My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, December 11, 2017

The “Hole” in Whole Life Insurance

One issue that confounds most accountants and their clients alike is life insurance. The products can be complex and you are always concerned whether you are being sold something you don't need or something more than you need.

Today and next week, I have guest posts by Doug Leyland and Jordan Matters two Chartered Professional Accountants who deal full-time in insurance solutions for Leyland Insurance Solutions Inc. I am hoping you find their posts help demystify term life insurance and permanent insurance (whole life and universal life insurance) for you, or at least clarify what you should be looking for in an "investment" insurance policy for you personally or your corporation. I thank Doug and Jordan for their efforts.

Please keep in mind that these two posts are Doug and Jordan's beliefs and there are insurance advisors and accountants who may not necessarily agree with their opinions.

The “Hole” in Whole Life Insurance

By Doug Leyland and Jordan Matters

What is your opinion on life insurance? Chances are it is good, bad, or ugly with no middle ground. Is this opinion based on personal experience or what you have heard from friends and colleagues? There is a vast array of life insurance strategies and products available and this can make the landscape appear to be somewhat complex. Some people base their opinions on a limited understanding of the various applications and benefits that life insurance can offer, especially for business owners. The goal of this post is to provide insight on this and simplify things for you.

The need for insurance and the related tax-free proceeds a policy can provide arises from the undesirable economic consequences of either a premature death or an estate liquidity need (i.e. your estate needs to sell real estate in a down market to raise funds to pay income tax for the estate of the deceased person).

Typically, a term insurance policy is used to cover a premature death, while an estate need is most often satisfied by permanent insurance, either Participating Whole Life ("Par") or Universal Life ("UL"). All types of life insurance are simply a promise to pay by a third party in the event of death.

In the next couple paragraphs we will provide some background on these various insurance options.

Term Life Insurance


Term coverage represents insurance in its most traditional and simple form – transferring risks that are too high for you to accept to an insurance company in exchange for a fee.

If the insured does not die during the term, there is no residual benefit other than the ability to convert the contract to either Par or UL without a medical or to renew the term coverage at contractually specified amounts. In many cases, these polices are left to lapse and are not renewed in any form.

Let us ask you this simple question. What might the financial implications be if you were to die prematurely?

This question leads to a needs analysis that considers the following important issues:
  • How do you replace the decline in a business’ value (Goodwill or Key Person insurance)?
  • How do you ensure there are funds available to buy out the shares of a deceased business partner?
  • Do you wish to have insurance to pay off a mortgage or other debts?
  • Do you wish to ensure there is funding for your children/grandchildren education?
  • Do you want to replace your lost income and provide spousal support, if applicable, to avoid having your spouse needing to find employment?
If your objectives are listed above, a term life insurance policy is likely the most appropriate for you.

Permanent Life Insurance


There are significant differences between Par and UL contracts. Understanding the differences is essential because they will have a profound impact on the premiums required to fund the contracts and the likelihood that your estate financial objectives will be achieved. The key take away here is to understand which party to an insurance contract assumes the investment risk of turning premium dollars into a paid promise.

With a Par policy, the risk is shared by the policy owner and insurance company (this represents the “hole” in whole life). With certain forms of UL, the risk falls entirely to the insurance company (i.e. minimum funded Level Cost of Insurance (COI) and Limited Pay UL contracts).

Where the goal is to fund an estimated estate liquidity need, in our opinion, this risk should be third partied entirely via a minimum funded UL contract.

Once again, please consider the following question. What are the liquidity implications for my estate or spouses estate, when I, and/or my spouse, die near life expectancy?

This question about your liquidity requirements causes you to consider some of the common estate needs detailed below:

1. How do I fund capital gains taxes?
2. How do I ensure Estate Equalization (For example, when some heirs are in the business while others are not)?
3. How can I use insurance to assist with my succession planning (Transfer assets to the next generation tax free)?

Other economically beneficial strategies using permanent life insurance include:

1. Life Insurance as an Investment – Estate Anchor & Maximization
2. Charitable Giving
3. Retirement Income

Now that we have explored some of  the various needs for insurance, next week in Part 2 we will discuss some of the appropriate strategies.

