My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and 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.

Tuesday, June 14, 2011

The Income Tax Planning tail wagging the Tax Dodge

It is said that the biblical verse "Render unto Caesar that which is Caesar’s", commands people to respect state authority and to pay the taxes the state demands of them. In modern day Canada, this phrase often seems to be interpreted as: render unto Stephen Harper the absolute minimum in income tax payments, even if the consequences of minimizing one’s income tax payments are at significant personal detriment.

Why the new modern day interpretation? I find that many people are so averse to paying income taxes that they dive into very short-sighted income tax plans oblivious to the consequences. I believe in minimizing income taxes to the greatest extent possible, however, you cannot tax plan in isolation.

Enough philosophy, lets get to some examples.

In many Canadian families, the high income earner either contributes to their own Registered Retirement Savings Plan ("RRSP") or makes a spousal contribution; in both cases the high income earning spouse receives the income tax deduction at their marginal income tax rate. However, over the years I have seen many people so focused on the the potential income tax savings a RRSP contribution will garner, that they also make RRSP contributions for their stay at home spouses, to utilize their spouses RRSP contribution limits (these are not spousal contributions). But, because the spouse has minimal or no income, no income tax refund is generated and the RRSP deduction is not utilized (it can however, be carried forward to a future year).

The ultimate example of the tax tail wagging the tax dodge is the purchase of a Flow- Through Limited Partnership (“FTLP”) unit. These tax shelters are condoned by the Canada Revenue Agency and certainly have income tax benefits, but also have investment risk. In simple terms, you purchase a FTLP for say $5,000, obtain an income tax deduction for $5,000 and then have a mutual fund of small cap resource stocks with a nil cost base that you can sell two years hence. People become so enamoured with the income tax savings that they don’t realize they have over allocated their portfolio to risky small cap resource stocks (I call these people, tax shelter junkies) and in some cases, in the ultimate irony, they purchase such a large amount of FTLP's, that they create alternative minimum tax, defeating their original intent of saving on income taxes.

Now, let’s next look at some probate misplanning.

Probates taxes in Ontario are for all intents and purposes 1.5% of your estate upon death. Yet people blindly transfer stock investments to their children to avoid these taxes. These people are very pleased with themselves, as they have saved 1.5% in probate fees. However, their chest thumping quickly seems to abate when I inform them they may now owe 23% capital gains tax on the deemed disposition they caused by transferring their investments to their children.

Many Canadians also commonly open a bank account with joint ownership and the right of survivorship with one of their children for ease of administration as they age and to avoid probate tax. The parent typically assumes that the monies in joint ownership belong to their estate to be shared by all their children. However, the child they opened the account with often considers those funds to be theirs alone. Thus, the parent may have saved 1.5% in probate tax, but they also may have been the catalyst for litigation amongst their children.[I have an all encompassing blog discussing various probate issues including income tax, legal and estate issues such as the Pecore case (which has applicability to the joint ownership transfer above) in progress, that I hope to post in the next week or two].

In conclusion, care must be taken to ensure your income tax planning does not leave you barking up the wrong tree.