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 tax partner and the managing partner of Cunningham LLP 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 do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, September 1, 2014

The Best of The Blunt Bean Counter - Is it Morbid or Realistic to Plan for an Inheritance?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today is my last re-post (where did the summer go?) and I selected a post on whether it is morbid or realistic to plan for an inheritance. I selected this post because it seems to polarize people. They either think it abhorrent to consider planning for an inheritance or don't understand why it is not practical financial planning.

I recently followed this post up with Inheriting Money - Are you a Loving Child, a Waiter or Hoverer, a post that discusses four types of behaviour by those who will inherit money.


Is it Morbid or Realistic to Plan for an Inheritance?


I have written several blog posts on estate planning and inheritances, including “Taking it to the Grave,” a blog I wrote for the Canadian Capitalist, in which I discuss whether parents should distribute future inheritances in part or in whole while they are alive and “How your Family Dynamic can affect your Estate Planning”  in which I discuss how parents have to navigate a minefield of family issues with respect to the determination of executors, the distribution of family heirlooms and the distribution of hard assets.

These blogs elicited a wide range of opinions and comments that I found fascinating. Some people believe they are better off because their parents made them work for everything and they don’t want any financial assistance from their parents either during their life or after they pass away. Others state that as long as parents are careful to ensure they don’t destroy their children’s motivation, partial inheritances make sense. Finally, others say they have been sickened as they observe children waiting at a parent’s deathbed salivating at the thought of their inheritance.

All this leads me to another very touchy subject; should a child (let’s assume the child is at least 40 years old) plan their own future based on a known or presumed inheritance? To add some perspective to this issue, it is interesting to note that a recent survey by the Investors Group states that 53% of Canadians are expecting an inheritance, with over 57% of those, expecting an inheritance greater than $100,000.

Inheritances can be categorized as either known or presumed inheritances. An inheritance would be categorized as known, when a parent(s) has/have discussed the contents of their will with their child(ren) or at least made known their intentions. In these cases, while the certainty of the inheritance in known, the quantum is subject to the vagaries of the parent(s) health, the parent(s) lifestyle, the income taxes due on the death of the last to survive parent and the economic conditions of the day. (Speaking of discussing the will with your children, it is very interesting to note that my blog post One Big Happy Family until we discuss the Will which had limited initial traction, is now by far and away the most read blog I have ever written).

An inheritance may be presumed where the financial circumstances of the family are obvious. A child cannot help but observe that the house their parents purchased 30 or 40 years ago for $25,000 is now worth $800,000 to $1,000,000, or that the cottage their family bought for $100,000 many years ago can be subdivided and is now worth $700,000.
Many average Canadian families have amassed significant net worth just by virtue of the gains on their real estate purchases. These families would not be considered wealthy based on lifestyle or income level, yet their legacy can have a significant impact upon their children. Inheritances are not only an issue for wealthy families.

I think most people will agree that where an inheritance will be so substantial that it will be life changing; parents need to downplay the inheritance issue and/or manage the inheritance by providing partial gifts during their lifetime. Rarely can a child become aware of a life-changing inheritance without losing motivation and experiencing a change in their philosophical outlook on life.

Although life changing inheritances are rare, life "affecting" inheritances are not. So, should children change how they live and how they plan for the future based on a known or presumed future inheritance? In my opinion, if the inheritance is known and will be substantial enough to alter a child’s current or future living standard, the answer is a lukewarm yes, subject to the various caveats I discuss below.

I think it is imprudent to ignore reality and where an inheritance has the attributes I note above, it should be considered as part of your future financial plan. However, I would discount the amount used for planning purposes significantly, to account for inherent risks. Those risks include the longevity of a parent, economic downturns that reduce your parent(s) yearly income stream,  potential medical costs and finally, the ultimate risk one takes in planning for an inheritance; the risk of somehow falling out of favour and being removed from your parent(s) will.

Where there is a presumed inheritance, I would suggest you need to be ultra conservative if you want to plan for the inheritance, since not only are you guessing at the inheritance amount, but you face an additional risk that your parent(s) may have offsetting liabilities such as a mortgage or line of credit of which you are unaware.

So what do the experts have to say on this matter? In the press release for the Investors Group survey, Christine Van Cauwenberghe, Director, Tax and Estate Planning, says that "Knowing the dollars and cents behind your inheritance can have an impact on your financial plans. It is smart to know what you can expect so you can plan accordingly and family dialogue is a good place to start."

Ted Rechtshaffen, a certified financial planner at Tri-Delta Financial, in a National Post article I discuss below, says "he may be in the minority but he encourages clients to count on their inheritances when planning to some degree." He however, goes on to say he tells clients to be super-conservative. Finally, he concludes with "I know it goes against the grain because you are counting on money you don't have", adding, "it depends where your parents are in their life cycle and how clearly they have signalled their intentions".

