Debt and taxes: Savvy moves for those in the red

When you’re in debt, every dollar counts. With tax season upon us, now’s the time for those with a negative bank balance to consider some savvy tax moves.

Ensuring your tax return works to your best advantage starts with being informed.

Forty-six per cent of Canadians did their own tax returns in 2012, according to a Bank of Montreal survey, but many said they don’t understand key details.

Fifty-eighty per cent said they’re unsure of how capital gains are taxed, for example, while 62 per cent aren’t knowledgeable about the way dividend income is taxed, and 33 per cent lack knowledge on how charitable donations are taxed. Another 25 per cent don’t understand the tax implications of a Registered Retirement Savings Plan (RRSP).

“It’s important for Canadians who are having difficulty managing debt or think they will owe on their taxes to take advantage of any tax savings opportunity,” says Chris Mazur, trustee in bankruptcy and partner of BDO Canada.

“These opportunities may be in the form of tax deductions or credits, which may help reduce the amount of tax owed or even result in a refund that can be used to pay down other debt.”

In 2012, the average family of four could have saved more than $3,200 in taxes had they used all of the credits available to them, Mazur notes.

“That’s a significant amount to put towards a high interest credit card balance,” he says.

Although the Canada Revenue Agency (CRA) lists all available tax credits on its website, many go overlooked. Consider a few:

• Medical Expenses. This tax credit is for eligible medical expenses paid by you or your spouse or common-law partner. Expenses include wigs, water filters, crutches, air conditioners, baby breathing monitors, and vision devices, provided they’re medically necessary.

• Moving Expenses. This deduction is available to cover specified expenses for individuals who have had to move more than 40 kilometres for a new position or who have been relocated by their employer.

• The Children’s Arts Tax Credit allows eligible Canadian families to claim a 15 per cent non-refundable tax credit on an amount up to $500 for the cost of registering a child in eligible artistic, cultural, or other programs, such as music lessons or tutoring. (The Children’s Fitness Tax Credit offers the same deductions.)

• The Family Caregiver Tax Credit is a 15 per cent non-refundable tax credit on an amount of up to $2,040 that provides tax relief to caregivers of infirm and/or dependent relatives.

• The Tuition, Education and Textbook credit provides tax relief to students.

• The Public Transit Tax Credit allows Canadians to claim the full amount they spend on transit passes and other eligible expenses for the year.

• The Volunteer Firefighters’ Tax Credit is available to any volunteer firefighter who serves at least 200 hours per year at one or more fire departments in their community.

File your taxes early -- or at least on time
“If you have a refund coming to you, file your taxes early,” says Marissa Verskin, senior manager, tax, at Crowe Soberman LLP, a chartered accounting firm. “You can then use the extra funds to pay down your debt sooner to save on interest costs.

“If you have a balance due, make sure that you pay it on time,” she adds. “Failure to do so will result in interest charges being assessed by Canada Revenue Agency. These charges compounded daily, and are additionally expensive as they’re never tax-deductible.”

Understand your options
If you can’t meet your financial obligations to the CRA, the offers relief from penalty or interest in certain situations. They include “extraordinary circumstances” and the inability to pay or financial hardship.

Plan ahead
Some tax moves need to be made well in advance, so consider the year ahead now.

If you’re going to keep a slush fund, consider keeping it in your Tax-Free Savings Account (TFSA), Verskin suggests, since interest earned is tax-free. Plus, when you withdraw funds from your TFSA, you don’t lose the contribution room. Rather, you can re-contribute the amount you withdrew in the following year.

Consider paying off your mortgage instead of contributing to your RRSP.

Verskin emphasizes that everyone’s circumstances are different, but in some cases, it pays to focus on the biggest debt you’ll ever carry rather than those much-publicized RRSPs. Something to keep in mind for the 2014 tax year and beyond.

“Mortgage interest is expensive, as you must pay the cost using after-tax dollars,” Verskin says. “An RRSP provides tax-free growth of your investments but still requires you to pay tax on the funds when you withdraw them. To the extent that your marginal tax rate at your withdrawal date is the same as your marginal tax rate at your contribution date, the RRSP provides only a tax deferral, not an absolute tax saving.

Be organized.

“Keeping tax files organized all year long, by using folders or envelopes labelled for various deductions, credits, T4s and other important tax-related documents will make filing taxes easier,” Mazur notes, “and perhaps will result in a larger refund.”