KNOW HOW FEDERAL BUDGET CHANGES AFFECT YOU

The news media pegged the February 1994 federal budget as having few significant tax changes. However, a couple of elements will have an impact on seniors.

Capital Gains Changes

The $100,000 lifetime capital gains exemption was eliminated for gains accruing after the February 22, 1994, budget day. If you didn't actually sell assets before then to realize capital gains, you can still make a special election in your 1994 income tax return. You would be treated as though you had disposed of selected assets on February 22, 1994, which would trigger capital gains qualifying for the exemption. Special rules apply to gains on real estate, and to trust and partnerships.

Short-term tax surprise

Many people will discover a hidden expense. That's because your capital gain is added to your net income before the exemption is taken. If your net income rises above $25,921, the Age Tax Credit you can claim will decrease. If your net income is pushed over $53,214, you will also be required to repay some or all of your Old Age Security benefits (commonly known as the "OAS clawback").

It is important to bear in mind, however, that this tax surprise is a one-time-only event. If you don't take the unrealized portion of your $100,000 exemption on your 1994 tax return, you will have to pay capital gains tax when you actually sell or make a gift of the investment to someone else. Your estate could be burdened with unnecessary capital gains tax if you still own your present investment when you die.

Depending on your circumstances, that could end up costing significantly more than the one-time tax hit you may be in for by making the special tax election next April.

Age Tax Credit Changes

The age credit, currently $3,482, which was available to everyone who had attained the age of 65 has been changed to an income-tested credit. Individuals with incomes under $25,921 are not affected. For individuals with incomes greater than $25,921, their credit will be reduced by 15 per cent of the excess. Individuals who are over 65 and who have income in excess of $49,134 will no longer receive the age credit. The reduction will be phased in over a two-year period. For 1994, the reduction will be one-half the amount otherwise determined. For 1995 and subsequent years, the full reduction will apply.

Spread the wealth

The best defense against these clawbacks may be splitting your income. Here are some possibilities you can explore with your tax advisor:

Spousal RSP's - If you are still working or still have earned income such as net rental income, consider making RSP contributions into a spousal plan. This is especially effective if, in retirement, your spouse will be subject to a lower marginal tax rate or if your spouse will need income qualifying for the $1000 pension income amount.

Last year for pension transfers - If you are married, or have a common-law spouse, receive periodic Registered Pension Plan or Deferred Profit Sharing Plan payments and your spouse is under age 72 throughout the year, 1994 is your last chance to transfer up to $6,000 of these payments to a spousal RSP. The transfer can provide tax-savings for the 1994 taxation year and income-splitting when funds are later withdrawn by your spouse.

Split Canada Pension Plan benefits - If one spouse receives more retirement income than the other, splitting CPP benefits with the lower-income spouse may reduce clawbacks and lower your total bill.

Rob Peter to pay Paula - Use the lower-earning spouse's income to invest and the higher earning spouse's income to live on. This will net you a better after-tax return on interest and dividends.

In each case, ensure the step is truly beneficial to you. As well, if you're planning to transfer assets to others primarily for tax purposes, don't assume. Find out beforehand whether the tax on those assets will or will not be attributed back to you.

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