Doug Leyland CPA, CA, MBA & Jordan Matters CPA, CA work together at Leyland Insurance Solutions Inc. in Burlington, Ontario. They assist their clients with insurance based tax and estate planning strategies. If you would like to get in touch with Doug or Jordan, their emails are dleyland@leylandinsurance.com and jmatters@leylandinsurance.com or you can call them at 905-331-2885.

The above blog post is for general information purposes only and does not constitute legal, insurance or estate planning or other professional advice of any kind. Readers are advised to seek specific legal, insurance or estate planning advice regarding any specific issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, December 4, 2017

Let Me Tell You! Marriage Tips From a 30 Year Expert

As I noted in October, I am planning to write occasional blog posts under the title “Let Me Tell You” that delve into topics that may a bit more philosophical or life lessons as opposed to the usual tax and financial fare. Today I share some great marriage tips from a friend.

This summer my buddies and I hosted a dinner at my house to celebrate the engagement of our friend's daughter. We had a great time and some of us gave toasts to the future couple. One of my friends, Monty Warsh, a well-known leasing lawyer for Aird & Berlis, came equipped with multiple que cards for his toast (hey he is a lawyer after-all).

Monty who has been married 31 years to his lovely bride, presented a David Letterman like top ten tips to keep your marriage strong. I was not expecting much (sorry Mont) but was so impressed with his list that I asked for a copy to post on my blog.

Top Ten Tips for a Successful Marriage


Without further ado, here are Monty's top ten tips for a happy and enduring marriage:

10) Maintain Your Independence - Don’t give up who you were and some of the activities and pursuits you had before marriage. Continue to pursue those hobbies and friendships that make you happy.

9) Compromise - You are not always right and neither is your spouse. Find a middle ground that both of you can live with.

 8) Do Not Cross Enemy Lines - Do not make a practice of confronting the in-laws with issues, but rather go through your spouse to communicate the message. Blood relatives are more easily forgiven.

7) The Unexpected Celebration - Celebrating birthdays, anniversaries and Valentines day is nice, but very commercial. Bring home flowers or gifts on non-holidays and for no special occasion.

6) Vacation - Put some money away for a holiday or there will always be somewhere else to deploy your money. It is important to get away and relax and re-energize.

5) Sense of Humor - Laughing releases the tension…..and we all like to be around happy positive people and laughing is contagious.


4) Don’t go to Bed Angry - Things can fester and blow out of proportion if you do.

3) Communication - No one is a mind reader….let your other half know what you are thinking. Don’t be afraid to show vulnerability if it means being transparent.

2) Date Night - Preserve the passion and avoid the trap of slipping into regular and sometimes boring routines.

1) Yes Dear - Guys, sometimes you just have to do it.

There you have it, 30 years of wisdom and common sense. As someone who just celebrated his 30th anniversary, I think Monty has provided some great advice and marriage tips.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, November 27, 2017

The Results Are In From The Financial Survey!


Earlier this year, I wrote about a survey BDO Canada LLP was conducting to assess the impact of financial and wealth trends. Many of you took part in this study – thank you very much for your tremendous participation and input. Some of you received a free copy of my book Let’s Get Blunt About Your Financial Affairs for participating. I hope you enjoyed the book and found some useful financial tidbits.

The survey results are now in and they provide exactly the type of perspective I had hoped to glean. Almost 1000 Canadians contributed to provide a trove of valuable insights on how we deal with family, finances and retirement planning. Very interestingly, a significant number of the survey respondents were small business owners. As such, BDO decided to create two reports:
  • one for small business owners, which was just released on November 21st titled "From Plan to Retirement: How Business Owners Manage Their Wealth, Lives and Legacies
  • a second report, for non-business owners which will be released in early 2018.
The current report, which is very timely given the recent Liberal tax proposals for private business owners, focuses on the challenges they face in managing their wealth. If you are a business owner, I suggest you download the report which can be found here.

While this report centers on business owners, it delivers some great tips and strategies for all Canadians. Jonathan Townsend, the National Wealth Advisory Services leader for BDO Canada LLP provides a synopsis of the report in his guest post below. 

