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, August 8, 2011

Common Personal Income Tax Errors

In today’s blog, I will discuss some of the more common personal income tax planning and personal income tax tracking errors I observe as a tax chartered accountant. Most of these planning and tracking errors are very subtle in nature. Many taxpayers utilize income tax software programs to prepare their personal income tax returns; I would suggest that these programs would not necessarily bring these matters to your attention, as the issues are not input based.

The following are common errors I observe on a consistent basis:

Transfer of investments with unrealized losses to a RRSP


Where you transfer an investment with an unrealized loss to your RRSP as a RRSP contribution, the capital loss on the disposition to your RRSP is disallowed. For example, if you bought shares of Research in Motion for $50 and transferred it from your non-registered trading account to your RRSP when the value was $35, the $15 capital loss would be denied. I have seen taxpayers claim this capital loss when they are not entitled to do so. Thus, you should be extremely careful to ensure you do not transfer any investments with an unrealized capital loss to your RRSP.

Spousal RRSP


A spousal RRSP counts as a contribution by the contributor. If Jennifer has a RRSP contribution limit of $18,000 and contributes $18,000 to her husband Tom’s RRSP, she receives the $18,000 income tax deduction and cannot contribute to her own RRSP. If Jennifer contributed $12,000 to Tom’s RRSP, she can only contribute up to $6,000 to her RRSP. The combined total cannot exceed her $18,000 RRSP limit. However, I often see people misinterpret these rules and make total contributions that exceed their RRSP contribution limit.

T3 income tax slips


These tax slips may contain an amount indicated in Box 42. This box relates to the return of capital on income trusts and similar investments. The amount in Box 42 indicates the amount of tax-free distributions received during the year and must reduce the adjusted cost base of the related investment. Many people do not keep track of their reduced adjusted cost bases. For example, if you purchased an income trust or similar investment for $14 in 2010 and the amount in Box 42 in the 2010 T3 slip is $1.50, the new adjusted cost base of that investment would now $12.50. If you were to sell the investment in 2011 for $15, the capital gain would be $2.50, not $1.

Depreciation on rental properties


A very subtle but significant error is in connection with rental properties. Many people purchase rental properties with friends or relatives and do not give any consideration to signing a partnership or joint venture agreement in regards to the property. This is a complicated legal issue, however, for income tax purposes, if the property is a partnership, the capital cost allowance [(“CCA”), known to many as depreciation for tax purposes] must be claimed at the partnership level and thus, the partners share in the CCA claim. However, if the property was purchased as a joint venture, each venturer can claim their own CCA, regardless of what the other person has done. (I will discuss this issue in greater depth in an upcoming blog on the income tax implications of owning a rental property).

Joint bank accounts


Many spouses arbitrarily open bank and investment accounts in the names of both spouses even though only one spouse may have earned and contributed all or the majority of the funds. This may lead to incorrect tax reporting results. For personal income tax purposes, technically, the spouse who earned and contributed the money to the account originally should report 100% of the interest, dividends or capital gains that are earned in that account on the original amount (there is no attribution back to the contributing spouse on the income earned on the income (i.e. “secondary” income). This is not necessarily what I see happening in reality.

Car expenses and home office related to employment


Many employees require their cars for work or are required to maintain a home office. Should you fall into either of these categories, you should ensure you get your employer to sign Form T2200, which will enable you to deduct these costs as employment expenses. Often, when I ask whether a taxpayer if they have obtained the Form T2200, they answer no.

Interest expense


Many people use their line of credit to borrow to make investments. The interest on these monies is typically deductible for income tax purposes. However, many people also use their line of credit for personal expenses, thus, mixing non-deductible personal interest expense with deductible investment interest expense. Where this is the case, you should track the amount the principal amount of the line of credit used for the investments on an excel spreadsheet for back-up in case of an audit by CRA. For example, if you took out $15,000 on your line of credit to make an investment, and the total line of credit balance is $100,000, you should allocate 15% of that month’s interest to your deductible interest expense. Any repayments to the line of credit must be prorated between the personal and non-personal amounts outstanding and cannot be allocated in whole to one or the other. Taxpayers often believe that they can apply the full repayment to the personal portion of their line of credit and therefore can claim a higher interest expense deduction for personal tax purposes.

1994 capital gains election


In 1994, the $100,000 capital gains exemption was phased out. However, individuals were eligible to make an election on their 1994 personal tax return to bump the value of their capital properties by up to $100,000. Many people made this election on their cottages and stock investments and never informed their children. Where the parent ages and forgets about this election or in some cases passes away, the children may not be aware of this election and the estate can pay more income tax than is necessary.

Tax planning does not always mean NO tax


The errors noted above are actual physical income tax planning errors. However, the biggest error committed by many people, is more mental than physical; when they attempt to reduce their income tax bill at any cost. As discussed in my blog The Income Tax Planning dog, wagging the Tax Dodge, this philosophy can often be at a significant personal detriment. 

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.

2 comments:

  1. Spouses, joint bank accounts: Since there is no gift tax in Canada, couldn't a joint bank account simply be considered a continuing gift from the husband to the wife?

    In that case, the money would be legally 50/50 owned by both people, and the tax can be reported 50/50 on both returns.

    If both spouses are employed and married for more than a few years, it seems impossible to track who contributed/withdrew what sums.

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  2. Hey Anon

    There are attribution rules in Canada so you cannot gift funds to your spouse, since these rules attribute the income and gains back to you. The reality is the CRA does not seem overly concerned where two spouses are working and there are not huge disparities in income, however, where one spouse is working or one spouse makes significantly more money, the CRA could attribute the income back to the higher spouse. Again, this does not seem high on the CRA priority list, but is always a concern. Some people set up two accounts one for the higher income spouse and one for the lower income spouse and the higher income spouse pays all the household expenses and the lower income spouse invests their full salary.

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