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, December 22, 2014

Year-end Financial Cleanup


In 2015, would you like to improve your money management, minimize taxes and ensure your loved ones have a financial road map?

Then this holiday season, in between your family gatherings and watching the 2015 IIHF World Junior Championships consider undertaking a financial cleanup.

So what is a financial cleanup? In the Blunt Bean Counter’s household it entails the following:

Yearly Spending Summary


I use Quicken to reconcile my bank and track my spending during the year. If I am not too hazy on New Year’s Day, I print out my spending by category for the year. This exercise usually provides some eye opening and sometimes depressing data, and often is the catalyst for me to dip back into the spiked eggnog!

But seriously, the information is invaluable. It provides the basis for yearly budgeting, income tax information (see below), and amongst other uses provides a starting point for determining your cash requirements in retirement.

Portfolio Review


The holidays or early in the New Year is a great time to review your investment portfolio and annual rates of return. I like to compare my returns to standard indexes and to the yearly returns on the Canadian Couch Potato’s low cost ETF model portfolios. The Couch Potato typically provides the data for the prior year’s returns on his model portfolio’s in the first week or two of January. I also have the advantage of reviewing my returns to those of the various investment managers my clients engage.

January is also a great time to review your asset allocation, and to re-balance to your desired allocation and risk tolerance.

Tax Items


As noted above, I use my yearly Quicken report for tax purposes. I print out the details of donations and medical receipts (acts as checklist of the receipts I should have or will receive) and summaries of expenses that may be deductible for tax purposes such as auto expenses. If you use your home office for business or employment purposes (remember you need a T2200 from your employer), you should print out a summary of your home related expenses.

Where you claim auto expenses, you should get in the habit of checking your odometer reading on the first day of January each year. This allows you to quantify how many kilometres you drive in any given year, which is often helpful in determining the percentage of employment or business use of your car (since, if you are like most people, you probably do not keep a detailed log as the CRA would prefer).

Medical/Dental Insurance Claims


As I have a health insurance plan at work, I also start to assemble the receipts for my final insurance claim for the calendar year. I find if I don’t deal with this early in the year, I tend to get busy and forget about it.

To facilitate the claim, I ask certain health providers to issue yearly payment summaries. This ensures I have not missed any receipts and also assists in claiming my medical expenses on my income tax return. You can do this for physiotherapy, massage, chiropractors, orthodontists, and even some drug stores provide yearly prescription summaries.

Stress-Test Checklist


If you are a regular reader, you know I have written numerous times about stress-testing your finances and writing your financial story ( in case you pass away). The holidays or early January is a great time to update your financial story or checklist for any changes that occurred in the prior year. Such things as new brokerage accounts, online passwords, changes in insurance, etc. need to be updated. If you have not yet got around to stress-testing your finances and writing your financial story, there is no better time to start than early in the year.

Speaking of the year-end, this is my last post for 2014 and I wish you and your family a Merry Christmas and/or Happy Holidays and a Happy New Year. See you in January.

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

Monday, December 15, 2014

The Family Tax Cut - Should Joint Filing be Next?

In late October, while I was vacationing in South Africa, details of the proposed Family Tax Cut were announced by Prime Minister Stephen Harper. Since the financial press was all over this, I will provide a quick recap below. Then for a fun (hey I am an accountant, I know fun!) mental exercise, I will compare the income tax burden for a family that maximizes the income splitting benefits of the Family Tax Cut in Canada, to that of a comparable U.S. family that files a joint income tax return.

Family Tax Cut


In Canada, we are required to file our own personal tax return; there is no concept of a joint family filing. Thus, in many cases, where one spouse earns significantly more income than the other spouse (either the second spouse is a stay at home spouse or just makes less money), that family unit often pays more income tax than a two-earner couple that has the exact same family income, but has two working spouses making roughly the same money.

This is because our tax rates are graduated and two spouses making the same income may both be in the 25% tax bracket, whereas a large single earner may be in the 35% tax bracket.

The proposed Family Tax Cut attempts to fix this family income inequality, by allowing the higher-income spouse to transfer up to $50,000 of taxable income to a lower income/lower tax bracket spouse for federal tax purposes. The maximum tax benefit available to a qualifying family is $2,000. Amongst the various conditions to claim the tax credit is that you must have at least one child who is under the age of 18 at the end of the year and who resided with you or your spouse throughout the taxation year. More details can be found here.

