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.

Monday, November 28, 2016

Tax Loss Selling (or for 2016 - Tax Gain Selling?)

In keeping with my annual tradition, I am today posting a blog on tax loss selling (or as per paragraph 3, maybe tax gain selling this year). 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 have to 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; however, there is one issue I wish to discuss. I have had a few calls from clients asking whether they should sell their stocks with unrealized gains this year, instead of selling their stocks with unrealized losses. They are asking this question because they are worried the 2017 Federal budget may change the inclusion rate on capital gains from 1/2 to 3/4 as rumoured in the last budget.

I will provide you the same answer I provide them. I cannot tell you what to do. The Liberals have not clearly stated they intend to do such and thus, any change appears to be conjecture. However, given the Liberal's clear intention to tax the "rich", such a change would not be surprising, though many "middle class" taxpayers would also be affected. So you have to roll the dice either way.

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 2016 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 strong this year, you hopefully will have only a few stocks with unrealized capital losses you can sell to use the losses against capital gains reported the last 3 years. Alternatively, you may want to trigger a capital loss to utilize against capital gains you have already realized in 2016.

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, 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 2016 will have to be reported on Schedule 3 of your 2016 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. 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 2015 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information may also be accessed online if you have registered with the Canada Revenue Agency.

2. If you do not have capital losses to carryforward, retrieve your 2013, 2014 and 2015 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 2013, 2014 and 2015.

3. For each of 2013-2015, 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 2014 or 2015, review whether you carried back those losses to 2013 or 2014 on form T1A of your tax return. If you carried back a loss to either 2013 or 2014, 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 2013 to 2015, you can potentially generate an income tax refund by carrying back a net capital loss from 2016 to any or all of 2013, 2014 or 2015.

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:

· 2016: realized capital loss of $30,000

· 2015: taxable capital gain of $15,000

· 2014: taxable capital gain of $5,000

· 2013: 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 2016 against the $7,000 and $5,000 taxable capital gains in 2013 and 2014, respectively, and apply the remaining $3,000 against your 2015 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 2015 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 2016 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2015. Alternatively, if you have capital gains in 2016, 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 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 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 2016 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2016 and 2017, 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 2018 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 stocks in 2016 will be December 23rd. 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 2016 by December 23, 2016.

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 21, 2016

The Top 10 Estate Planning Mistakes

I think it is fair to suggest, that most of us wish to plan our estates to minimize any income tax and probate fees owing upon our passing. Yet, many of us do not seek professional assistance to deal with the various technical income tax, probate planning and "soft family" issues that must be considered when dealing with our estates.  As such, we often end-up eroding our estates because of unanticipated tax obligations and significant legal costs when family members litigate the estate. Today, Neil Milton an estates expert discusses the Top 10 Estate Planning Mistakes he observes in his practice.


The Top 10 Estate Planning Mistakes

By Neil Milton


There are many widely held myths and misconceptions about wills, probate and estates. These myths and misconceptions lead to estate planning mistakes. These mistakes can cause a lot of damage – both to your wallet and to relationships with family members. In this blog we have gathered 10 of most common and yet easily avoided estate planning mistakes.

1. Not Having a Will

The rules for how an estate is divided in Ontario when there is no will (intestate succession) can have some shocking consequences. Remarkably few people are aware that if you die without a will:
  • Your common law spouse inherits nothing. Zero. (They might have a claim for support, but that is a very different thing).
  • If you are separated but not divorced from a spouse, your legally married, they will inherit the bulk of your estate (The first $200k + a healthy chunk thereafter).
  • If you are legally married and not divorced, your parents and siblings get nothing.
  • If you have ‘step children’ that you have not legally adopted, they get nothing.
Everyone adult should have a will. If you do not have a will, get one now (74% of Canadians do not have an up-to-date will).

2. Do It Yourself Wills

Sure you can save $500 by doing your own will, but that does not mean you should. You can also do your own dental surgery. For both wills and dental work, the results of DIY are rarely satisfactory and often very expensive to fix.