I think Christine and Ted's comments clearly point out the conundrum here, for which there is no black and white answer. It is probably unwise to ignore a known potential inheritance, but because the final inheritance is subject to so many variables, you must risk assess that inheritance and discount its quantum by a significant amount, such that your planning becomes a paradoxical situation.

But what if you see no risk in your parent(s) financial situation deteriorating and you feel you will never be removed from the will, how can your financial planning be affected? For argument’s sake, let’s say your inheritance will be large enough to affect your future planning, but not large enough to affect your motivation or change your lifestyle.

The most obvious change to your financial plan may be to underfund your RRSP. Most Canadians struggle to make yearly RRSP contributions. They live in mortal fear that they will not have enough money to live the retirement they envision. But, if you know your parent(s) have enough funds to live out their life/lives comfortably, and say your inheritance will be in the $300,000 to $500,000 range, do you need to make your maximum RRSP contributions?

Other planning issues include whether you should purchase a home out of your price range or underfund your children’s education fund, knowing that you will receive an inheritance to pay off the mortgage or to pay off any education related loans. Alternatively, you may over fund your child’s education by sending them to a private school you would never had considered without knowledge or presumption of a future inheritance.

How you deal with debt could also be affected. If you have debt, should you just limit it to a manageable level and not concern yourself with paying it down? Or alternatively, should you pay it off because you can reallocate funds once committed to your RRSP, TFSA or RESP, knowing your inheritance will cover your RRSP, TFSA or RESP?

We have all heard about about the huge debt level many Canadians are carrying. Based on comments made by Benjamin Tal, deputy chief economist for the CIBC, one wonders if at least subconsciously some of this debt level in being carried because people know they have an inheritance coming? Mr.Tal in an article in the Toronto Star on Baby boomers set to inherit $1 trillion says "people talk about how much debt there is without looking at the size of the potential assets to come. Debt is relative to your income today, but your wealth tomorrow will improve when an inheritance comes."

So, have I seen people bank on an inheritance? Yes. To date, where I have observed such behaviour, the inheritances have come as expected. However, these cases may not be predictive of future cases.

Is it morbid to plan for an inheritance? Clearly, it is. Would most people rather have their parents instead of the inheritance? Yes. This topic is a very touchy subject and an extremely slippery slope, but to ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical.  However, if your financial planning takes into account a future inheritance, you should ensure you have discounted that amount to cover the various risks and variable that could curtail your inheritance and be extremely conservative in your planning.

Post script:


As the expression goes "Those who hesitate are lost". I started writing this blog back in late November, but could not come to a conclusion (if one can call the lukewarm recommendation I suggest above a conclusion) until recently on whether one should or should not plan for an inheritance. Thus, this blog post just sat. In the interim there have been two excellent articles on this topic. The first by Garry Marr of the Financial Post, titled Windfall no sure thing from which I quote Mr.Rechtshaffen above and another article by Preet Banerjee of the Globe and Mail, titled An inheritance should be a windfall, not a financial plan.

In Preet's article he notes the potential flaws of incorporating an inheritance into your financial plan. He also concludes with some words of wisdom "There are enough variables affecting your own financial success. Ideally, you shouldn’t bank on an inheritance in your financial plan, but rather treat it as an unexpected windfall. Most people would rather give it up in exchange for having their parents back".

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, August 25, 2014

The Best of The Blunt Bean Counter - The Income Tax Implications of Purchasing a Rental Property

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game (or more accurately, my golf game in rain conditions). Today, I am re-posting my most read blog of all-time; a post on the income tax implications of purchasing a rental property. This post has over 300 comments; so many that I have stopped answering questions on this topic. As there are many excellent questions within the 300 comments, I posted a new blog a few months ago highlighting those questions. I called that post, Rental Properties - Everything You Always Wanted to Know, but Were Afraid to Ask.

The Income Tax Implications of Purchasing a Rental Property



Many people have been burned by the stock market over the past decade and find the stock market a confusing and complex place. On the other hand, many people feel that they have a better understanding and feel for real estate and have far more comfort owning real estate; in particular, rental real estate. While both stocks and real estate have their own risks, some proportion of both these types of assets should typically be owned in a properly allocated investment portfolio. In this blog, I will address some of the income tax and business issues associated with purchasing and owing a rental property.

