Corporations and high-net-worth individuals (HNWIs) commonly apply tax loss harvesting strategies to reduce tax liabilities, improve cash flow, manage investments, smooth income, and maximize after-tax returns. This strategy can also be instrumental in estate planning, and minimization of taxes on death.
Disclaimer: While this article provides an informational overview, it is not legal advice. For tailored guidance on tax loss harvesting and other tax planning strategies, we recommend consulting with a professional tax lawyer at Fasken. As a leading corporate law firm representing large businesses and HNWIs, our expertise is tailored to address complex financial and tax matters.
What is Tax Loss Harvesting?
Tax loss harvesting involves selling securities or other property that is in a loss position to offset taxable gains from other investments. Here’s how it works in Canada:
Offsetting Capital Gains: When a security is sold at a loss, that loss can be used to offset capital gains, reducing taxable income. For example, if an investor realizes $10,000 in capital gains and $4,000 in losses in the same year, the net capital gain would be $6,000.
Carryforward and Carryback: Canada allows capital losses to be carried back three years or carried forward indefinitely. This flexibility helps in managing tax liabilities over time, rather than forcing gains and losses in the same calendar year. For example, if losses exceed gains in any given year, they may be applied to past gains for potential tax refunds, or against future gains, reducing those gains.
Spread Gain Over Multiple Years: Triggering smaller gains over time can spread the taxable portion of a gain over multiple years, potentially maximizing access to the 50% annual inclusion rate for the first $250,000 of capital gains realized by an individual.
By understanding and utilizing these principles, investors can significantly enhance their after-tax financial returns. The following sections explore the strategic benefits of tax loss harvesting for corporations and HNWIs.
Strategic Benefits of Tax Loss Harvesting in the Context of Estate Planning
Tax loss harvesting offers several strategic benefits that can be highly advantageous for corporations and HNWIs.
Reduction of Tax Liabilities
One of the primary benefits of tax loss harvesting is the current reduction of tax liabilities. By offsetting gains with losses, corporations and HNWIs can reduce overall taxable income, which is particularly beneficial during profitable years. Utilizing carryforward and carryback provisions may allow for strategic planning across multiple tax years, providing long-term benefits.
Cash Flow Management
Managing cash flow is critical for maintaining liquidity and funding future investments. Lowering taxable income through tax loss harvesting can free up capital, allowing for reinvestment or deployment of cash for operational needs in a business. This enhanced liquidity can be essential for corporations and HNWIs looking to maintain financial flexibility.
Strategic Investment Management
Effective tax planning is essential for achieving financial goals. Holding assets that may produce capital gains personally (rather than through a corporation) may be more tax-efficient, to take advantage of the annual 50% inclusion allowance for individuals realizing up to $250,000 of capital gains. Year-end capital loss planning may be more valuable now, given the introduction of these new tax rules in 2024. However, tax loss harvesting must be done in a way that avoids the superficial loss rule, which can be triggered when identical securities are purchased within 30 days.
Income Smoothing
Individuals are taxed at progressively higher marginal rates as their income increases in any given year. Smoothing income over several years may prevent large fluctuations in taxable income. By timing the sale of assets in lower-income years or managing gains and losses over multiple tax years, HNWIs can potentially benefit from lower marginal tax rates, maintain stable taxable income, and mitigate income spikes that could lead to higher tax brackets in certain years. This approach may also provide for a more stable financial outcome over time.
Maximizing After-Tax Returns
Maximizing after-tax returns is crucial for long-term wealth accumulation. By reducing taxes, more capital can remain invested, compounding growth over time. And by strategically timing the realization of gains and losses, investors can enhance overall investment performance, leading to greater long-term wealth growth.
Estate Planning
Aside from pairing gains and losses, a planned and phased sale of assets over time – particularly those with substantial unrealized capital gains – may reduce tax owing on death. In this way, planning with harvested losses over time may also allow for more efficient transfer of wealth. This is particularly important for HNWIs who want to ensure their estate planning is effective.
Example Scenario – Tax Loss Harvesting in Estate Planning
Imagine an investor realizing a $20,000 gain from stock A and a $15,000 loss from stock B in the same year. By offsetting the gain with the loss in the same year, the capital gain is reduced to $5,000. If the stock and other property were instead held over time and owned as of the date of death, the entire appreciated value would be taxed in the year of death, and the deemed capital gain above $250,000 would be subject to the 66.67% inclusion rate. Other potential ways to crystallize a gain are by transfer to a corporation or partnership, under the right circumstances and with appropriate tax advice.
Considerations and Professional Advice
Understanding the rules and best practices is key to successful tax loss harvesting. Changes to the alternative minimum tax (AMT) introduced in 2024 may affect this planning for individuals who are applying losses to other taxation years. When engaging in tax loss harvesting or any other tax planning, it's important to seek professional advice, which will vary according to the exact circumstances in play. Due to the complexity of the rules around the various strategies mentioned above and the rapidly evolving tax environment in Canada, consulting a tax lawyer is prudent for tailored advice and proper compliance.
Fasken's Private Client Services team is dedicated to providing top-tier legal services to private enterprises, family offices, entrepreneurs and HNWIs. Our seasoned professionals bring extensive experience and deep knowledge of tax law to assist businesses in navigating complex tax matters. Lori Bokenfohr is a tax lawyer who excels in business succession planning, estates, and cross-border tax issues. KC Miu is a corporate/commercial lawyer who focusses on financing transactions. With over 950 lawyers across Canada, the UK, and Johannesburg, our team ensures that each client receives personalized and effective solutions tailored to their unique needs.
Conclusion
Tax loss harvesting offers significant advantages for managing tax liabilities in Canada. By understanding its principles and employing strategic planning, corporations and HNWIs can enhance their after-tax financial outcomes. For deeper insights and personalized guidance, consider consulting our corporate tax lawyers at Fasken.
