misleading.
RRSP is a vehicle designed by the Canadian government to defer your tax burdens. Simply put, you do not have to pay tax on the amount that you put into your RRSP account, and the money will grow in the account tax-deferred. However, when you withdraw from the account, you will have to pay tax on the withdrawal.
With RRSP, you can only save on tax if you will be in a lower tax bracket in the future (e.g., when you retire) than now.
Therefore, to reduce your tax burden as much as possible, you need to be strategic about your RRSP contribution, instead of just blindly contributing the maximum every year.
Here are some circumstances under which you may want to save your RRSP contribution room for a future year
- If you have a temporary reduction of income in one year (e.g., go back to school full-time, or go on maternity/paternity leave)
- If you can claim many other taxable benefits and deductions to reduce your income to a minimum
- If you anticipate that your income will go up in the future (e.g., if you are fresh out of school and are just starting your career).
I typically recommend that you maximize your TFSA contribution first before thinking about your RRSP contribution.
Of course, if you worry that by not contributing, you will just waste the money, then you should still contribute to the RRSP account. As well, if you believe the benefit of letting your investment grow tax-free in an RRSP account longer outweighs the benefits of waiting, then you should contribute. After all, you may not necessarily get the promotion or salary increase you want, and $1 savings in tax today is certainly worth more than $1 10 years from now.
2. Your total TFSA contribution room is the same as that since inception ($88,000 in 2023)
The total TFSA contribution room is a general guideline. While it applies to a vast majority of people, it is still incorrect for a portion of the population.
The TFSA program did not begin until 2009, and it has two criteria:
- You must be 18 years of age or older
- You must have a valid social insurance number.
If you were under 18 when the program began, then you were not eligible for the program for the first few years. As well, if you are an immigrant without a valid social insurance number, then you are not eligible until you receive your SIN.
As such, when you see a blanket statement online saying that you can contribute up to the full amount in your TFSA account, think again. You may not necessarily be eligible for the full amount. Over-contribution to TFSA is subject to a significant financial penalty, so make sure you are careful.
3. If you incorrectly contributed to your TFSA account, you will have to wait until next year for the contribution room to reset even if you withdraw the fund this year
This is typically true for most cases. However, if you realize your mistake immediately, you can try calling your financial services firm and ask them to reverse the transaction for you. There is a small window after you make your contribution when a reversal is possible, so give it a try.
If the firm does let you reverse the contribution, then the incorrect transaction won’t adversely impact the current year’s contribution room.
4. You should claim a capital loss to save money on personal tax
There are two problems with this statement:
- You can only save money if you have realized capital gain. That is, the allowable capital loss can only be used to offset taxable capital gains (i.e., money earned through investing). It cannot be used to offset other sources of earnings, such as your regular paychecks.
- Saving money should not be the reason why you are selling a stock. The purpose of claiming capital loss is not to save money, but rather to reduce loss. You are still losing money overall, though less. You should only sell your stocks if you no longer want to hold them in your portfolio.
Bear in mind that you can carry back allowable capital loss for up to three years and carry forward indefinitely, so if you want to sell a losing stock, even if you don’t have a taxable capital gain to offset it in the current year, you should still go ahead and do it.
Note that if you sell a losing stock and buy it back too quickly (in Canada it’s 30 days), the loss will be counted as a superficial loss, and you will be denied the allowable capital loss.
5. Donate to charity to save taxes
While it is true that you will receive federal and provincial tax credits by donating to charity, you are still net negative cash. The tax credits will never be as large as the sum of money you donate because otherwise, you are not really donating. It would simply be like a transfer from the government to the charity through you.
Donate to charity because you want to, not because donations can help you save on tax.
6. Don’t report side hustle income
As Canadians, you are responsible for paying taxes on all sources of income. Sources of income can include your regular day job, part-time job, side hustle, your investment income, or income from other parts of the world (e.g., rental income in Florida). Even if you get paid in cash, you still need to report it.
7. Do not claim expenses because you will get audited
Legitimate expenses that enable you to make income can be included and deducted from your income. For example, as a blogger, I do have expenses such as hosting, website maintenance, and ads. These are expenses that I can claim against my blogging income.
Do not be afraid to claim legitimate expenses; otherwise, you are just leaving money on the table. If you get audited, just show the CRA the receipts. I like to keep a small note on each of the receipts so I know exactly what the expense is for.
8. Confusing tax avoidance with tax evasion
Tax evasion is illegal. Tax avoidance, on the other hand, is the legal way to avoid taxes. It involves using legal methods, such as claiming all eligible deductions and credits, to minimize the income tax owed by an individual or a business.
It is completely okay to claim all deductions and credits you are eligible for. These amounts are designed by the government to help reduce your tax burdens, so make sure you use them.
9. You do not need to worry anything about your taxes if you hire a professional tax preparer
Although hiring a professional tax preparer can indeed save a lot of headaches, in the end, you are still responsible for your tax returns. Even if the professional made an error that resulted in penalties, you are still responsible for paying the penalties (of course, you could negotiate with your tax preparer).
If the error resulted from your omission of information, then you will be fully responsible for any related penalties. You must make an effort to correct the mistake with your tax preparer.
When in doubt, seek a qualified tax professional, such as a CPA. You will be in much better hands than publications online.