The determination of a property’s location and the issue as to what is a fair price to pay for any rental property is a book unto its own. For purposes of this blog, let’s assume you have resolved these two issues and are about to purchase a rental property. The following are some of the issues you need to consider:

Legal Structure


Your first decision when purchasing a rental property is whether to incorporate a company to acquire the property or to purchase the property in a personal/partnership capacity of some kind. If you are purchasing a one-off property, in most cases, as long as you can cover off any potential legal liability with insurance, there is minimal benefit of using a corporate structure. 

In 2011, in Ontario, there is no tax benefit to purchasing the property in a corporation given the fact that the corporate income tax rate for passive rental income is identical to the highest personal marginal income tax rate, 46%. Given their is no income tax incentive to utilize a corporation, when you include the cost of the professional fees associated with a corporation, in most cases, the use of a corporation does not make sense.

In addition, if the property is purchased in one’s personal capacity, any operating losses can be used to offset other personal income. If the property runs an operating loss and is owned by a corporation, those losses will remain in the corporation and can only be utilized once the rental property incurs a profit.

If you decide to purchase a rental property in your personal capacity, you must then decide whether the legal structure will be sole ownership, a partnership or a joint venture. Many people purchase rental properties with friends or relatives and/or want to have the property held jointly with a spouse. Where it has been determined that the property will be owned with another person, most people fail to give any consideration to signing a partnership or joint venture agreement in regards to the property. This can be a costly oversight if the relationship between the property owners goes astray or there is disagreement between the parties in terms of how the rental property should be run.

One should also note that there are subtle differences between a partnership and a joint venture. This is a complicated legal issue, but for income tax purposes if the property is a partnership, the capital cost allowance (“CCA”) known to many as depreciation, must be claimed at the partnership level. Thus, the partners share in the CCA claim. However, if the property is purchased as a joint venture, each venturer can claim their own CCA, regardless of what the other person has done. This is a subtle, but significant difference.

Allocation of Purchase Price


Once the rental property is purchased, you must allocate the purchase price between land and building. Land is not depreciable for income tax purposes, so you will typically want to allocate the greatest proportion of the purchase price to the building which can be depreciated at 4% (assuming a residential rental property) on a declining basis per year. Most people do not have any hard data to support the allocation (the amount insured or realty tax bill may be useful) so it has become somewhat standard to allocate the purchase price typically 75% -80% to building and 25% - 20% to the land. However, where you have some support for another allocation, you should consider use of that allocation. Typically for condominium purchases, no allocation or, at maximum, an allocation of 10% is assigned to land.

Repairs and Maintenance


If you are purchasing a property and it is not in a condition to rent immediately, typically, those expenses must be capitalized to the cost of the building and depreciation will only commence once the building is available for use. When a building is purchased and is immediately available for rent or has been owned for some time and then requires some work to be done, you must review all significant repairs to determine if they can be considered a betterment to the property or the repairs simply return the property back to its original state. If a repair betters the property, the Canada Revenue Agency’s ("CRA") position set forth in Interpretation Bulletin 128R paragraph 4, is that the repair should be capitalized and not expensed. This is often a bone of contention between taxpayers and the CRA,

CCA


CCA (i.e. depreciation for tax purposes) is a double-edged sword. Where a property generates net income, depreciation can be claimed to the extent of the property’s net income. Generally, you cannot create a rental loss with tax depreciation unless the rental/leasing property is a principal business corporation. The depreciation claim tends to create positive cash flow once the property is fully rented, as the depreciation either eliminates or, at minimum, reduces the income tax owing in any year (depreciation is a non-cash deduction, thereby saving actual cash with no outlay of cash). Many people use the cash flow savings that result from the depreciation claim to aggressively pay down the mortgage on the renal property. The downside to claiming tax depreciation over the years is that upon the sale of the property, all the tax depreciation claimed in prior years is added back into income in the year of sale (assuming the property is sold for an amount greater than the original cost of the rental property). This add-back of prior year’s tax depreciation is known as recapture.

People who have owned a rental property for a long period, sometimes reach a point in time where they have such large recapture tax to pay, they don’t want to sell the rental property. Personally, I do not agree with this position, since it is really a question of what will be your net position upon a sale and are you selling the property at a good price. However, recapture is always an issue to be considered, especially for older properties that have been depreciated for years.

Also, if you have taken tax depreciation on a property and you decide at some point in time to move into the property, you will not be able to defer the gain under the “change of use” rules in the Income Tax Act. I discuss these "change of use" rules in a guest blog "Your principal residence is tax exempt" I wrote for The Retire Happy Blog.

