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.

Tuesday, May 29, 2012

Memory Overload, Alzheimer’s and Death in the Digital World

About a year and a half ago, my wife who is an avid reader, kept telling me about a book she was reading titled “Still Alice” by Lisa Genova. Eventually I became so intrigued, I read the book. This bestselling novel tracks the tragic decline of a brilliant 50-year-old woman suffering from the early onset of Alzheimer’s, the impact on her family and the decisions she makes, once she accepts the reality of what is happening to her. If you have not read the book I suggest you read it. It is both disturbing and thought provoking.

After reading the book, I recommended it to a service provider of mine. This person read the book and one day we discussed it. Our discussion veered off onto how hard it is for a person with full capacity to remember all the electronic passwords we are required to set up in this day and age (assuming you do not use the same password for all your financial and social sites; which is frowned upon by most computer security experts). As our discussion progressed, we considered the nightmare it would be to deal with all the electronic banking, billing, etc. if god-forbid we developed Alzheimer’s as Alice did in the book.

The discussion took an unexpectedly darker turn, when the person told me that they had a huge issue recently when a family member had passed away un-expectedly at a fairly young age, and since that person was computer literate, much of their world was digital and no one had a clue as to the electronic passwords of the family member.

The above discussion revealed three different scenarios that can arise in this electronic and digital era:

(1) You have full capacity but just cannot remember all your passwords;
(2) Your capacity begins to diminish whether through Alzheimer’s or just old age;
(3) You or a family member passes away, and you or a family member as executors must deal with electronic and digital records for which you have no access and whose existence you may not even be aware of.

Personally, I have completed an information checklist so my wife is aware of the assets we have. I have also made sure she is aware of our more important financial passwords. As someone who is by no means a computer whiz, I surfed the web to see what others were recommending or suggesting in regards to these various digital issues, and came across a Forbes.com article titled Six Ways To Store Securely The Keys To Your Online Financial Life by Deborah L. Jacobs, who is a lawyer and journalist.

 Some of Ms. Jacobs’s suggestions to secure your financial online life are as follows:

Use an electronic password manager


Ms. Jacobs noted there are a number of services that allow you to enter all your passwords into a single database and lock them up with a master electronic key. You (or your agent) only need to remember one password to access the list. In her article, Deborah notes the free service LastPass; however, there are several other services available.

Ms. Jacobs also suggests you can back up onto a USB flash drive, which becomes a mini encrypted vault with a password of its own. She notes the drawback is you must find someplace secure to store it.

Using either a USB flash drive or password service, addresses situation #1, where you have full mental capacity, but are just suffering from password overload.

Rely on a digital gatekeeper


Ms. Jacobs’s notes there are several new services, aimed at people who are doing estate planning, that charge a monthly or yearly fee to store the digital data that you enter, and release it according to your instructions. 

In an article titled “Where Are Your Digital Assets?”by Paul Fensom on the All About Estates Blog, he notes three new firms that have come onto the scene that help individuals protect and transfer their digital assets. Those being iCroak , Entrustet and Legacy Locker.

I took a quick look at these websites, and all appear to be small start ups. I have no recommendation on whether you should use these sites or not; I am just making you aware of their existence. Mr. Fensom also just noted these sites without providing an endorsement.

In any event, these sites or others that are developed in the future (I would suggest eventually the large trust companies will develop something similar) are probably the wave of the future and would address situations number #2 and #3.

Old School Solutions


Finally, Ms. Jacobs suggests two “old school” solutions: (1). Enter vital information in a loose-leaf or notebook and (2) use an old-fashioned lock box. 

I would suggest that both these solutions are probably used in some manner by many people, but are not exactly state of the art and have inherent security issues.

As I stated earlier, I am far from a computer security whiz. The intention of this blog post is to bring attention to the various electronic and digital issues noted above, and to make sure if you have not already addressed these issues in some manner, you consider doing such.

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.

Tuesday, May 22, 2012

Cottages - Cost Base Additions, are they a new CRA Audit Target?

Canadians have a love affair with their cottages. They enjoy the fresh air, the tranquility, the loons calling out, drinks on the dock, the gathering of friends and family and in many cases; they often enjoy a substantial financial profit on their cottage properties.

When a cottage property has increased in value, it often brings unwanted income tax and estate planning issues. I wrote about some of these issues a year ago April, in a three part series for the Canadian Capitalist titled Transferring the Family Cottage - There is no Panacea. In Part 1, I discuss the historical nature of the income tax rules, while in Part 2 I discuss the income tax implications of transferring or gifting a cottage and finally in Part 3 I discuss alternative income tax planning opportunities that may mitigate or defer income tax upon the transfer of a family cottage.