3. Joint Accounts to Avoid Probate Tax

Do not put your investments or bank accounts in the name of one of your adult children to avoid probate tax without proper advice. You may save probate, but you may trigger significant income tax consequences. In addition, you may create a lot of grief and legal fees to fix the mess where the child whose name you put on the account, claims it for their own and the other children sue.

4. Joint Ownership of Houses to Avoid Probate Tax

Do not put one of your adult children on title to your house (“joint tenancy”) to avoid probate tax without very careful proper planning and documentation. You can create income tax issues and unless you document in writing your intention to give the house as a gift to that child to the exclusion of your other children, you do not save probate tax and you create lots of misery and a legal fee bonanza.

5. Assuming Your children get Along


Do your children really get along? Are they really facing similar financial circumstances and stresses? Many children have serious issues with their siblings. Do not assume that just because they are your children that they trust or work well with each other. This is particularly relevant to your choice of executor.



6. Choosing an Executor who is Not Up to the Job

Being an executor is a difficult job, not an honour. Good executors are a rare breed. They are prudent but decisive, can handle conflict (especially among beneficiaries), are attentive to detail, communicate well, are financially savvy, enjoy accounting and taxes, and must complete, send and receive many letters and forms. An ideal executor is tech savvy, and can scan, print, and email at will.

Your favourite caregiver may be a wonderful person, but that does not mean they will be a good executor. Being an executor is a hard job and you should provide for reasonable compensation (“pay peanuts, get monkeys” applies here). Also consider aging – your executor must be able to perform when the time comes, which may be a long time from now. At the very least, you should have an alternate if the primary choice is unable to act.

I strongly recommend that you consider using a professional to handle this complex job at a pre-agreed fair rate of compensation (which does not have to be a flat 5%).

See Mark's post on the duties of being named an executor for more information.

7. Putting Your Executor in a Conflict of Interest

Enormous trust is placed in an executor, and it is very difficult to force an executor to act at all or decently. If you do not trust someone absolutely to behave quickly, properly and fairly as between all beneficiaries, do not appoint them at all. Too many executors have massive conflicts of interest between their interests and the interests of other beneficiaries, and these conflicts were created by the testator.

For instance, if one child lives with you in your home, and you name that child your executor, they have a clear conflict between their desire to stay in the house as long as they can and to avoid paying rent, versus their obligation to sell the home and distribute the estate. It is unfair to them and the other beneficiaries to put them in this awkward spot – choose an executor without a conflict of interest.

8. Hedging Your Bets With Multiple Executors

Being an executor is a hard enough job without having to chase a co-executor for approval and signatures on everything. In most cases you should choose one person as your primary executor, and name an alternate. Do not name co-executors because you don’t trust one or you are too indecisive to choose between them.

9. Not Thinking Gifts Through or Keeping Them up to Date

Just because someone is your child does not mean that they will outlive you. You need to plan for contingencies. Similarly, if you appoint someone a trustee of funds for a minor child, make sure that they are willing and able to handle the task, and will be able to for the duration of the trust – if a trust for a child might last 20+ years, do not name someone who is already in their 70s as the trustee.

10. Not Giving Enough Away Sooner or to Charity

Gifts of things or experiences to your loved ones (to support their education, or travel for instance) while you are alive often have a much bigger impact on the recipients than lump sums of cash when you pass away (See Mark's blog post on Family Vacations. Meaningful gifts to mark milestones like graduation often get remembered much longer than cash inheritances. See Mark's blog post on Family Vacations for how meaningful and fulfilling a family vacation can be.

Even modest gifts to charity can have a big impact on the intended charity. Gifts to charity teach your values to your family. Also, a gift to a charity can create a legacy that is shared among your survivors giving them a common bond and remembrance of you that the same amount of cash, divided among them as inheritance, can never have. Lastly, there are tax benefits for gifts to charity.

Estate law is complex because life is complex. There are often many options, and choosing the options that are best for you and your family depends on your unique circumstances. We strongly recommend that you get advice from an expert in the field who can help you weigh the options, choose a desired outcome, and get there efficiently.