From Plan to Retirement: How Business Owners Manage Their Wealth, Lives and Legacies  By Jonathan Townsend


Business owners occupy a unique space in Canadian society. On the one hand, they share concerns with most hard-working Canadians who receive a paycheque from their employer. They strive to get ahead. They balance current-day spending with future financial needs. They worry about their family. Sometimes they worry about their health.

But business owners are also a tribe to themselves, lacking workplace standards like employer-sponsored pension plans and paid vacation allotments. The entrepreneurial tendencies that initially called them to business ownership only deepen when faced with the reality of “eating what they kill.” As their business moves through the business life cycle, their independent experience affects all aspects of their lives.

This is where this new report by BDO Canada excels: in contrasting business owners with non-business owners. Using survey results provided by almost 1000 Canadians of both groups, the report analyzes key points along the retirement/wealth management journey for business owners, from speed bumps to roadblocks to open roads under clear skies.

Among the key findings from our study:

  • Preparedness - Business owners plan more for retirement than non-business owners but feel less on track
  • Work in retirement - Almost one-third of business owners plan to work part-time after retirement — compared to 12 percent of the general population
  • On succession - More than one in three business owners in our study plans to retire in the next five years. Without the right succession planning, these businesses are at risk of adversely affecting the owners, their families, employees and the wider Canadian economy
  • On family - Financial support for children was more common among the business owners we surveyed than among non-business owners
These results — and strategies highlighted in the report — provide takeaways to fold into your own successful planning. I invite you to download the report here.

Jonathan Townsend is the National Wealth Advisory Leader at BDO Canada LLP. If you have any questions, please contact him at 519-432-5534 or jtownsend@bdo.ca

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the material is time sensitive and subject to changes in legislation or law.

Monday, November 20, 2017

Tax Loss Selling - 2017 Version

In keeping with my annual tradition, I am today posting a blog on tax loss selling. I am doing it again because the topic is very timely and every year around this time, people get busy with holiday shopping and forget to sell the “dogs” in their portfolio and as a consequence, they pay unnecessary income tax on their capital gains in April.

Additionally, while most investment advisors are pretty good at contacting their clients to discuss possible tax loss selling, I am still amazed each year at how many advisors do not discuss the issue with their clients. So, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options (if you must initiate the contact, consider that a huge black mark against your advisor).

For full disclosure, there is very little that is new in this post from last year's version. Similar to last year, when there were rumours that the 2017 Federal budget may change the inclusion rate on capital gains from 1/2 to 3/4, I know some people are considering taking gains as they have seen where the Liberal government is going with taxation policies and they feel it is just a matter of time until the capital gains inclusion rate is changed. I have no knowledge of whether such a change is on the table, however, it would not surprise me at this point, although, to be honest, nothing taxation wise from this government would surprise me. It is also interesting to note the change as to how the settlement date for stock trades is determined, see the second last paragraph of this post for the details.

Many people persist in waiting until the third week of December to trigger their capital losses to use against their current or prior years capital gains. To avoid this predicament, you may wish to set aside some time this weekend or next, to review your 2017 capital gain/loss situation in a calm methodical manner. You can then execute your trades on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling. As the markets have been surprisingly strong (at least to me) this year, hopefully you don't have very many stocks with unrealized capital losses you can sell to use the losses against capital gains you have realized in 2017 or that you can carryback to one of the last 3 years.

I would like to provide one caution in respect of tax loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes, with the intention of re-purchasing those stocks and one or two of the stocks take off during the 30 day wait period and the cost to repurchase is far in excess of their tax savings. Thus, you should first and foremost consider selling your "dog stocks" that you and/or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock.

This blog post will take you through each step of the tax-loss selling process.

Reporting Capital Gains and Capital Losses – The Basics


All capital gain and capital loss transactions for 2017 will have to be reported on Schedule 3 of your 2017 personal income tax return. You then subtract the total capital gains from the total capital losses and multiply the net capital gain/loss by ½. That amount becomes your taxable capital gain or net capital loss for the year. If you have a taxable capital gain, the amount is carried forward to the tax return jacket on Line 127. For example, if you have a capital gain of $120 and a capital loss of $30 in the year, ½ of the net amount of $90 would be taxable and $45 would be carried forward to Line 127. The taxable capital gains are then subject to income tax at your marginal income tax rate.