Today, I want to discuss the fact that the CRA seems to be looking at cottage sales as audit targets and in particular, they are reviewing additions to the original adjusted cost base (“ACB”) of the cottage.

Income Tax Issues

Before I charge ahead with this post, I think a quick income tax primer is in order. Prior to 1982, a taxpayer and their spouse could each designate their own principal residence (“PR”) and each could claim their own principal residence exemption (“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 of both properties would be tax-free.

Alas, the taxman felt this treatment was too generous and changed the Income Tax Act. Beginning in 1982 a family unit (a family unit of the taxpayer includes the taxpayers spouse or common-law partner and unmarried children that are 18 years old or younger) could only designate one principal residence between them for each tax year after 1981.

As if the above is not complex enough, anyone selling a cottage must also consider the following ACB 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. 

The Principal Residence Exemption


As noted above, if you owned a cottage prior to 1982, you can make a PRE claim for those years on your cottage. Where the per year gain on your cottage is in excess of the per year gain on your home, you may want to consider whether for years after 1982, it makes sense to allocate the PRE to your cottage instead of your home, if you have not already used the PRE on prior home or cottage sales. In these cases, I would suggest professional advice due to the complexity of the rules. In completing the PR Designation tax form (T2091), there are cases where you may need the ACB and FMV at December 31, 1981, but I will ignore this issue for purposes of this discussion.

Putting together the pieces of the ACB Puzzle


So how do all these rules come together in determining your ACB? First, if you owned your cottage prior to 1972, you will need to determine the FMV at December 31, 1971 as that is your opening ACB. If you purchased the cottage after 1971, but before 1994, your ACB will be your purchase cost plus legal and land transfer costs. Next, you will have to determine whether you increased your ACB by electing to bump your ACB in 1994.

If you inherited the property, you will need to find out the FMV of the cottage on the date of the death of the person you inherited the property from. If the property was inherited before 1994, you will have to determine whether you increased your ACB by electing in 1994.

Finally, 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. I would argue however, that the cost of materials for a capital improvement would qualify if you do the work yourself.

Unfortunately, many people do not keep track of these improvements nor do they keep their receipts (in addition, I suspect one or two cottage owners may have done the occasional cash deal with various contractors for which there will not be a supporting invoice), which brings us to the CRA, who appear to be auditing the sale of cottages more intently.

I think it was six pages back I said something about a quick income tax primer before I discussed the CRA audit issue :(

The Audit Issue


Anyways, on to the audit issue (or more properly called an information request). Some accountants think the CRA is going directly to cottage municipalities to determine cottages that have been sold and then tracking the owners to ensure they have reflected the disposition for income tax purposes. Others think the CRA is just following up reported dispositions of cottages on personal income tax returns. In either event, we have seen a couple information requests/audits recently.

So once the CRA decides to review your cottage sale, what are they looking at and what information are they requesting?

Amongst other things they are asking you to support the adjusted cost base of the property, by providing the following:

a. your copy of the original purchase agreement stating the purchase price;

b. the statement of adjustments where the purchase of the property involved the services of a lawyer;

c. if the property was either inherited or purchased in a non-arms length transaction, indicate the FMV of the property on the date of acquisition and supply documentation to support your figure. If the property was inherited, indicate the date of acquisition;

d. a schedule of all capital additions to the property. The schedule must indicate the nature of the addition or improvement (i.e. new roof) as well as the cost.

A and B above just provide the CRA the original ACB. Item C is interesting in that where there was a family sale or inheritance, the CRA is asking for validation of the sale price, but surely it is also cross-checking to see if the family member reported the sale of the cottage and in the case of a deceased person, to ensure the terminal income tax return of the deceased reported the value of the cottage at death.

Item D is where the CRA is zeroing in on; the capital additions, which as I noted above, are often not tracked and source documents are often not maintained.

The CRA is also asking for support of the proceeds of disposition, requesting such items as a copy of the accepted offer to purchase, the statement of adjustments and the full name of the purchaser in addition to their relationship, if any, to you (i.e. relative or otherwise).

They are also asking if while owned by you, was the property your principal residence for any period of time. This relates to the discussion above on whether the gain was larger on your cottage than your house and thus you designated your cottage. The CRA will then most likely confirm you did not sell any other residence during that time period.