Reasonable Expectation of Profit Test


Previously, if a rental property historically incurred losses for a period of time, the CRA may have challenged the deductibility of these losses on the basis that the taxpayer had no “reasonable expectation of profit”. Fortunately, the CRA's powers with respect to the enforcement of this test have been severely limited. The test has been reviewed by the Supreme Court of Canada and their view is that where the activity lacks any element of personal benefit and where the activity is not a hobby (i.e. it has been organized and carried on as a legitimate commercial activity) “the test should be applied sparingly and with a latitude favouring the taxpayer, whose business judgement may have been less than competent.” Consequently, concerns previously held in respect to utilizing losses from rental properties, even if the properties are not profitable for some period of time, are now mitigated.

Purchasing a rental property requires a considerable amount of thought and due diligence prior to the actual acquisition. Having a basic understanding of the income tax consequences can assist in making the final determination to purchase the rental property.

Bloggers Note: I will no longer answer any questions on this blog post. There are over 300 questions and answers in the comment section below. I would suggest your question has probably been answered within those Q&A. Thanks for your understanding.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, August 18, 2014

The Best of The Blunt Bean Counter - Are Money and Success the Same Thing?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. The work is actually beginning to pay off. While playing the Hoot at Osprey Valley (the 3 courses at Osprey are typically listed in the top 100 Canadian courses), I missed two makeable putts on 16 & 17 or I would have broken 80.

Today, I am re-posting a two-part blog on "Are Money and Success the Same Thing?" This post was described by The Big Cajun Man (blogger behind Canadian Personal Finance blog) as a very Zen post. I figured Zen was good for reading while sitting on your cottage dock with a glass of wine.

Are Money and Success the Same Thing?


Moneyville runs a weekly feature called Fame and Fortune, where famous people discuss various financial lessons they have learned and provide financial advice. The last question is always “Are money and success the same thing?” In the columns I have read, I do not ever recall a featured guest answering yes to this question. Yet, the fact that the question is asked insinuates that some people feel the answer is yes. I would further suggest, that we all have met people who we think would answer yes to this question; or should answer yes, based on their actions.

In my opinion, the brevity of the Moneyville column forces a cliché answer from most of the guests. The guests typically say things such as “money is fleeting” or “money does not buy love” or “people should not be defined by their money”. However, this simple question is actually very complex when you peel back the layers. Success can be defined and interpreted in so many ways. I believe that money and success are not one and the same, but are so closely intertwined in some circumstances, that money may allow you to buy certain variations of success, while in other situations it can derail success.

Today, I will not get into how we look at money, a topic I discussed in a July 2011 blog post, but will focus solely on the success side of the question.

What is Success?


The definition of success is elusive. If you ask 100 people, you would probably get 100 different answers as to how they define success. So I turn to some famous and less famous people and their definitions and interpretations of success (and money) are as follows.

Ralph Waldo Emerson, a famous American essayist and poet, wrote this poem about success (although there is some debate if he indeed wrote this poem):

"What is success?
To laugh often and much;
To win the respect of intelligent people
and the affection of children;
To earn the appreciation of honest critics
and endure the betrayal of false friends;
To appreciate the beauty;
To find the best in others;
To leave the world a bit better, whether by
a healthy child, a garden patch
Or a redeemed social condition;
To know even one life has breathed
easier because you have lived;
This is to have succeeded."

John Wooden, considered by many as the greatest basketball coach ever, had this definition, “Success is peace of mind, which is a direct result of self-satisfaction in knowing you made the effort to do your best to become the best that you are capable of becoming."

According to John Maxwell, an evangelical Christian author, success is when “Those who know you the best love you the most.”

A less spiritual interpretation of money and success is provided by American author and motivational speaker Wayne Dyer who states, “Successful people make money. It's not that people who make money become successful, but that successful people attract money. They bring success to what they do.”

Finally, and I am not sure who said this, but another more financial oriented definition of success is “The world defines success in terms of achieving one's goal, acquiring wealth, status, prestige and power.”

I have been told by other bloggers that the average reader only pays attention for 400 words (I assume my readers are not average, since I breach the 400 word limit regularly) and since I am already over 600 words, I will stop here. However, tonight, when you are relaxing in your La-Z-Boy recliner (ignore the screaming kids and barking dog), contemplate how you would answer the question of whether money and success are one and the same? I will conclude my thoughts tomorrow.

Here is the link to the second part of this series, should you wish to read more on this Zen topic.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, August 11, 2014

The Best of The Blunt Bean Counter - Transferring Property Among Family Members - A Potential Income Tax Nightmare

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting my second most read blog of all-time; a post on transferring property amongst family members. As you will read, there is potential for some strange income tax results and care must be taken when transferring property to family members. I thus strongly suggest you obtain professional advice before undertaking any such transfer.

I also wrote this article for The Globe and Mail on the same topic. 