Capital Losses


If you have a net capital loss in the current year, the loss cannot be deducted against other sources of income (unless you are filing for a deceased person. In that case, get professional advice as the rules are different. I will post on this issue in 2018). However, the net capital loss may be carried back to offset any taxable capital gains incurred in any of the 3 preceding years, or, if you did not have any gains in the 3 prior years, the net capital loss becomes an amount that can be carried forward indefinitely to utilize against any future taxable capital gains.

Planning Preparation


I suggest you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2016 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information is also easily accessed online if you have registered with the CRA My Account Program.

2. If you do not have capital losses to carryforward, retrieve your 2014, 2015 and 2016 income tax returns to determine if you have taxable capital gains upon which you can carryback a current year capital loss. On an Excel spreadsheet or multi-column paper, note any taxable capital gains you reported in 2014, 2015 and 2016.

3. For each of 2014-2016, review your returns to determine if you applied a net capital loss from a prior year on line 253 of your tax return. If yes, reduce the taxable capital gain on your excel spreadsheet by the loss applied.

4. Finally, if you had net capital losses in 2015 or 2016, review whether you carried back those losses to 2014 or 2015 on form T1A of your tax return. If you carried back a loss to either 2014 or 2015, reduce the gain on your spreadsheet by the loss carried back.

5. If after adjusting your taxable gains by the net capital losses under steps #3 and #4 you still have a positive balance remaining for any of the years from 2014 to 2016, you can potentially generate an income tax refund by carrying back a net capital loss from 2017 to any or all of 2014, 2015 or 2016.

6. If you have an investment advisor, call your advisor and request a realized capital gain/loss summary from January 1st to date to determine if you are in a net gain or loss position. If you trade yourself, ensure you update your capital gain/loss schedule (or Excel spreadsheet, whatever you use) for the year.

Now that you have all the information you need, it is time to be strategic about how to use your losses.

Basic Use of Losses


For discussion purposes, let’s assume the following:

· 2017: realized capital loss of $30,000

· 2016: taxable capital gain of $15,000

· 2015: taxable capital gain of $5,000

· 2014: taxable capital gain of $7,000

Based on the above, you will be able to carry back your $15,000 net capital loss ($30,000 x ½) from 2017 against the $7,000 and $5,000 taxable capital gains in 2014 and 2015, respectively, and apply the remaining $3,000 against your 2016 taxable capital gain. As you will not have absorbed $12,000 ($15,000 of original gain less the $3,000 net capital loss carry back) of your 2016 taxable capital gains, you may want to consider whether you want to sell any “dogs” in your portfolio so that you can carry back the additional 2017 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2016. Alternatively, if you have capital gains in 2017, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

Identical Shares


Many people buy the same company's shares (say Bell Canada) in different accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their accounts, but ignore the shares they own of Bell Canada in another account. However, be aware, you have to calculate your adjusted cost base on all the identical shares you own in say Bell Canada and average the total cost of all your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell are higher in one of your accounts, you cannot pick and choose to realize a loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares, not the higher cost base shares.

Creating Gains when you have Unutilized Losses


Where you have a large capital loss carryforward from prior years and it is unlikely that the losses will be utilized either due to the quantum of the loss or because you are out of the stock market and don’t anticipate any future capital gains of any kind (such as the sale of real estate), it may make sense for you to purchase a flow-through limited partnership (be aware; although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks and you must discuss any purchase with your investment advisor). 

Purchasing a flow-through limited partnership will provide you with a write off against regular income pretty much equal to the cost of the unit; and any future capital gain can be reduced or eliminated by your capital loss carryforward. For example, if you have a net capital loss carry forward of $75,000 and you purchase a flow-through investment in 2017 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2017 and 2018, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $10,700 in taxes. When you sell the unit, a capital gain will arise. This is because the $20,000 income tax deduction reduces your adjusted cost base from $20,000 to nil (there may be other adjustments to the cost base). Assuming you sell the unit in 2019 for $18,000 you will have a capital gain of $18,000 (subject to any other adjustments) and the entire $18,000 gain will be eliminated by your capital loss carry forward. Thus, in this example, you would have total after-tax proceeds of $28,700 ($18,000 +$10,700 in tax savings) on a $20,000 investment.