Another request is that if you elected to report a capital gain on the property in 1994, they want you to supply a copy of the form T664, Election to Report a Capital Gain on Property Held at the end of February 22, 1994, that was filed with your 1994 income tax return. This is interesting since many people have not kept their older tax returns and I don’t think the CRA keeps its returns that far back. I am not sure what the CRA is doing in cases where taxpayers have destroyed their elections.

In conclusion, if you have sold a cottage in the last couple years, make sure you have all your documentation in place should you receive an information request, and if you currently own a cottage, use this road map to ensure you have updated your cottage ACB and have a file for any documentation needed to support that ACB.

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.

Tuesday, May 15, 2012

How much Control do I have from the Grave?

Last week I wrote a blog post on the virtues of spending some of your kid's inheritance on a family vacation while you are alive. That post reflected my personal philosophy that a parent(s) who is/are fairly certain that they will have more cash than they will require for retirement, should consider partial gifts to their children or grandchildren while alive. My rationale is simple: why not receive directly or vicariously, while alive, the pleasure and joy from those gifts, rather than giving from your grave.
  
However, I understand that viewpoint is not held by all, and that some people only wish to distribute their wealth after they die. In addition, there are some people who not only wish to wait until they die to distribute their wealth, but wish to continue to control their wealth after their death.

For a discussion on whether it is actually possible to control your wealth from the grave; today I have a guest blog post by Albert Luk, a lawyer, who is an estate and wills specialist.

How Much Control do I Have From the Grave?


If nothing else, Charles Millar had a good sense of humor. The lawyer turned entrepreneur stipulated in his will that on the ten year anniversary of his death a portion of his estate was to be given: “to the mother who has since my death given birth in Toronto to the greatest number of children…” Given Millar was a wealthy man in life, and his estate well managed in death, the baby bonus was worth approximately $750,000: a small fortune to the depression era mothers hoping to win the prize. The ensuing local baby boom would be known as The Great Stork Derby.

Charles Millar’s estate represents one end of the will planning spectrum. A testator (the legal term for the will-maker) rather whimsically plays one final practical joke on the world. On the other end of the spectrum, testators attempt to control the lives of their beneficiaries from their graves, sometimes with the best of intentions but sometimes for more sinister purposes. It is not unusual for a frustrated father-in-law to write: “To my son, I give the sum of $50,000.00 if he divorces his wife” in a will.

To testators, the question often becomes, “How much control can I assert from the grave?” To beneficiaries, the question is often asked, “Do I really have to conform to those conditions in the will?”

The answer, as usual, is that it depends. Conceptually, it is possible to give a gift with conditions. The analysis is often whether the conditions themselves survive scrutiny or how long of a reach one truly has from the grave.

A general and non-exhaustive review of the Canadian law provides the following information:

  • The more uncertain the condition of the gift, the more likely the condition will fail. An Albertan case found the condition that a home be gifted as long as the beneficiary lived in it and kept it in “good condition” was too uncertain. Specifically, who defines what “good condition” means? Martha Stewart or Frank the Tank? As the condition was too ambiguous, the condition failed and the home was gifted without conditions.
  • A restraint on alienation (a legal term for restricting the sale of land) is not a valid condition. A mother once attempted to divide a plot of land equally to her sons on the condition one son sell his half at a specified time and specified price. As this condition restricted the ability of either son to sell, the condition failed. The exception to this rule is that property can be left to a beneficiary only for the duration of their life.
  • Conditions contrary to public policy will be struck down. Violations of public policy would include conditions which, if carried out, would be considered to be in violation of the Charter of Rights and Freedoms or require the beneficiary to commit a hate crime or engage in criminal behaviour. For example, “I give to my son the sum of $50,000 only if he renounces his homosexual lifestyle,” or, “I give my daughter the sum of $100,000 if she burns down John Smith’s farmhouse,” would be conditions struck down as being contrary to public policy (not to mention the ethics behind such conditions).
  • Conditions promoting marital or family breakdowns will also be struck down. Conditions which grant a beneficiary a sum of money conditional upon leaving or divorcing his spouse or requiring a child to live with one parent have been struck down as being contrary to public policy. However, conditions prohibiting a widow or widower from marrying again or prohibiting a marriage not in accordance with religious rules, tantamount to forcing someone to convert, are valid. It is not as clear whether partial restraints on marriage are valid conditions or not. Confused? These types of restrictions are confusing and qualified advice should be sought before contemplating any such condition.
  • Conditions of residence should be reviewed carefully. “I give my son $75,000.00 to return home to Mother Russia” may or may not be upheld. Often these conditions are void for being too uncertain. However, if drafted carefully, they may hold up to scrutiny.
In summary, one’s reach from the grave can be quite long if the will is properly crafted. Courts have held in the past conditions which are positive (“I give my daughter $10,000 if she graduates high school and $25,000 if she earns a university degree”) are generally enforceable. Conditions which are progressively more restrictive are correspondingly more difficult to enforce if not struck down altogether. If struck down, the gift is usually granted without some or all of the conditions.