Transferring Property Among Family Members - A Potential Income Tax Nightmare


In today’s blog post, I will discuss the income tax implications relating to the transfer of property among family members. These transfers often create significant income tax issues and can be either errors of commission or errors of omission. Over my 25 years as an accountant, I have been referred some unbelievably messed up situations involving intra-family transfers of property. Most of these referrals come about because someone has read an article and decides they are now probate experts or real estate lawyers have decided they are also tax lawyers. 

Transfers of Property - Why They Are Undertaken


Many individuals transfer capital properties (real estate and common shares, being the most common) in and amongst their families like hot cakes. Some of the reasons for undertaking these transfers include: (1) the transferor has creditor issues and believes that if certain properties are transferred, the properties will become creditor protected (2) the transferor wishes to reduce probate fees on his or her death and (3) the transferor wishes to either gift the property, transfer beneficial title or income split with lower-income family members.

I will not discuss the first reason today because it is legal in nature. But be aware, Section 160(1) of the Income Tax Act can make you legally responsible for the transferor's income tax liability and there may be fraudulent conveyance issues amongst other matters.

Transfers of Property - Income Tax Implications


When a property is transferred without consideration (i.e. as gift or to just transfer property into another person's name), the transferor is generally deemed to have sold the property for proceeds equal to its fair market value (“FMV”). If the property has increased in value since the time the transferor first acquired the property, a capital gain will be realized and there will be taxes to be paid even though ownership of the property has stayed within the family. For example, if mom owns a rental property worth $500,000 which she purchased for $100,000 and she transfers it to her daughter, mom is deemed to have a $400,000 capital gain, even though she did not receive any money.

There is one common exception to the deemed disposition rule. The Income Tax Act permits transfers between spouses to take place at the transferor’s adjusted cost base instead of at the FMV of the capital property.

This difference is best illustrated by an example: Mary owns shares of Bell Canada which she purchased 5 years ago at $50. The FMV of the shares today is $75. If Mary transferred the shares of Bell Canada to her brother, Bob, she would realize a capital gain of $25. If instead Mary transferred the shares of Bell Canada to her husband, Doug, the shares would be transferred at Mary’s adjusted cost base of $50 and no capital gain would be realized. It must be noted that if Doug sells the shares in the future, Mary would be required to report the capital gain realized at that time (i.e. the proceeds Doug receives from selling the shares less Mary’s original cost of $50) and Mary would be required to report any dividends received by Doug on those shares from the date of transfer.

As noted in the example above, when transfers are made to spouses or children who are minors (under the age of 18), the income attribution rules can apply and any income generated by the transferred properties is attributed back to the transferor (the exception being there is no attribution on capital gains earned by a minor). The application of this rule is reflected in that Mary must report the capital gain and any dividends received by Doug. If the transferred property is sold, there is often attribution even on the substituted property.

We have discussed where property is transferred to a non-arm’s length person that the vendor is deemed to have sold the property at its FMV. However, what happens when the non-arm’s length person has paid no consideration or consideration less than the FMV? The answer is that in all cases other than gifts, bequests and inheritances, the transferees cost is the amount they actually paid for the property and there is no adjustment to FMV, a very punitive result.

In English, what these last two sentences are saying is that if you legally gift something, the cost base and proceeds of disposition are the FMV. But if say your brother pays you $5,000 for shares worth $50,000, you will be deemed to sell the shares for $50,000, but your brothers cost will now only be $5,000; whereas if you gifted the shares, his cost base would be $50,000. A strange result considering he actually paid you. This generally results in “double taxation” when the property is ultimately sold by the transferee (your brother in this case), as you were deemed to sell at $50,000 and your brothers gain is measured from only $5,000 and not the FMV of $50,000.

Transfers of a Principal Residence - The Ultimate Potential Tax Nightmare


I have seen several cases where a parent decides to change the ownership of his or her principal residence such that it is to be held jointly by the parent and one or more of their children. In the case of a parent changing ownership of say half of their principal residence to one of their children, the parent is deemed to have disposed of ½ of the property. This initial transfer is tax-free, since it is the parent’s principal residence. However, a transfer into joint ownership can often create an unforeseen tax problem when the property is eventually sold. Subsequent to the change in ownership, the child will own ½ the principal residence. When the property is eventually sold, the gain realized by the parent on his or her half of the property is exempt from tax since it qualifies for the principal residence exemption; however, since the child now owns half of the property, the child is subject to tax on any capital gain realized on their half of the property (i.e. 50% of the difference between the sale price and the FMV at the time the parent transferred the property to the child, assuming the child has a principal residence of their own).

An example of the above is discussed in this Toronto Star story that outlines a $700,000 tax mistake made by one parent in gifting their principal residence to their children.