Neil Milton is an experienced estates lawyer who advises estate trustees (executors) and beneficiaries on all aspects of probate, guardianship, and estate administration, and helps resolve estate-related disputes. Miltons Estates Law has offices serves clients across Ontario from offices in Ottawa and Toronto, and provides a wealth of free information and eBooks on its website www.ontario-probate.ca. Feel free to contact Neil directly at nmilton@miltonsip.com or 1.866-297-1179 ext 224

Please note that this post is based on Ontario law. If you live outside of Ontario, it is strongly recommended that you consult with an estates lawyer licensed to practice in your province.

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

Monday, November 14, 2016

The Nest

In February, 2012, I wrote on the taboo topic of whether it is morbid or realistic to plan for an inheritance. In the blog post, I noted that I had observed over my career, a couple people living beyond their current means, on the assumption they would inherit money at a later date. Their future inheritance would be the fix for their current overspending and excessive debt.

In the circumstances I witnessed, the inheritances were actually received as hoped for/expected by the children when their parents passed away. I noted in the post that I had yet to observe a circumstance where a planned inheritance had been less than what the beneficiaries expected and that is still the case to date.

Thus, when searching for a book to read last summer, I was intrigued when I saw The Nest, by Cynthia D’Aprix Sweeney on The New York Times Best Sellers List. The Times described the book as “Set in New York, The Nest features four neurotic siblings who are squabbling over their inheritance and struggling with the disappointments of middle age. Their joint trust fund, which they call “the nest,” is jeopardized when Leo, the hard-partying black sheep of the family, gets in a drunken-driving accident with a teenage waitress in the passenger seat”.

While the book may not be one of my all-time favourites, this satire about the dysfunctional Plumb family was definitely an entertaining read. More Magazine said this about the book “Few things are more compelling than looking into the interiors of other people’s lives-and finding a truth or two about our own. In Cynthia D’Aprix Sweeney’s wickedly funny novel THE NEST, four midlife siblings squabble over their inheritance; universal questions about love, trust, ambition, and rivalry roil.”

As I do not want to give away too much about the book should you decide to read it, I will just note a few of the interesting concepts Ms. D’Aprix highlights:

1. How a known inheritance can impact current day living.

2. How future plans are premised on the known inheritance.

3. The desperation that ensues when a planned inheritance is jeopardized.

4. How family dynamics can be improved or worsened through the process.

5. Money is not everything.

Retrospective


In my "morbid or realistic" blog post I had the following conclusion:

“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”.

I still feel that in situations where there is a high certainty of an inheritance (significant family assets, strong family bonds, etc.) it is nonsensical to ignore the inheritance in your planning.

However, in other less certain cases, I think Preet Banerjee (whom I quote in the postscript) has it right. He says "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”.

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 7, 2016

Family Dynamics & Estate Planning - Mostly Money Mostly Canadian Podcast

Mostly Money, Mostly Canadian -  with Preet Banerjee

I was recently interviewed by Preet Banerjee for his Mostly Money Mostly Canadian podcast. In lieu of writing a blog post today, I am linking to the podcast here, so you can listen to me for 25 minutes waxing eloquently on topics such as family dynamics, estate planning, the family cottage, personal use property such as art and collectibles and even my bucket list. Here is the link.

I think the interview is pretty good (if I do say so myself) and if Preet had recorded the first run instead of forgetting to push the start button on his recording device, it would have been even better :)

All joking aside, Preet is one smart guy, a terrific speaker and writer and a sort of a Dos Equis most interesting man in the world type of guy. He even started out trying to be a Race Car driver and somehow ended up in the financial service industry. Talk about a downturn in your career.

If you follow personal finance, you will know Preet from his TV appearances on the CBC's National, as a Bottom Line Panelist and/or The Lang and O'Leary Exchange, his writing for The Globe and Mail and Money Sense Magazine or as the host of the TV Show Million Dollar Neighborhood (well actually not sure if anyone watched it, so maybe you don't know him from there). Preet's most recent book Stop Over-thinking Your Money! The Five Simple Rules of Financial Success was a Canadian best-seller.