Donation of Flow-Through Shares


Prior to March 22, 2011, you could donate your publicly listed flow-through shares to charity and obtain a donation receipt for the fair market value ("FMV") of the shares. In addition, the capital gain you incurred [FMV less your ACB (ACB is typically nil or very low after claiming flow-through deductions)] would be exempted from income tax. However, for any flow-through agreement entered into after March 21, 2011, the tax benefit relating to the capital gain is eliminated or reduced. Simply put (the rules are more complicated, especially for limited partnership units converted to mutual funds and an advisor should be consulted), if you paid $25,000 for your flow-through shares, only the gain in excess of $25,000 will now be exempt and the first $25,000 will be taxable.

So if you are donating flow-through shares to charity this year, ensure you speak to your accountant as the rules can be complex and you may create an unwanted capital gain.

Superficial Losses


One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchase an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and added to the cost base of the new shares acquired.

Disappearing Dividend Income


Every year I ask at least one or two clients why their dividend income is lower on their personal tax return. Typically the answer is, "oops, it is lower because I sold a stock early in the year that I forgot to tell you about". Thus, if you manage you own investments; you may wish to review your dividend income being paid each month or quarter with that of last years to see if it is lower. If the dividend income is lower because you have sold a stock, confirm you have picked up that capital gain in your calculations.

Creating Capital Losses-Transferring Losses to a Spouse Who Has Gains


In certain cases you can use certain provisions of the Income Tax Act to transfer losses to your spouse. As these provisions are complicated and subject to missteps, you need to engage professional tax advice.

Settlement Date


It is my understanding that the settlement date for Canadian stock markets in 2017 will be December 27th, as the settlement date has changed from the old trade date +3 days, to the trade date plus 2 days (U.S. exchanges may be different). Please confirm this date with your broker, but assuming this date is correct, you must sell any stock you want to crystallize the gain or loss in 2017 by December 27, 2017.

Summary


As discussed above, there are a multitude of factors to consider when tax-loss selling. It would therefore be prudent to start planning now, so that you can consider all your options rather than frantically selling via your mobile device while waiting in line with your kids to see Santa the third week of December.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, November 13, 2017

Public Retirement Systems - Part 2

This is the second blog post in a series on public retirement systems. The first post, compared CPP/OAS in Canada to Social Security in the United States.Today's post discusses the
Totalization Agreement between Canada and the U.S. which affects Canadians and Americans that have worked in both countries over their working lives.

For many Canadians, contributing to CPP throughout their working lives doesn’t require much thought. It just happens with the understanding that when retirement comes they will be able to collect the money that they put in. However, for those Canadians that spent a portion of their working lives in the United States or vice versa, the proverbial waters become a little muddy.  Questions often arise concerning whether the worker must pay social security taxes in two countries while they work as well as which country’s benefits (or both) they are entitled to when retirement comes around.  The answers to these questions and more can be found in the Totalization Agreement between Canada and the U.S.

What is a Totalization Agreement?


The Totalization Agreement came into effect on August 1, 1984 with the purpose to integrate social security protection for individuals who have worked in both countries over the course of their lives.  Without the agreement, some workers would not be eligible under the respective countries’ requirements to collect retirement, disability or survivor benefits despite having made contributions to the plan.  The agreement also helps prevent people from having to pay social security taxes to both countries on the same earnings, which is commonly referred to as “double taxation”.

Preventing Double Taxation for Employees on Temporary Assignments


Let’s take the example of an employee who works for a Canadian company whose Canadian employer requires them to temporarily to work on a project in the U.S.  The employee is now subject to the U.S. taxation system, and both the employee and employer are subject to U.S. FICA taxes (Social Security and Medicare). This is a fairly expensive detriment as you recall from Part 1, since the U.S. FICA contribution requirements are much higher than CPP.  In addition, the employee would still be required to make CPP contributions, and hence would be subject to double taxation.