I have been engaged at least three times over the years by new clients to sort out similar family transfer issues.

Transfers for Probate Purposes


As noted in the first paragraph, many troublesome family transfers are done to avoid probate tax. Since I wrote on this topic previously and this post is somewhat overlapping, I will just provide you the link to that blog post titled Probate Fee Planning - Income Tax, Estate and Legal Issues to consider.

Many people are far too cavalier when transferring property among family members. It should be clear by now that extreme care should be taken before undertaking any transfer of real estate, shares or investments to a family member. I strongly urge you to consult with your accountant or to engage an accountant when contemplating a family transfer or you may be penny wise but $700,000 tax foolish.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, August 4, 2014

You Have Been Named An Executor- Part 2- Now What?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting the second of a 3 part series I wrote on executors. This post is my 10th most read post and deals with the duties upon being named an executor; which is unfortunately, a surprise appointment in many cases.

The first post in this series recounts the fascinating betrayal of Paul Penna (founder of Agnico-Eagle Gold Mines Ltd.) by a close friend who was named the executor of his estate; while the third blog, a guest post by Heni Ashley discusses the issue of whether you should use a corporate executor.


You Have Been Named An Executor- Part 2- Now What?


As I noted in the first installment of this series, I have been an executor for three estates. I have also advised numerous executors in my capacity as the tax advisor/accountant for the estates of deceased taxpayers. The responsibility of being named an executor is overwhelming for many; notwithstanding the fact many individuals appointed as executors had no idea they were going to be named an executor of an estate. In my opinion, not discussing this appointment beforehand is a huge mistake. I would suggest at a minimum,you should always ask a potential executor if they are willing to assume the job (before your will is drafted), but that is a topic for another day.

So, John Stiff dies and you are named as an executor. What duties and responsibilities will you have? Immediately you may be charged with organizing the funeral, but in many cases, the immediate family will handle those arrangements, assuming there is an immediate family in town. What’s next? Well, a lot of work and frustration dealing with financial institutions, the family members and the beneficiaries.

Below is a laundry list of many of the duties and responsibilities you will have as an executor:

  • Your first duty is to participate in a game of hide and seek to find the will and safety deposit box key(s).  If you are lucky, someone can tell you who Mr. Stiff's lawyer was and, if you can find him or her, you can get a copy of the will. Many people leave their will in their safety deposit box; so you may need to find the safety deposit key first, so you can open the safety deposit box to access the will.
  • You will then need to meet with the lawyer to co-coordinate responsibilities and understand your fiduciary duties from a legal perspective. The lawyer will also provide guidance in respect of obtaining a certificate of appointment of estate trustee with a will ("Letters Probate"), a very important step in Ontario and most other provinces. 
  • You will then want to arrange a meeting with Mr. Stiff's accountant (if he had one) to determine whether you will need his/her help in the administration of the estate or, at a minimum, for filing the required income tax returns. If the deceased does not have an accountant, you will probably want to engage one. 
  • Next up may be attending the lawyer’s office for the reading of the will; however, this is not always necessary and is probably more a "Hollywood creation" than a reality. 
  • You will then want to notify all beneficiaries of the will of their entitlement and collect their personal information (address, social insurance number etc).
  • You will then start the laborious process of trying to piece together the deceased’s assets and liabilities (see my blog Where are the Assets for a suggestion on how to make this task easy for your executor). 
  • The next task can sometimes prove to be extremely interesting. It is time to open the safety deposit box at the bank. I say extremely interesting because what if you find significant cash in the box? If you find cash, you then have your first dilemma; is this cash unreported, and what is your duty in that case?
  • It is strongly suggested that you attend the review of the contents of the safety deposit box with another executor. A bank representative will open the box for you and you need to make a list on the spot of the boxes contents, which must then be signed by all present.
  • While you are at the bank opening the safety deposit box, you will want to meet with a bank representative to open an estate bank account and find out what expenses the bank will let you pay from that account (assuming there are sufficient funds) until you obtain probate. Most banks will allow funds to be withdrawn from the deceased’s bank account to pay for the funeral expenses and the actual probate fees. However, they can be very restrictive initially and each bank has its own set of rules. 
  • As soon as possible you will want to change Mr. Stiff's mailing address to your address and cancel credit cards, utilities, newspapers, fitness clubs, etc. 
  • As soon as you have a handle on the assets and liabilities of the estate, you will want to file for letters of probate, as moving forward without probate is next to impossible in most cases. 
  • You will need to advise the various institutions of the passing of Mr. Stiff and find out what documents will be required to access the funds they have on hand. In one estate I had about 10 different institutions to deal with and I swear not one seemed to have the exact same informational requirement. 
  • If there is insurance, you will need to file claims and make claims for things such as the CPP benefit. 
  • You will need to advertise in certain legal publications or newspapers to ensure there are no unknown creditors; your lawyer will advise what is necessary.
  • It is important that you either have the accountant track all monies flowing in and out of the estate or you do it yourself in an accounting program or excel. You may need to engage someone to summarize this information in a format acceptable to the courts if a “passing of accounts” is required in your province to finalize the estate. 
  • You will also need to arrange for the re-investment of funds with the various investment advisor(s) until the funds can be paid out. For real estate you will need to ensure supervision and/or management of any properties and ensure insurance is renewed until the properties are sold. 
  • A sometimes troublesome issue is family members taking items, whether for sentimental value or for other reasons. They must be made to understand that all items must be allocated and nothing can be taken.  
  • You will need to arrange with the accountant to file the terminal return covering the period from January 1st to the date of death. Consider whether a special return for “rights and things” should be filed. You may also be required to file an “executor’s year” tax return for the period from the date of death to the one year anniversary of Mr. Stiff's death. Once all the assets have been collected and the tax returns filed, you will need to obtain a clearance certificate to absolve yourself of any responsibility for the estate and create a plan of distribution for the remaining assets (you may have paid out interim distributions during the year).
The above is just a brief list of some of the more important duties of an executor. For the sake of brevity I have ignored many others (see Jim Yih's blog for an executor's checklist).

