Can I Deduct Investment Management Fees?

When Are Investment Fees Tax Deductible?

Subsection 20(1)BB) of the ITA specifies the conditions for evaluating the tax deductibility of an investment charge. A taxpayer may generally deduct fees and the applicable sales tax at a high level.—i.e., Goods and Services Tax (GST), Harmonized Sales Tax (HST), and Quebec Sales Tax (QST)—if such fees are incurred:

• Compensated for buy/sell advice on specific stocks or for the administration or management of securities held by that taxpayer

A fee-based service provider (e.g., an advisor) or corporation (e.g., an investment firm) whose primary business is to provide buy/sell advice on specific securities or administer or manage securities. Suppose the investment fees are paid to satisfy the requirements. In that case, they will be deductible against any taxable income earned throughout the year. Embedded costs, such as MERs, are deducted by the fund. A mutual fund or segregated fund before payment is distributed or allocated to investors, lowering taxable income for those investors.

When you sell stocks or exchange-traded funds, you don’t get to subtract the money you paid for commissions. But when you sell a security, the commission you paid is added to the cost of that security. It means that when you sell a security for more than you paid for it, the commission will be subtracted from the money you make. And when you sell a security for less than what you paid for it, the commission will be added to your loss.

You can’t deduct the fees you pay for general financial counseling or planning. You also cannot deduct the costs of economic journals and newspapers.

Fees in a Registered Account

Regardless of the amount invested, Advisory and other investment fees paid on registered assets are not tax-deductible. These fees can be paid from the written or the investor’s taxable accounts. Suppose the registered payment is settled outside of the registered account. In that case, the advantage rules do not apply, nor does the 100% advantage tax.

There are proper and improper ways to pay registration costs, depending on the type of account. For example, a tax-free savings account (TFSA), where after-tax dollars can grow tax-free. Paying the fee outside the TFSA can maximize those tax-free savings as the payment does not directly reduce them.

However, the answer will be determined by your time horizon and rate of return. And tax rate when considering registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs), where amounts are taxed when withdrawn. These variables would only be known with certainty in the future. It’s worth noting that if the fee is paid within an RRSP or RRIF, it is done using pre-tax money. It lowers the amount of taxes the CRA withholds from your withdrawals over time while decreasing the value of your tax-deferred investment.

Segregated Fund Contracts

The fees for getting investment counseling and advice for entering or redeeming segregated fund contracts in taxable accounts are not currently seen as being deductible by the CRA.4 This is because they believe a segregated fund contract is an insurance contract and not a share or security of the investor, which is an essential requirement for fee deductibility. The fund can also use the MER of a segregated fund contract to lower its income before allocation, just like its mutual fund equivalents.

Tax Analysis of Investment Management Fees and MER

Are you wondering if there is a difference between a tax-deductible fee and an MER on your investments? Let’s examine that using an illustration, though. In a taxed account, Stephanie has $250,000 invested. She wants to contrast the tax advantages of a mutual fund trust (Series A) with just an MER and another with both an MER and an advisor fee (Series F). For simplicity, she invests in a fixed-income mutual fund with a 5% return that pays out all of its profits as interest. Series A has a 2% MER. For the same total fee of $2, the Series F will have a 1% MER and 1%. Her marginal tax rate is 50 percent. The following table summarizes her findings:

Series A Series F

Investment phase $250,000 $250,000

$12,500 in interest earnings $2 percent, 1 percent, and $5k of the $12,500 MER ($2,500)

Distribution $7,500 $10,000

($2,500) Advisor fee (0 percent), (1 percent)

Payment that is taxable $7,500 $7,500

($3,750) ($3,750) Tax on distribution

$3,750 after taxes $3,750

As you can see, the total fee is the same whether you receive interest income. Because you have the total duplicate payments ($5,000), you have the same amount of taxable income ($12,500 in interest income).

What Investment Costs Are Tax Deductible?

The IRS allows taxpayers to deduct various investment-related expenses, provided such fees are tied to creating taxable investment income. Do your expenses qualify?

The Internal Revenue Service provides a variety of tax deductions for investment-related expenses, provided such expenses are associated with generating taxable investment income. The Tax Cuts and Jobs Act was passed in 2017. Numerous rules affecting the tax-deductibility of investment expenses have been amended.