The key is that anyone looking to impose positive or negative conditions in their will, or any beneficiary subject to conditions, should seek qualified legal advice to determine their rights.

As for The Great Stork Derby, Millar’s estate survived challenges to the clause, withstanding even Supreme Court of Canada scrutiny. He was, after all, a lawyer. Four women each won $125,000 (over $1.5 million today) having nine (!) children in the ten year period. Two women—each having had ten children, but several out of wedlock (remember, this was the 1930’s)—sued the estate and settled for $12,500 each.

Albert Luk is a lawyer at Devry Smith Frank LLP, a Toronto based law firm who act as trusted advisors and advocates for corporations, individuals and small businesses. His particular expertise is in advising owner-managers on their business affairs and planning their wills and estates. Albert can be reached directly at albert.luk@devrylaw.ca.

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.

Tuesday, May 8, 2012

A Family Vacation- A Memory worth not Dying for

I have written several times on the topic of whether parents, who have the financial means, should provide partial gifts while they are alive, as opposed to just leaving an inheritance to their children or grandchildren.

I am a proponent of providing partial gifts while alive if you have the financial resources. My rationale is simple. Why not receive the pleasure of your gift either directly (such as a family vacation) or vicariously (by observing your children or grandchildren enjoy their gift such as a bike, car or even cottage).

The concept of a partial gift being used at least in part for a family vacation has substantial appeal to many parents. A family vacation is appealing because a parent can participate in the experience, the vacation more often than not, results in memories that last a lifetime for all the participants, and lastly, the parent has control over the gift.

I can attest personally to the benefits of a family vacation. Several years ago, my in-laws funded a Disney Cruise vacation for their children, their children's spouses and their grandchildren. This trip had a profound impact on the bonding of the grandchildren. In the case of my in-laws, the memories and enhancement of their grandchildren’s relationships was priceless and continues to this day.

Another very poignant and moving example of the gift of travel is the story of Les Brooks. Les, a Vietnam veteran, had unresolved issues relating to the war and as he states in a Princess Cruises travel blog “Vietnam was a place I left in 1966 praying I would never have to go back. But Christle sensed the deeper truth…I was curious about the place; I wanted and needed to see for myself what life was like today for the people of a country that I left so torn apart by war.”.

One day during the course of a conversation, Les’ mother asked him if he could take a trip anywhere in the world, where would he go. After thinking about the question he surprised his mother by saying Vietnam. Unbeknownst to Les, she later booked him on a cruise to Vietnam. 

Sadly, his mother passed away before Les took the cruise and could not observe the impact this gift had on her son’s life; but I would surmise, she knew the impact it would have as she paid for the cruise. Les says this about the special gift his mother provided while alive; “I realize my mother’s gift had opened the door to many profound gifts. Through her kindness and intuition, she provided the way back to Vietnam and my healing. There, through the smiling acceptance and unspoken forgiveness of that little girl and the many other Vietnamese who welcomed me, I was able to put aside much of the guilt that had gnawed at me for so long."

Here is a link to Les' travel blog.

While Les’ gift was not a family bonding vacation, it was a gift provided while his mother was alive, a trip that may never have occurred if Les inherited the money and spent it otherwise.

The concept of using a partial gift to fund a family vacation has become popular for both family bonding and financial reasons as discussed in this USA Today article . As grandparent David Campbell says in the article, he is mostly motivated by a desire to make his children's lives a little easier. "It's getting to a point I'd like them to enjoy life," says Campbell, a regional sales manager. "And if they're going to enjoy it, they might as well enjoy it with me."

I have observed the family vacation phenomenon on several of my own vacations. Suddenly a horde of people arrive at the pool or restaurant (not necessarily a welcome site for other vacationers) with corny matching t-shirts, saying “Smith Family Vacation 2011” or some other similar sentiment. 

Although we all know that any large family gathering can veer off the rails, these trips often bridge the generation gap between offspring and grandparents and parents. I often hear people reference these types of family vacations when they have a family get-together or the topic arises over dinner with non-family members.

Personally, I would rather hear my grandchildren say or know they are saying "When I was young, my grandparents took me on the most amazing trip!", than, “I just inherited $25,000 from my grandparents, what should I buy with it?”

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.