The job of an executor is demanding and draining. Should you wish to take executor fees for your efforts, there is a standard schedule for fees in most provinces. For example in Ontario, the fee is 2.5% of the receipts of estate and 2.5% of the disbursements of the estate.

Finally, it is important to note that executor fees are taxable as the taxman gets you coming, going and even administering the going.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, July 28, 2014

One Big Happy Family - Until We Discuss the Will

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting my 17th blog which I wrote way back in December 2010. This post tackles the taboo subject of whether you should discuss your will with your family. While this is my fifth most read post of all-time, it only had 6 comments which I find puzzling. Maybe our aversion to discussing our will goes as far as commenting on articles about the topic?

I almost forgot that when I started this blog, I used to post a non-financial post with ever tax or financial post, as evidenced by my Dentist's Wallpaper discussion that follows the main post.

One Big Happy Family - Until We Discuss the Will


What I want to discuss in today’s blog is the issue of whether parents should discuss their will with their children.

When there is a “black sheep” child in the family, or a child who is not treated equally in the will, I expect that a family meeting would likely be a disaster. But what about a meeting in situations when the children are treated somewhat equally? There is no right or wrong answer, but I think a family meeting is wise. Any meeting of this type can turn ugly because of money issues, but more likely, any ugliness will be the result of historical family jealousies or resentment over some prior issue or treatment. Nevertheless, if you feel you can navigate the minefields noted above, the family meeting can be very effective and useful.

The family meeting could be used to deal or clarify several different types of issues. For example:
1. Possible perceived inequalities: The meeting could be used to explain why you have left your Picasso to your daughter instead of your son so that he doesn’t feel slighted when the will is read. This discussion could involve explaining that since your daughter studied Art History at university, you feel she would appreciate the Picasso; however, since it is worth $500,000, you have left your son $500,000 of stock to equalize (or if you have not tried to equalize, you can explain why face to face). Also, where you have left more money to one child (perhaps they make less money than the other children), you can use the meeting to clarify why and explain that it has nothing to do with loving that child more, you are just helping them since they have not been as fortunate as the other siblings.
    2. Determine wants and needs of the beneficiaries: Many families have second properties such as cottages or ski chalets. Some children may have attachments to these properties while others might not, or maybe you are not sure whether any child would want to take over the property when you pass. A meeting provides the opportunity to raise the issue for your children to decide among themselves if they will want to sell the property, share the use, or have one child inherit the property. This issue may be best discussed prior to a will being finalized.
    3.  Deciding on an executor: Most children have no idea of the responsibilities and the burden of being named an executor of the will. You can broach this topic at the meeting to explain the duties of the executor and determine if the children or child you wish to be an executor(s) are/is willing to undertake the position.
    4.  Full disclosure: Finally, depending upon how open you wish the meeting to be, you can provide a current list of assets to your children so they know what assets you own and where they are held. In any event, you should also provide such a list to your accountant, lawyer or spouse. A copy of the list should also go into your safety deposit box. They key take-away is that you must ensure such a document exists and someone knows where it is.
    The decision to have a family meeting to explain your estate planning while alive and in good mental and physical health is a complex decision based on past family history and relationships. However, if you feel the meeting can be held without creating a “civil war,” it gives you a great chance to explain your estate planning and to get everyone onside.