Given that maximizing your tax deductions has the potential to minimize your tax liability. Let’s examine some of the most frequent deductible investing expenses and how they can reduce your taxable income.

No Longer Deductible Are Investment-related Miscellaneous Expenses

Before the Tax Cuts and Jobs Act (TCJA), taxpayers may deduct some expenses known as “miscellaneous itemized deductions.” The miscellaneous itemized deductions were fees for investment advice, IRA custody fees, and accounting charges required to generate or collect taxable income. Certain assumptions are no longer allowed for tax years 2018 through 2025.

Despite worries about the loss of these deductions, most likely many investors did not benefit from them under the previous tax regime. Before the TCJA, individuals lost a portion or all of their deductions due to three key restrictions:

• Before receiving any advantage, the 2 percent adjusted gross income (AGI) limitation on miscellaneous itemized deductions required that your miscellaneous itemized deductions be more significant than 2 percent of your AGI.
• The 3 percent Pease limitation could reduce your total itemized deductions after a specific income level.
• Suppose your income and deductions were too high. In that case, the alternative minimum tax (AMT) could apply, resulting in the loss of all or a portion of your itemized deductions.

As a result of these limitations, many taxpayers mistakenly believed they had gotten a deduction when, in reality, they had either lost the deduction or received a limited benefit.

For many taxpayers, the TCJA’s other changes (such as the new tax rates and brackets) may have compensated for the loss of various itemized deductions.

Investment Interest Expense

If you itemize your deductions, you may qualify for removing investment interest expenses. Investment interest expense represents the interest paid on borrowed funds used to acquire taxable investments. It includes margin loans for stock purchases in a brokerage account. Sometimes, you may be eligible to deduct the margin loan’s interest. It would not be the case if the loan were utilized to purchase tax-favored investments such as municipal bonds.

The amount you can deduct is limited to your annual net taxable investment income. Any remaining interest expenditure is carried over to the following year and may be utilized to lower taxes in the future.

For you to determine your deductible investment interest expenditure, you must know:

• Your total investment income from investments subject to standard taxation
• Your total interest expenses on assets (for loans used to purchase taxable investments)

To calculate your investment interest expense deduction, you must first establish your net investment income. It often includes conventional dividends and interest income. Still, it excludes investment income taxed at the lower capital gains tax rates, such as qualified dividends and tax-exempt municipal bond interest.

Now, compare your net investment income to your investment interest expenses. You can deduct the full investment interest charge if your expenses are less than your net investment income. If interest expenses exceed net investment income, you may deduct interest expenses up to the amount of net investment income. The remaining expenses are carried forward to the following year.

For instance, Mary has a total income of $150,000, $8,000 in investment income (from ordinary dividends and interest), $10,500 in investment interest charges from a margin loan, and $13,000 in additional itemized deductions (such as mortgage interest and state taxes).

Eligible Dividends

Preferentially taxed qualified dividends are not considered investment income for purposes of the investment interest cost deduction. However, you have the option to classify eligible dividends as ordinary income.

In the right circumstances, treating qualified dividends as ordinary dividends might enhance your investment interest. Cost deduction allows you to pay 0% tax on the profits rather than the 15% or 20% tax that qualified dividends ordinarily receive. Here is an illustration of how it could function.

In addition to the facts presented in the first example, suppose Mary has $2,000 in qualified dividends on which she would typically pay $300 in tax ($2,000 multiplied by the 15% tax rate). If Mary chose to treat eligible dividends as ordinary income, her net investment income would increase from $8,000 to $10,000. As a result, she could deduct a greater portion of her investment interest expense in the current year. And she would not be required to pay tax on the qualifying dividends.

Summary

Investment management fees can be tax deductible if they meet the criteria set out in the Income Tax Act. The fees must be paid on investments that are held in taxable accounts. Fees paid in registered accounts are not tax-deductible but can be laid inside or outside these accounts. Whether embedded in a product (like an MER) or tax-deductible for the investor, investment fees reduce the taxable income from those investments. The distinction is that an MER lowers the fund’s taxable revenue. In contrast, an investment counsel fee reduces the investor’s taxable income.

Frequently Asked Questions About Can I Deduct Investment Management Fees