Finally, you may wish to check out and subscribe to his U-tube Channel, Money School which is informative and often amusing.

Wow, I am exhausted just writing about all the things Preet does, to be young again. Anyways, enjoy the podcast and check out some of Preet's work.

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 24, 2016

The New Principal Residence Reporting Requirements – Large Implications for the Average Canadian

On October 3, 2016, the Government announced administrative changes to the reporting requirements for the sale of a principal residence (“PR”) and the designation of the principal residence exemption (“PRE”), which provides for the tax-free sale of your home. The changes were premised on closing a tax loophole that allowed non-residents to buy homes and later claim a tax exemption on the sale by using family members or trusts. While I think the changes in reporting requirements were made in part to close this loophole, a skeptical person may think the government used the “foreign-buyer loophole” issue, to remedy lax reporting requirements for the sale of a PR by all Canadians.

In fact, I suggest the Government will get significantly more revenue from resident Canadians who have been misreporting the sale of their PR, than they will from foreign buyers. I see three (there are more than three, but these are the most obvious) potential areas the new rules will catch the average Canadian:
  1. Misunderstanding of the rules where you own both a home and a cottage 
  2. Divorce
  3. Flipping of houses

The New Reporting Requirements


Starting with the 2016 tax year, the new rules will require you to report the sale of your PR on Schedule 3 - Capital Gains or Losses, of your personal tax return. You will now be required to designate the property as your PR on Schedule 3. Previously, the administrative position of the Canada Revenue Agency (“CRA”) was that you were not required to report the sale of your PR if the property was your PR for every year you owned it.

If you do not designate the property as your PR for all the years you owned the property (such as where you had sold your cottage in a prior year and claimed the PRE for certain years), you are required to also file Form T2091.

I would not be surprised, if in the future, the CRA has follow-up information requests on PR sales, requesting the history of any prior PR sale that was not reportable under the old system to ensure there has been no duplication of the PRE.

History and Rules


Prior to 1982, a taxpayer and their spouse could each designate their own PR and each could claim their own PRE. Therefore, where a family owned a cottage and a family home, each spouse could potentially claim their own PRE, one on the cottage and one on the family home, and accordingly the sale or gifting of both properties would be tax-free.

However, for any year after 1981, a family unit (generally considered to be the taxpayer, his or his spouse or common-law partner and unmarried minor children) can only designate one property between them for purposes of the PRE. Although the designation of a property as a PR is a yearly designation, it is only made when there is an actual disposition of a home. For example, if you owned and lived in both a cottage and a house between 2001 and 2016 and sold them both in 2016, you could choose to designate your cottage as your PR for 2001 to 2003 and your house from 2004 to 2016 or any other permutation +1 (see formula calculation and discussion of the +1 rule below).

In order to decide which property to designate for which years after 1981, you must determine whether there is a larger gain per year on your cottage or your home in the city. Once that determination is made, in most cases it makes sense to designate the property with the larger gain per year as your personal residence for purposes of the PRE.

As if the above is not complex enough, anyone selling a cottage and claiming the PRE must also consider the following adjusted cost base adjustments:

1. If your cottage was purchased prior to 1972, you will need to know the fair market value (“FMV”) on December 31, 1971; the FMV of your cottage on this date became your cost base when the CRA brought in capital gains taxation.

2. In 1994 the CRA eliminated the $100,000 capital gains exemption; however, they allowed taxpayers to elect to bump the ACB of properties such as real estate to their FMV to a maximum of $100,000 (subject to some restrictions not worth discussing here). Many Canadians took advantage of this election and increased the ACB of their cottages.

3. Many people have inherited cottages. When someone passes away, they are deemed to dispose of their capital property at the FMV on the date of their death (unless the property is transferred to their spouse). The person inheriting the property assumes the deceased's FMV on their death, as their ACB.

4. Most people have made various capital improvements to their cottages over the years. For income tax purposes, these improvements are added to the ACB you have determined above. Examples of capital improvements would be the addition of a deck, a dock, a new roof or new windows that were better than the original roof or windows, new well or pump. General repairs are not capital improvements and you cannot value your own work if you are the handyman type.