    Update: I followed this blog post up with another in February 2012, which reviews an Investors Group survey of Canadians attitudes towards discussing their wills. If you have any interest, here is the link.

    The Dentist’s Wallpaper


    There is not much to do while you are in the dentist’s chair, especially if you are not lucky enough to have nitrous oxide administered. Personally, I look for anything to take my mind off that damn drill.

    One day while having a cavity filled I started reading my dentist’s wallpaper. Before you say “I think you really did have nitrous oxide administered and maybe too much,” you must understand my dentist’s wallpaper actually has “life quotes” all over it. One of the quotes was “Life is Hard by the Yard, But by the Inch Life’s a Cinch.”

    I don’t want to get all philosophical here, but I just found the quote so interesting; it actually took my mind of the drill. Such a simple adage that says so much.

    We all can get overwhelmed when we look at all the tasks and requirements of our daily lives, but if you break those tasks down into bite-sized pieces, the totality of all the tasks is less overwhelming. Although this is easier said than done, I do try and remember this quote when I feel overwhelmed.

    The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

    Monday, July 21, 2014

    CRA Audit- Will I Be Selected?

    This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game (after this weekend's 2 birdie, 5 par and 3 triple bogey performance, I still need lots of work on my consistency). Today, I am re-posting a February, 2011 blog on your chances of being selected for audit. This is my third most read post of all-time and has over 150 comments; I wonder why :)

    CRA Audit- Will I Be Selected?


    I am often asked how the Canada Revenue Agency (“CRA”) selects its audit victims; oops, I meant to say taxpayers subject to audit. Through experience I know certain taxpayers, certain claims and certain industries seem to trigger audits. With that in mind, I will list below what I have seen and how I believe the CRA selects certain individuals and businesses for audit.

    Reasons for Individuals and Corporations

     

    I would suggest there is nothing worse than a scorned lover, a business partner you have had a falling out with or a dismissed employee to trigger a CRA audit. These individuals know your little secrets; a cash deal here, an offshore account there and a conference you expensed that was really a vacation. These people are also vindictive and in some cases, they make statements and claims that are not factual in nature; however, the claims are enough to bring the CRA to your door.

    Update: The CRA has introduced the "snitch line" which offers a reward for tipsters who inform on taxpayers hiding money offshore, as per this National Post Article.

    CRA also loves net worth audits. These are audits undertaken because you live in a 3,000 square foot home, have a Porsche and kids in private school, and yet show minimal income on your tax return. Typically the CRA either stumbles upon these situations, or information from one of the individuals noted in the preceding paragraph provides a lead.

    Reasons Specific to Individuals


    We see far more desk audits (information requests in regard to certain deductions claimed) than full blown audits for individuals. You can expect an inquiry if you claim any of the following:
    • a significant interest expense,
    • an allowable business investment loss (usually if you held shares in a bankrupt private Canadian company),
    • tuition from a university outside Canada (typically the child and parent are tied together as most children transfer $5,000 of their tuition claim to their parents),
    • a child care claim for a nanny; even if you have filed a T4 for the nanny with CRA. Why CRA cannot crosscheck their records is baffling and befuddling.
    In all the above cases you are just providing back-up information, these are not audits.

    In past years individuals who purchased any tax shelter other than an oil & gas or mineral flow through have been audited. However, in most cases the CRA is auditing the tax shelter itself and the individual investors just get reassessed personally.

    Full blown audits seem to occur with regularity in regard to individuals who earn commission income or self employment income and claim expenses against that income. In those cases, CRA gravitates to auto expense claims, requesting logs books they know one in 100 people actually keep, and advertising and promotion expenses they consider personal in nature.

    Reasons Specific to Corporations


    Corporations seem to be selected for three distinct reasons.

    They carry on a business that is CRA’s flavour of the year; some prior flavours have been pharmacies, contractors and the real estate industry and any other industry CRA feels is a “cash is king” industry.

    Corporations file General Indexed Financial Information known as GIFI. This information provides a comparative year to year summary of income and expenses. It is suspected by many accountants that CRA uses this information to review year to year expense and income variances of the filing corporation and to also compare corporations within a similar industry sector to identify those outside the standard ratios, but we don't know that for certain.

    The final reason is that it is just your turn. I have no knowledge of this, but it seems like CRA just runs down a list and if you don’t get caught in regard to #1 or #2, your turn just eventually comes up.

    In all cases it is imperative you keep your source documents to provide to the auditor; CRA more then ever wants source documents. It is also vitally important if you and not your accountant are meeting with the auditor, that you try and keep your cool. In the end, the auditor is just doing his or her job and if you treat them badly, you are not doing yourself any favours.

    The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.