Department of Finance Example


In the backgrounder to the Family Tax Cut press release, the Department of Finance provided the following example of the family tax cut:

“Pat and Chris are a two-earner couple with two children. Pat earns $60,000 of taxable income and Chris earns $12,000, for a combined taxable income of $72,000. Pat faces a marginal federal tax rate of 22 per cent. Chris is in the first tax bracket, where income is taxed at 15 per cent. Since the value of his non-refundable tax credits is greater than the tax on taxable income, Chris does not pay federal tax.

For federal tax purposes, under the proposed Family Tax Cut, Pat would be able to, in effect, transfer $24,000 of taxable income to Chris. This would bring their taxable incomes for the purposes of calculating the credit to $36,000 each, which puts both of them in the 15-per-cent tax bracket. In addition, Chris would be able to use up his unused non-refundable tax credits with the notional transfer of income. As one person in the couple may claim the Family Tax Cut, they decide that Pat would do so. The Family Tax Cut would reduce Pat’s tax payable by about $1,260 in 2014, taking into account both the reduced tax on their taxable incomes, and the additional value of the non-refundable credits that Chris is able to use.”

Greater Detail


I ran some numbers for Pat and Chris and determined that they would pay approximately $10,900 in tax in Ontario before the Family Tax Cut. Thus, after the Family Tax Cut they would owe around $9,640 ($10,900 less $1,260 Family Cut Savings).

Since the Conservatives initially announced this income splitting initiative a couple years ago, I have wondered (often aloud or in writing) why they chose an income splitting option as opposed to moving to a U.S. style joint return? If philosophically the government is concerned about inequities in dual family incomes, why not just file as a family and put all couples, on the same tax footing?

I thus thought it would be interesting to compare how much tax Pat and Chris would owe if they lived in California, or if they lived in Michigan. I asked a CPA friend in the U.S. to run some numbers for me. He told me that if Pat and Chris lived in California, they would owe approximately $4,700 in U.S. federal and California state tax. If they lived in Michigan, they would owe approximately $6,130 in U.S. federal and Michigan state tax. Since I always thought California was a high taxing state, I asked him how this happened and he said it was because California has graduated tax rates, while Michigan has a flat rate.

The numbers reflect that, the Canadian Pat and Chris would owe approximately $5,000 more than if they lived in California (keeping in mind that the CA state rate would increase at higher income levels) and $3,500 more in tax than if they lived in Michigan. This comparison assumes the same exchange rate.

As I am comparing Canadian apples to U.S. oranges, this comparison can be misconstrued, but it does reflect that the Family Tax Cut does not save Canadians as much as if they went to a comparable U.S. joint return, with similar U.S. federal and state tax rates.

There are various macro factors as to why Canada has a higher tax rate. As demonstrated above, most U.S. citizens pay far less tax than the equivalent Canadian. However, the U.S. imposes estate tax for wealthier citizens when they die. We can characterize the Canadian tax system as a “pay me now”, while the U.S. is more of a “pay me later” tax system.

As I stated at the outset, this post was sort of a fun mental exercise for me and does not prove much of anything. However, I would suggest that since we are now into family income splitting, it would probably make some sense to move to a joint return filing system in Canada in the near future.

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

Monday, December 8, 2014

Personal Pension Plans

The last time I wrote about Individual Pension Plans (“IPPs”) was in 2011; see my blog. Recently, I have received a few emails from my readers asking if I planned to update the discussion on this topic. As it happens, over the last year or so, I have met and spoken to Jean-Pierre Laporte of INTEGRIS Pension Management Corp. about his company’s personal pension plan (“INTEGRIS PPP”), and I thought I would ask Jean-Pierre to write a guest blog.

It should be noted upfront that the INTEGRIS PPP while similar to an IPP, is more of an IPP on steroids, and was created to be a private sector version of the major public sector defined pension plans for incorporated individuals.

While I think that for some small business owners, a personal pension plan may make sense (especially for anyone concerned their corporation is a personal service business), please be aware, that neither Cunningham LLP nor The Blunt Bean Counter blog is endorsing INTEGRIS Pension Management Corp. or the INTEGRIS PPP in any manner, and you should obtain independent professional advice on whether an IPP or a personal pension plan makes sense for your own circumstances.

With all the caveats out of the way, I will leave it to Jean-Pierre to discuss personal pension plans.