The Actual PRE Formula


The actual calculation to determine your principal residence exemption is equal to:

The capital gain on the sale of your home multiplied by:

The number of years you have lived in your home plus 1 
The number of years you have owned the property

The one year bonus is meant to ensure you are not penalized when you move from one house to another in the same year.

The Three Potential Issues for Resident Canadians


Misunderstanding of the Rules Where You Own a Home and a Cottage


As noted above, the PRE rules are extremely complex and the formula is often misunderstood. Many Canadians have simply understood or pretended to understand that any sale of a home or a cottage was tax-free if it was used by you and your family. Since there were no reporting required on your tax return until these changes, the CRA could not track whether you were properly reporting the sale of your PR. The new reporting will now allow the CRA to track overlapping ownership periods (i.e. you bought your home in 1990 and your cottage in 2000 and sold your cottage in 2016 and claim the PRE for 16 years. The CRA will now have a record that you have used 16 years of your PRE and you cannot claim those 16 years when you sell your home). This required filing will also force you to consider any prior PRE claims that may have occurred during the 16 years above (say for example you had sold the home you purchased in 1990 in 2010 and purchased a new home that same year. Under this circumstance you could not claim 16 years PRE on your cottage).

As noted above, I would expect at some point in the future, to see information requests and audits of reported gains by the CRA, specifically asking about prior PRE claims to ensure there was no overlapping of of PRE claims.

Divorce


In June of this year, I wrote a post on the income tax implications of divorce where you owned a home and a cottage and the various misunderstandings of how to claim the PRE exemption that arise on divorce. You can read this post if it is of interest to you, but some of the key points I made were as follows:

1. A couple can only claim one PRE during the marriage (other than when a spouse who was throughout the year living apart from and was separated under a judicial or written separation agreement). This one PRE rule per couple is clearly noted in this interesting case, Balanko v The Queen.

2. It is vital that the right to the PRE or the allocation of the PRE must be accounted for in any marriage settlement, for both purposes of the actual claim, and the related income tax one of the spouses may incur. If the use of the exemption is not addressed in the separation agreement, it is then a first-come, first-served claim.

I would suggest that many divorced couples have inadvertently double claimed the PRE.

Flipping of Houses & Condominiums


The CRA has been going after “house and condominium flippers” for the last few years. However, since there has been no reporting requirement for the sale of a PRE, if a “flipper” felt or considered the sale to be of their PR, the CRA was constrained in tracking these house flips. While prior sales may be hard to audit, the new rules force someone flipping a house to report the gain as a PRE and I am sure any sale of homes and condominiums that are of short duration will be subject to follow-up or audit.

Assessment and Penalties


For the sale of a PR in 2016 or later years, the CRA will only allow the PRE if you report the sale and designation on your tax return. If you fail to report the sale, you will have to ask the CRA to amend your return. Under the proposed changes, the CRA will be able to accept a late designation but a penalty may apply, equal to the lesser of $8,000 and $100 for each month you are late from the original required filing. This is a potentially fairly large penalty for non-compliance. The period of re-assessment will also be extended where a disposition has not been reported.

Wow, what some may have seen as a fairly innocuous change to catch non-residents, will certainly have substantial implications on resident Canadians going forward and in some cases, on previous non-filings related to PRE claims.

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 17, 2016

The Registered Disability Savings Plan – A Government-Assisted Savings Plan for Family Members that Qualify for the Disability Tax Credit

Last week, Katy Basi wrote about using Henson Trusts to estate plan for disabled beneficiaries.

Today, Howard Kazdan, a tax expert with BDO Canada LLP, discusses what a Registered Disability Savings Plan is and where it may be a useful tax planning vehicle for the parents of a disabled child.

I thank Howard and Katy for their excellent posts.

