Defer income till new year to shave tax bill
Saturday, December 14, 2002
Back in December, 1993, the U.S. Postal Service overcame rain, sleet and fog to make sure that its 3,300 employees based in Hampton Roads, Va., went home News Year's Eve with their pay cheques. You see, it seems that the cheques the postal workers were supposed to receive the week before Christmas got stuck, well, in the mail.
Not wanting employees to face the new year empty-handed, Postal Service officials in Hampton Roads decided to reissue the pay cheques locally. "They've been cutting cheques since this morning," Gordon Richardson, president of the Norfolk, Va.-based chapter of the American Postal Workers Union, said at the time.
Postal employees are usually paid every other Thursday or Friday. The cheques arrive at the beginning of the week and are dispersed by the end. The cheques are issued from a postal finance centre in Minneapolis. Those destined for Hampton Roads never arrived. Go figure.
Not unlike those postal workers in Virginia, most Canadians would prefer to receive their income as quickly as humanly possible. But what if I were to tell you that delaying the receipt of certain income until the new year can actually make sense -- for two reasons. First, effective tax rates are expected to be lower in 2003, and second, the time value of money can create a lower tax burden itself. Let me explain.
The tax rates
Effective tax rates will generally be lower in 2003, thanks to the indexing of tax brackets and credits to inflation federally, and in most provinces. The federal Department of Finance announced on Nov. 12 that tax brackets and credits will be indexed upward by 1.6 per cent for 2003.
The result? The lowest tax bracket does not end until you're earning $32,183 in 2003 ($31,677 for 2002). The highest tax bracket for 2003 will not start until you're earning $104,648 in 2003 ($103,000 for 2002). Further, the basic personal amount, which represents the amount of income that you can receive tax free federally, will be $7,756 for 2003 ($7,634 for 2002).
While the indexing of tax brackets and credits won't make you rich, it's better than a kick in the pants. And while it's not expected that any province will increase tax rates in 2003 (although nothing is impossible), a number of provinces have yet to fully implement tax cuts announced in the past two years.
This could spell lower tax rates provincially in 2003 in addition to indexation of tax brackets and credits. In this event, you'll enjoy an even lower effective tax rate in 2003, making the deferral of income a worthwhile pursuit.
The time value
If you have the option of paying a $1,000 tax bill today, or one year from now, you'll choose to pay it one year from now, all other things being equal.
The reason, of course, is that the $1,000 remains in your hands for an additional year. If you can earn income on that $1,000, you'll be glad you managed to defer the tax hit. There's a time value to money.
Consider some numbers. If you owe $1,000 in taxes, but can defer that tax bill for one year and can earn 8 per cent on that money between now and when you pay your taxes, your tax bill will really cost you just $926 in today's dollars. Defer that tax hit for, say, five years, and that $1,000 tax bill will cost you just $681 in today's dollars.
You'll be in a good position to defer the receipt of income if you're self-employed and can control your own compensation or revenue, or if you're an employee due to receive a bonus for 2002. Consider these strategies.
Delay the completion of certain work in your business until the new year, if possible, where it will allow you to defer the recognition of income.
Delay the payment of dividends or bonuses from your corporation until the new year.
If you're due to receive a bonus from your employer for 2002, arrange for it to be paid in January, 2003, instead of this year. You won't face tax until 2003. In fact, bonuses can be deferred for up to three years and you won't face tax until the year you receive the bonus.
Consider borrowing to make certain payments that should be made by year-end, then pay off that debt with dividends from your company, or bonuses, that have been deferred until January. For example, you might borrow to donate to charity, contribute to a registered education savings plan, or to make other payments, then pay off the debt in January once you receive your deferred income.