The Totalization Agreement can provide relief from this double taxation dilemma.  As this is a temporary assignment, the employee can seek exemption from the FICA taxes provided that the assignment is five years or less.  The employee will then only be required to make CPP contributions while they work abroad in the U.S.  However, this exemption is not automatic.  A request for a Certificate of Coverage must be completed and sent to the CPP/EI rulings Division of the Canada Revenue Agency in order to claim the exemption.

It’s important to note that this exemption is not available when a Canadian moves to the U.S. to work for a U.S. employer, even if it is temporary.  In this case, the employee and the employer would contribute to FICA, but would not be required to contribute to CPP on those same earnings.  It is possible in this situation that the Canadian would have now contributed to both Canadian and U.S. social security programs during their working life.  This leads us to our next section on how one navigates entitlement to claim their benefits when they have contributed to social security programs in both Canada and the U.S.

Using the Totalization Agreement to Qualify for Benefits


In Part I, I discussed eligibility for U.S. Social Security where one had to have 40 credits, or 10 full years of work, in order to qualify for U.S. social security.  An employee who has spent time working for employers in Canada and the U.S. may find that although they made contributions to U.S. Social Security, they lack the requisite 40 credits to be eligible to claim benefits.  The Totalization Agreement assists in this regard by allowing the employee to “totalize” the partial eligibility rights accumulated in both countries so that the employee can use their years of CPP contributions in Canada to count toward the 10 year eligibility requirement for U.S. Social Security.  Qualifying for CPP would typically not require the use of the Totalization Agreement, as the eligibility threshold for CPP is much lower than the U.S. where only one contribution is needed to qualify for CPP benefits.

Conversely, for an American who moved to Canada but lacks the Canadian residency requirements to qualify for OAS, the Totalization Agreement requires Canada to consider U.S. Social Security credits earned when determining if OAS residence requirements are met.

Windfall Elimination Provision


In some cases, the employee may have contributed sufficiently to U.S. social security and CPP and therefore qualifies for both pensions without requiring the assistance of the Totalization Agreement.  In this case, U.S. Social Security benefits may be subject to reduction due to the Windfall Elimination Provision (WEP).  The calculation of Social Security benefits generally favours low income workers.  So this provision promotes fairness by providing a reduction to the benefits in the case of someone who earned a high income but was not subject to Social Security taxes on much of it, which may be the case of a Canadian who also worked in Canada and contributed to CPP during their lifetime.  If the employee earned more than 120 credits (representing thirty full years), then the WEP is not applied.

Taxation of Social Security Benefits


When a Canadian receives U.S. Social Security benefits or an American receives CPP and OAS, the tax treaty between Canada and the U.S. provides guidance on what country retains the right to tax the benefits.  While the initial reaction may be to assume the benefits are taxed in the country to which the benefit came from, the treaty actually provides that benefits received under social security legislation are taxable in the country to which the individual is resident.  This means that a Canadian resident earning U.S. Social Security only pays tax on that benefit in Canada and an American resident receiving CPP and/or OAS only pays tax on that benefit in the U.S.  For a Canadian resident, the treaty furthermore provides that only 85% of the U.S. Social Security benefit is taxable in Canada. For some, only 50% of the income is taxable in Canada if Social Security benefits have been continuously received by the pensioner since prior to 1996.  For an American resident, no more than 85% of the U.S. Social Security benefit is taxable under U.S. domestic law, and the treaty provides that CPP and OAS should be treated as if it were a benefit under the U.S. Social Security Act, therefore being subject to the same inclusion rate of taxation as the U.S. Social Security benefit.

I would like to thank Alyssa Tawadros, Senior Manager, U.S. Tax for BDO Canada LLP for her very extensive assistance in writing this post. If you wish to engage Alyssa for individual U.S. tax planning, she can be reached at atawadros@bdo.ca.


This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, October 30, 2017

Tax Efficient Investing - Part 2

Two weeks ago I discussed tax efficient investing within a TFSA. Today I conclude this discussion with a review of tax-efficient investing options within non-registered accounts, TFSAs and RESPS.