The Registered Disability Savings Plan – A Government-Assisted Savings Plan for Family Members that Qualify for the Disability Tax Credit

By Howard Kazdan


A Registered Disability Savings Plan (“RDSP”) is a savings plan that is intended to help parents and others save for the long term financial security of a person who is eligible for the disability tax credit (“DTC”). A person is eligible for the DTC only if a medical practitioner certifies on Form T2201, Disability Tax Credit Certificate, that this person has a severe and prolonged impairment in physical or mental functions. This form must also be approved by the CRA.

Where you have a family member living with a physical or mental disability, consideration should be given to opening a Registered Disability Savings Plan.

What is an RDSP?


RDSPs are tax deferred savings plans which can provide long-term financial benefits for a disabled individual resident in Canada. Qualifying individuals may receive grants and bonds that the Government of Canada contributes to the RDSP.

How does the RDSP work?


RDSPs can be opened by either a beneficiary who has reached the age of majority and is contractually competent to open an RDSP for themselves or, before 2019, by their parents or other legal representative.

There is no limit to how much can be contributed to an RDSP in any particular year, however, the lifetime maximum contribution limit is $200,000. Contributions can be made until the end of the year in which the disabled person turns 59.

It is important to note that there is no tax deduction for contributing to an RDSP. These plans are somewhat similar to a Registered Education Savings Plan (if you have opened such an account for your child’s education). On the flip side, when the original contributions are withdrawn, the disabled individual will not be taxed on those contributions. However, income earned and government grants (discussed below) and bonds received will be taxed when they are paid out of the RDSP. If the plan is established for a long period of time, and the investments earn a good rate of return, then this may provide a long deferral from paying tax.

Subject to certain contribution and age limits, RRSP/RRIF proceeds can be transferred to an RDSP through a will if the disabled individual is financially dependent upon the deceased. This allows parents or grandparents of a disabled individual, to tax and estate plan for a future contribution to an RDSP and may provide you with comfort if it is not otherwise possible to maximize the contributions before this point.

Government Grants


The Government of Canada pays a grant to the RDSP, until the end of the year in which the beneficiary turns 49, that is dependent on the beneficiary’s family income and the amount contributed. The maximum grant is $3,500 each year, to a lifetime maximum of $70,000. The contribution rules allow for a 10-year carryforward of entitlements, for those who qualify but cannot contribute every year.


Beneficiary's family income
Grant**
Maximum
$90,563 or less


on the first $500
$3 for every $1 contributed
$1,500
on the next $1,000
$2 for every $1 contributed
$2,000
more than $90,563 or no income information at available at CRA
on the first $1,000
$1 for every $1 contributed
$1,000
**The beneficiary family income thresholds are indexed each year to inflation. The income thresholds shown are for 2016.


For minors, family net income is that of their parent(s) or legal guardian(s). From the year the beneficiary turns 18, family net income is the combined net income of the beneficiary and their spouse.

The Government of Canada may also pay up to $1,000/year, to a maximum of $20,000, in a Canada disability savings bond to low-income Canadians until the beneficiary turns 49. No contributions are required once the RDSP is opened.

Taxation


Since RDSPs are intended to be a long-term savings vehicle, if money is withdrawn, all or part of the government grants and bonds that have been in the RDSP for less than 10 years may have to be repaid. The beneficiary must repay $3 for every $1 that is taken out, up to the total amount of grants and bonds paid into the RDSP in the last 10 years. This can be very punitive if funds are required urgently.

The minimum regular scheduled payments that must begin when the beneficiary turns 60 are determined by a complicated formula.

If an RDSP terminates because the beneficiary no longer qualifies for the DTC or dies, then:
  • grants and bonds that have been in the plan for less than 10 years must be repaid, and
  • amounts paid to the beneficiary or his/her estate related to investment income, grants and bonds will be taxable.
If you are disabled, or have a disabled child, you should consider opening an RDSP if you have not already done so, to provide additional government-assisted long-term financial security.

Before opening the plan, confirm with the Canada Revenue Agency that the DTC eligibility status of the plan holder is up-to date so the DTC can be claimed and the benefits of an RDSP can be enjoyed. This should be monitored in the future so the benefits are not lost.

RDSPs can be a useful tax planning tool for the parents of a disabled child. However, as noted above, there are many rules for which you need to familiarize yourself with.

Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. He can be reached at 905-946-5459 or by email at hkazdan@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 10, 2016

Estate Planning for Disabled Beneficiaries – Henson Trusts

I have received several requests to write about tax and estate planning for disabled individuals. Thus, this week I have enlisted the help of Katy Basi, my resident wills and estate planning contributor, to write about Henson  trusts, an estate planning opportunity for disabled beneficiaries. Next week Howard Kazdan, a tax specialist with BDO Canada LLP, will write about Registered Disability Savings Plans ("RDSP's").

As Henson trusts are complex, I appreciate Katy providing a detailed analysis of the important issues to be considered in whether or not to use such a trust. So without further ado, here is Katy.

Estate Planning for Disabled Beneficiaries - Henson Trusts

By Katy Basi

It is fairly common for a client to come to me and say "my child has a disability and I've been told I need a Henson trust in my will - whatever that is...." My usual answer is "maybe - let's discuss your situation" - typical lawyer-speak but true nonetheless!

What is a Henson Trust


A Henson trust is a trust created in a will, or by way of a free-standing trust deed, which is completely discretionary and has a disabled beneficiary who is not also a trustee of the trust. “Completely discretionary” means that the trustee will have all decision making power with respect to the timing and amount of all payments made out of the trust. The benefit of having a Henson trust is that the disabled beneficiary’s interest in the trust is not considered to be an asset for purposes of the rules surrounding disability benefits in Ontario and in some other provinces (the “asset test”, in particular, limits the value of assets a recipient of disability benefits may own – further discussed below).

The term “Henson trust”, while common, does not have legal meaning in and of itself, but is generally taken to mean a trust having the attributes set out in the above paragraph. These trusts are called “Henson trusts” due to a court case in Ontario involving a father (last name being Henson) who established a trust of this nature for his disabled daughter. Her right to claim disability benefits was challenged (the government’s position was that her beneficial interest in the trust was a valuable enough asset to disqualify her). The Hensons won the case, based on their position that the beneficial interest in the trust did not have any value due to the discretionary nature of the trust. As the trustee could choose not to pay any of the trust funds to or for the benefit of the daughter, the beneficial interest was held not to have value for purposes of the disability benefit rules.

Planning Using a Henson Trust


In order to ascertain whether a Henson trust is appropriate planning for a client, I will usually ask about the nature of the disability, as this may impact:

  • the child's ability to eventually make capacitated financial and or health care decisions for him or herself,
  • their prospects of getting married and having children,
  • their life expectancy,
  • their ability to be financially independent,
  • their care requirements at various life stages, and
  • other factors that are relevant to their parent’s estate plan.

I will ensure that my client has investigated whether the disability tax credit (“DTC”) is available in relation to their child. We then discuss whether the child is likely to start claiming provincial disability benefits when they attain age 18, as the value placed on the availability of disability benefits varies greatly from parent to parent and affects whether Henson trust planning is appropriate.

Some disabled beneficiaries have good employment prospects, now or in the future, in which case disability benefits are really not relevant. When a disability does not affect the financial acumen of a beneficiary, and they are a relatively high functioning adult, the beneficiary may even receive an outright inheritance (i.e. not in any form of a trust, Henson or otherwise).

Some parents have a large estate, and want their child to have more access to their inheritance than would be permitted by Henson trust planning. These clients find the rules surrounding disability benefits very limiting and essentially assume that their child will not apply for benefits, which in turn makes other estate planning options available.

If disability benefits are important, then we discuss whether the child should inherit by way of a Henson trust set out in the parent’s will. Unfortunately, inheritances received in any way other than a Henson trust usually result in the recipient being cut off from disability benefits (for having access to assets valued at greater than $5,000 (the “asset test”)).

A Henson trust is, by necessity, limiting. As noted above, in order to have the Henson trust assets excluded from the asset test, the Henson trust must be drafted as a fully discretionary trust and the beneficiary cannot be the trustee. Essentially, the beneficiary cannot have the right to demand trust assets at any time, but must rely on the good judgment of the trustee. I have had a few clients decide against Henson trust planning for this reason alone.

