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Most people in Canada are very concerned about the amount of income tax they pay each year. In Quebec for example, it is not rare that our marginal tax rate gets to 42%, 45% and 48% for the highest bracket! This is the main reason why tax planning becomes so important. The three principles described in this post can be used in any country though depending on your income tax law.

Defer

Why pay now when you pay later? Good furniture stores learned that a long time ago and so do the tax experts If you are able to postpone any tax payment, you will become richer can richer as the power of interest compounding will work its magic on a bigger amount.

There are several ways of reporting your income tax. In Canada for example, making RRSP contributions is a way of deferring your tax income in time. The TFSA will be another great tax shelter as powerful as the RRSP and it’s coming in 2009. In the USA, I think that you are able to report taxable gains if you reinvest the money during the same year. With this technique, you can almost defer taxes until you die!

Deduct

There are several expenses that you can deduct from your income in order to save some taxes. Registered Retirement Saving Plans and pension contribution are too good examples of amount that you can deduct from your declared income. Tax deductible interest such as interest charges paid on investment loans or rental property mortgages are other examples.

Deductions will allow you to decrease your global revenue so you can pay less tax. It makes a huge difference in Canada as you can drop to a smaller tax bracket.

Divided

The last technique is based on the premise of tax brackets again. You are able to divide your income with your spouse or your children. It is all related to the source of revenue and how it is declared to the government. The idea behind this tax planning technique is to attribute a source of income that is taxed at a higher marginal tax rate to someone who is in a lower tax bracket.

For example, if you make 100K and your wife makes 25K, you should pay all the expenses and let her invest her money. Therefore, the interest, dividend and capital gains will be taxed under her income declaration. If you are self employed or own a company, you will be able to give a decent salary to your wife if she helps you running the company.

Then again, there are many permitted ways to divide your income among your family; it all depends where you live! You are better off consulting a good accountant in order to do these techniques correctly and (most importantly) legally!

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