Non-registered Account


To ensure we are on the same wavelength, when I say non-registered, I am talking about taxable investment accounts you hold, excluding RRSPs, RESPs and TFSAs.

I don’t want to be repetitive, so I will not again list the non-tax considerations one must account for before determining the most tax efficient use of this account (see these considerations in the TFSA discussion from the first post). However, one specific consideration applicable to non-registered accounts is your capital loss carryforward balance. If you have capital loss carryforwards, you will want to use these losses against future capital gains and have a definite bias towards holding equities that will produce capital gains.

For non-registered accounts, since they are taxable at your marginal rate, you will typically want to hold investments that are subject to the lowest tax rates.

1. Equities – since capital gains are subject to a 50% inclusion, you typically will prefer to hold your equities in your non-registered account, as they result in the lowest tax cost, say 26% or so at the highest marginal rate, as opposed to say interest instruments that would result in a 53% tax cost.

2. Canadian Dividends – since you receive a dividend tax credit for both eligible and non-eligible dividends, you will have a tax preference to use the dividend tax credits in your non-registered account or you lose the credit. Eligible dividends which come typically from public corporations are preferable to non-eligible dividends.

3. REIT – since you receive tax-free distributions of ROC and this ROC reduces your ACB resulting in larger capital gains, you may wish to hold a REITs or ROC type investment in a non-registered account. You will consider this if you are willing to deal with tracking the ACB (see the first post) and the REIT is not allocating significant other income that is subject to the high marginal rates. Note, if the ROC is not large or declining, you will likely not want to hold REITs in your non-registered account and may wish to hold them in your TFSA in any event to avoid the "tracking hassle".

RRSP


For registered accounts, since the income is earned tax-free before you start withdrawing from your RRSP/RRIF, you will typically want to hold investments that have the highest tax rates attached to them. In general you will not want to hold high growth equity, since even though large gains will be deferred and can compound tax-free within the RRSP, when you withdraw the funds, the 26% capital gain rate essentially becomes 53% if you withdraw money from your RRSP/RRIF at the high rate of tax. Thus you will have effectively lost the 50% tax savings associated with a capital gain (although you will have deferred the tax possibly many years).

1. U.S. Stocks that Pay Dividends – there is no foreign withholding tax on U.S. dividends paid to an RRSP, so an RRSP is very tax effective for such dividends. US dividends received by a non-registered account are taxed as regular income (as noted in the first post on this topic, US dividends in a TFSA are subject to the tax withholding with no tax credit benefit). Keep in mind, this tax treatment is specific to U.S. stocks and does not necessarily apply to other countries.

2. Fixed Income – because these investments are fully taxable, the tax savings are maximized in an RRSP. Conceptually, using fixed income prevents your RRSP from growing larger, since you do not have as large an equity component. However, in a balanced overall portfolio, you will likely have held that part of your equity component in lower taxing non-registered or TFSA accounts, so overall your total retirement pie should be somewhat equivalent.

Thus, when you start making RRSP withdrawals for your retirement, you will likely have a more effective taxable mix coming from smaller RRSP balance (that may be taxable at your highest marginal rate) with a mix of retirement funds that grew more tax effectively in your TFSA (that can be withdrawn tax free) and/or non-registered account, that may result in a lower overall tax cost at retirement.

RESP


These accounts have a singular purpose -- funding your children’s education. Thus, many experts suggest these accounts should have a more conservative bent. However, if you start the account for your child or children, at a very early age, you will be able to invest through one or two investment cycles and a well balance diversified portfolio may make sense, but speak to your investment advisor for their input.

As I stated at the outset of this series, tax and investment decisions should not be made in isolation, and tax efficiency must be considered in context of portfolio risk management and asset allocation. Once you have considered these issues, then the tax efficiencies above should be considered.

The above in not intended to provide investment advice. Please speak to your investment advisor.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, October 23, 2017

Tax Planning Using Private Corporations - The Liberal’s go with Piecemeal Announcements


I have pushed back my second post on tax efficient investing to next week so I can comment on the Traveling Libburys tax damage control tour (instead of Dylan, Petty, Lynne, Harrison and Orbison, we got Justin Trudeau, Bill Morneau and Bardish Chagger).

