Canada Revenue Agency: Avoid This Massive Tax Hike

CPP enhancement will take a bite out of your income this year, but you can offset its effects by holding dividend stocks like Fortis Inc (TSX:FTS) in a TFSA.

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A big tax hike is coming in 2023. I’m not talking about investment taxes or even something that everybody agrees is a tax. However, it’s collected by the Canada Revenue Agency, just like taxes are, and it’s based on your income. In this article, I will explore the big tax hike that’s coming in 2023 and what you can do to avoid it.

CPP enhancement

CPP enhancement is a program that will do many things. It aims to increase the percentage of a Canadian’s income that will be replaced by the Canada Pension Plan in old age. That’s a worthy goal, but it comes with costs today. In order to get the hoped-for increase in future CPP benefits, working age Canadians will have to pay a larger share of their income into the program now.

How large a share are we talking here?

Well, according to the CRA’s website, CPP contributions are going from 5.1% in 2019 to 5.95% in 2023. For the self-employed, both figures are doubled. The majority of the CPP enhancement hikes have already occurred, but the final one for 2023 will take contributions to their highest percentage of income yet.

There is a big debate about whether CPP contributions really are taxes. Proponents of the “CPP is a tax” position point to the non-optionality of CPP payments; detractors point to the fact that you’re supposed to get the money back when you retire. The jury is out, but from a purely administrative perspective, CPP premiums are taxes, as they are collected by the CRA as part of your tax bill.

How to offset it

If you want to offset the increase in tax you’re about to pay due to CPP enhancement, I’d give one main recommendation.

Invest in a Tax-Free Savings Account (TFSA). Assuming you’re going to be investing one way or the other, then investing in a TFSA rather than a taxable account will lower your tax bill.

Let’s say that you hold $50,000 in Fortis (TSX:FTS) stock. Fortis is a stock that offers both dividends and potential capital gains, so there’s a lot of tax savings to be realized by holding it in a TFSA.

Fortis stock has a 4% dividend yield. So, a $50,000 position in it pays $2,000 in dividends per year. If you had $2,000 in dividends and a 33% marginal tax rate, you’d pay $666 in dividend taxes (I’m ignoring the dividend tax credit for the sake of simplicity). Now, if you realized a 10% gain on your Fortis shares, and you sold all of them, you’d have a $5,000 capital gain. Half of that ($2,500) is taxable at your marginal rate, resulting in another $833 in taxes. Altogether, you’re looking at $1,499 in taxes on one stock!

But if you hold Fortis stock in a TFSA, that hypothetical $1,499 turns into $0. By contrast, 2023 CPP enhancement on $50,000 worth of taxable income would only increase taxes by about $125 compared to 2022 levels. So, the TFSA strategy more than makes up for CPP enhancement.

Foolish takeaway

As we’ve seen, the CRA is going to be hiking CPP premiums once more in 2023. It’s an extra cost you’ll have to pay, but if you invest diligently in tax-sheltered accounts, you stand a fighting chance at offsetting it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends Fortis. The Motley Fool has a disclosure policy.

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