Managing Your Taxable Income
“Managing your taxable income is important for social benefits like the Old Age Security and to reduce your overall tax expense.”
Many people have the misconception that once you cross into another tax bracket, all your income is taxed at that higher rate. In reality, it is only the income portion that crossed the threshold that is taxed higher. Part of cash flow planning is keeping your taxable income at a consistent level.
Things that could increase your taxable income for the year include draws from your RRSP and the realization of gains on the sale of an investment property or company share.
Earnings that make up ordinary income include employment income, business income, net rental income, interest, pension, RRSP / RRIF withdrawals, CPP, and Old Age Security. Ordinary income is subject to the highest rate of tax.
Dividends received from Canadian companies are taxed lower because the company has already paid some tax on the earnings. For eligible dividends, the company already paid 27% tax, so if the person has taxable income below $48,535, he/she can actually receive a tax refund by earning some eligible dividends.
If you know you will have a large income inclusion in one year, plan ahead to use available tax deductions. For instance, if selling a rental property with a large increase in value, it may be a good idea to keep some RRSP contribution room for that year since RRSP contributions are a deduction from taxable income and can be used to offset the capital gain income inclusion.
Tax credits do not reduce your taxable income, but help to reduce the tax you have to pay. Tax credits include donations, medical expenses, disability, basic personal credits, and many others. Be warned that social benefits like the Old Age Security are based on taxable income, regardless of how much credits you may have.