When a Henson trust is a good choice, the selection of the trustee, and alternate trustees, is very important given their broad powers. The trustee has the fairly onerous task of managing the trust funds to optimize the quality of life of the disabled beneficiary, without cutting them off from disability benefits – like walking on a tightrope, with significantly more reading and longer telephone calls to the government.

Also, a beneficiary in addition to the disabled beneficiary is usually named in the Henson trust in the event that the trust lasts longer than 21 years. (After 21 years, all trust income must be distributed by an Ontario trust to or for the benefit of a beneficiary. Without an alternate beneficiary, this rule could force a trustee to allocate income to a disabled beneficiary, and disability benefits could potentially be lost.) Sometimes the alternate beneficiary is a charity, and sometimes a family member such as a sibling.

When, as commonly happens, a sibling is both the trustee and alternate beneficiary, there can be a conflict of interest, and the parent needs to be very sure that the sibling will “do the right thing” and not profit personally from the Henson trust unless absolutely necessary. In addition, Henson trusts are often drafted to last for the lifetime of the disabled beneficiary unless the trustee decides to wind up the trust early. (In the latter case, common planning is to require the trust funds to be paid to the disabled beneficiary, which may, or may not, be appropriate under the circumstances.)

Upon the death of the disabled beneficiary, there is often a distribution of remaining Henson trust funds to the siblings of the beneficiary. If a sibling is also the trustee, we can have a conflict of interest, as minimizing distributions for the benefit of the disabled beneficiary during their lifetime maximizes the funds potentially received by the sibling/trustee upon the death of the beneficiary. Obviously, the trustee must be a very trustworthy, morally upstanding sibling!

We also generally ensure that the Henson trust terms specifically permit the trustee to make contributions to a Registered Disability Savings Plan (“RDSP”) set up for the disabled beneficiary in order to optimize the payment of government grants and bonds. We usually advise that the trustee exercise some caution here, as any funds left in the RDSP upon the death of the disabled beneficiary flow in accordance with the disabled beneficiary’s will (or the law of intestacy if there is no will). This may, or may not, be the result desired by my client…

Finally, as of 2016 it will be helpful, from an income tax perspective, if a Henson trust meets the “qualified disability trust” (“QDT”) definition. QDTs are one of the few remaining trusts able to access the graduated rates of tax on income. (All trusts other than QDTs and graduated rate estates pay tax at the highest rate). For a Henson trust to qualify as a QDT, the disabled beneficiary must receive the DTC and elect with the trustee that the Henson trust is their one and only QDT. One issue (yet to be resolved) is that a recovery tax is applicable if anyone other than the disabled beneficiary receives capital from the trust. As noted above, this can easily happen upon the death of the disabled beneficiary. Another issue is that many disabled beneficiaries are not sufficiently mentally capacitated to sign the QDT election form for themselves, and have no court-appointed guardian to sign the election form for them. (Contrary to common belief, parents are not automatically the guardians of an incapacitated adult beneficiary, at law). To ensure QDT status, it may be necessary to apply to the court for a formal appointment of a guardian for the incapacitated beneficiary – which is, of course, costly and time consuming.

The good news is that careful estate planning can ensure that disabled beneficiaries are well cared for their entire lives, even after their parents are deceased, giving peace of mind to the entire family.

Please note that as I am licensed to practice law in Ontario only, this post is based on Ontario law. If you live outside of Ontario, it is strongly recommended that you consult with an estates lawyer licensed to practice in your province – the member directory of the Society of Trust and Estate Practitioners (“STEP”) at step.org is a good place to begin.

Katy has written numerous popular estate planning posts for this blog over the years including Estate Planning for Blended Families, Qualifying Spousal Trusts - What are They and Why do we Care? and a three part series on new will provisions for the 21st century dealing with your digital life, RESPs and reproductive assets, the family cottage and a very well received post titled, An Estate Fairy Tale.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estates and income tax law (including incorporations and corporate restructurings). Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@basilaw.com. More articles by Katy can be found at her website, basilaw.com. 

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