The tour this week made stops in Stouffville Ontario, Hampton New Brunswick, Montreal Quebec and Erinsville, Ontario. At each location, the government provided a new tax morsel and comment on its tax proposals. However, without any details, many people are still not quite sure what the proposals really say or look like. A friend told me this is like a Trump tweet; do you take them at face value or is there more to them?

This is what we were told last week by the Prime Minister and Finance Minister in respect of the taxation of private corporations.

Income Splitting


The government announced the following in respect of the income splitting proposals:
  • It has committed to lower the small business tax rate to 10 per cent, effective January 1, 2018, and to 9 per cent, effective January 1, 2019. To be clear, this reduction is a drop from the current 10.5% rate and the provincial tax still needs to be added on. So for example in Ontario, the rate will drop to 14.5% from 15% for 2018.
  • The proposals to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members who do not contribute to the business will remain.
  • It will simplify the proposed measures with the aim of providing greater certainty for family members who contribute to a family business. Specifically, "the Government will work to reduce the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions, better target the proposed rules, and address double taxation concerns". I would suggest this will be much easier said than done and I would expect this determination to be fraught with issues.
  • It will not be moving forward with proposed measures to limit access to the Lifetime Capital Gains Exemption. I would not be surprised to see specific exclusions in the 2018 budget to this rule, such as excluding the exemption for those under 18.

Passive Income Proposals


This proposal was probably the most contentious issue to most small business owners who felt the initial proposal would impact their retirement planning and ability to fund the ups and downs of a business. The government gave a little here, but given the potential massive complexity of tracking passive income and the fact they say only 3% of the businesses will be caught by the rules, this is the one area I feel they should have left the status quo. Not one tax professional I spoke to understood how this is really going to work and could see any type of legislation that will not cause massive complexity and extra accounting costs to small businesses.

Here is what the government said:
  • The new rules will not apply to existing savings and income from those savings (thus some kind of tracking mechanism will have to be put in place. I see this as an accounting and tax nightmare, how do you track amounts contributed from this pot of funds back into the business and then taken back out, let alone track the income earned from the existing pot of funds. Are the original funds referenced going to be current investments only, at cost or fair market value, will they include cash in the business or is the initial savings the current retained earnings)?
  • The existing rules will apply on investment income earned from new savings up to a maximum of $50,000 of passive income in a year (equivalent to $1 million in savings, based on a nominal 5% rate of return). To the extent investment income from new investments exceeds $50,000 in a year, the new punitive tax rates will apply. The wording here is very simplistic and has been interpreted differently already by many commentators. The devil will be in the details.
  • Incentives are in place so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation.

Capital Gain Stripping


Finally, the government announced these proposals will not move ahead. This is a head-scratcher. As  I noted in my last blog post on this topic, many would argue some of the tactics used here while legal, were aggressive. The issue in relation to capital gains stripping was the proposals were causing business transition issues and double taxation on death by not being able to use a "pipeline" planning technique to prevent double tax.

This is what the government said:
  • They will not be moving forward with measures relating to the conversion of income into capital gains. "During the consultation period, the Government heard from business owners, including many farmers and fishers that the measures could result in several unintended consequences, such as in respect of taxation upon death and potential challenges with intergenerational transfers of businesses. The Government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation".

The National Post reported (sorry link has disappeared) that Mr. Morneau said “What I’m announcing this morning is we’re going to take a step back and reconsider that aspect of our tax reform proposal,” and "the government will instead embark on a year of consultations aimed at developing new proposals".

Thus, I think it fair to say, we may not have heard the end of these rules and the Liberal's will likely move to judiciously carve out the aggressive stripping while ensuring succession and estate planning are not side-swiped.

As noted at the outset, we are lacking clarity. We have no details, legislation, examples or FAQ, let alone confirmation or whether the effective date of these proposals has changed? We still have partial or full tax planning paralysis because of these ad hoc proposals and revisions.

In my humble opinion, the main miss here is the passive rules. The complexity of these rules will be overwhelming for such little tax gain to the government.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.