Tax season is right around the corner, and you know what that means: time to get counting your receipts!
The more tax deductions you claim on your income taxes, the bigger the refund you get from the Canada Revenue Agency (CRA) after you file. It is well known that more deductions lead to bigger tax refunds. However, there are other tricks for maximizing your tax refund that aren’t so well known. In this article, I will explore a two-step process to maximize the tax refund you can get from the CRA. The first step in this process is something you likely already know about; the second step is not as well known (but can save you even more money).
Step #1: Claim all deductions you can get
The first step to getting a larger tax refund is lowering your taxable income. You do that by claiming as many deductions and credits as possible. If you’re conventionally employed, you can claim things like donations, tuition, and student loan interest. If you’re self-employed, you can claim all of the same things a conventionally employed person can and then some. Here are some examples of deductions that self-employed people can claim:
- Home office space
- Transportation costs (the portion of them related to work)
- Licenses and subscriptions
Really, most things related to running a business are deductible for business owners. So, if you’re self-employed, be sure to claim as many such things as you can.
Step #2: Prioritize bonds then dividends in your TFSA
Another way to maximize your tax refund is to be careful about what you hold in your TFSA. In general, holding interest bearing bonds in a TFSA results in the most tax savings, followed by dividend stocks, followed finally by non-dividend stocks. The reason is that interest is taxed more heavily than dividends, while non-dividend stocks (if held long term) may not be taxed at all. So, assuming your portfolio consists of a mix of bonds, dividend stocks and non-dividend stocks, make sure the bonds take priority for being held within your TFSA. You can save money on stocks with the dividend tax credit, as I’ll show in the next section.
How much money you can save with the dividend tax credit
Consider the case of a hypothetical investor holding Toronto-Dominion Bank (TSX:TD) stock. TD is a good example to work with, because the stock pays a dividend and has a 5% yield. The maximum amount of accumulated TFSA contribution room a person can have in 2024 is $95,000. If someone were to invest that amount in TD stock, the person would get about $4,750 per year in dividends. None of those dividends are taxable within a TFSA, but by holding TD outside of a TFSA, some Canadians can actually get paid by the CRA to hold the stock!
How on earth does that work? It depends on your marginal tax rate; if it’s 15% or lower, then the dividend tax credit is worth more than your pre-credit taxes. A $4,750 dividend from TD Bank produces a $983 tax credit. That sum is arrived at by grossing up the dividend by 38% and then multiplying the grossed-up amount ($6,555) by 15%. If your marginal tax rate is lower than 15%, you actually get cash from the CRA by receiving TD Bank dividends, as your pre-credit taxes are lower than the tax credit you receive.
CRA money: The Foolish bottom line
The bottom line about taxes is you lower them by lowering your income. The dividend tax credit is a great way to get your reported income down. If your tax rate is low, by all means, hold your dividend stocks outside of your TFSA. And no matter what your tax rate is, don’t buy stocks in your TFSA until you are finished buying bonds.