Personal Pension Plans

By Jean-Pierre A. Laporte

If there is one thing that most business owners can agree on, it is that Canadians pay too much tax. Even with well-informed accountants providing advice in the background, there is a general feeling within Corporate Canada and in the small private sector that the various levels of government are in dire need of tax revenues.

Ontario’s recent introduction of new tax brackets for the “wealthy”, the increase in the taxation of non-eligible dividends and the punitive corporate taxation of personal service businesses, in conjunction with the introduction of the mandatory Ontario Retirement Pension Plan all reinforce this perception.

Personal Pension Plan vs RRSP


One option available to reduce this tax burden is a personal pension plan. Simply-put, a personal pension plan (or PPP) is a registered pension plan offered for the owner-operator of a business or for an incorporated professional. A PPP provides a flexible contribution mechanism that can match the available cash flow of the company while enjoying superior tax deductions unavailable to those saving through RRSPs.

For example, a 55 year old doctor earning $300,000 from her medical practice corporation could contribute $24,270 her RRSP this year. If the Dr. established a PPP, she would be allowed to contribute $33,395 to her PPP, and $24,270 to her RRSP as well in the year that the PPP is established.

The double RRSP and PPP contribution noted above can occur only if two conditions are met:

(1) the member had no T4 income in the year 1990 and

(2) the RRSP deductions can only occur in the year of PPP set up. For subsequent years, the RRSP deduction is limited to $600, called the PA Offset.

Moreover, if she had drawn T4 income from her company over the past 10 years, she would also be eligible to claim an additional corporate tax deduction (in this case $95,640 assuming she received the maximum pensionable salary over that 10 year period) in the year past service is purchased.

Any investment management fees the Dr. pays to have someone manage her registered assets are tax-deductible to her corporation.

At retirement, her basic pension benefit could also be enhanced with indexing protection or she could retire early on a full unreduced pension and make a final tax deductible contribution out of her corporation. For example, in the example above, if the Doctor decided to retire at age 60 instead of 65, on a full (i.e. unreduced) pension, the medical corporation would have to contribute $286,252. This amount called “terminal funding” is also tax-deductible in the hands of the medical corporation, against corporate income taxes. At 15.5% of corporate tax, the medical corporation will receive a cheque from the CRA worth $44,369.06. Not a bad way to start one’s retirement. In addition, by removing excess cash out of the sponsoring corporation, there is a secondary benefit of purifying the corporation for purposes of the $800,000 lifetime capital gains exemption, especially where you are preparing the company for sale.

The value of the tax refunds generated by the additional deductions permitted by pension law can often reach over $100,000 over a 20 year period, a sum that, by definition, cannot be accessed through an RRSP. The true value of the PPP though comes from the substantially higher tax-deferred compounding of assets resulting from higher contributions.

Personal Service Businesses


For small businesses who only have one large client (such as IT Consultants and oil patch service providers) and may be considered personal service corporations, a PPP may be a very effective tax planning tool. In Ontario, these types of corporations pay corporate tax at the rate of 39.5%. While deductions are limited to salaries and benefits, the Canada Revenue Agency does consider contributions to an individual pension plan such as the PPP to be an eligible corporate deduction. As such, the PPP provides a great way to convert tax owing into pension benefits.

The Disadvantages of a Personal Pension Plan


If a business owner is solely looking to their registered plan to claim a deduction but need to access all of their money at any time, the PPP is inappropriate since pension laws require that a portion of the contributions and interest be set aside to provide for a pension in retirement.

In addition, you cannot invest more than 10% of the book value of your pension fund into any one security, as that would be in violation of the specific investment rules that regulates most of the registered pension plans in Canada.

In conclusion, for incorporated professionals and owner/operators of companies (especially those deemed to be personal service businesses by the CRA), a Personal Pension Plan allows you to build up a substantial retirement nest-egg that is much larger than what RRSP rules allow. Even if the rate of return on assets is held constant, over 20 years, the difference in wealth accumulated between the two types of plans can be substantial.


Jean-Pierre A. Laporte, BA, MA, JD, is the Chief Executive Officer of INTEGRIS Pension Management Corp. The company is a private Canadian based company that offers business owners and incorporated professionals tax-effective ways to save for retirement by providing access to highly experienced actuaries, pension and compliance officers. The company has alliances with some of Canada’s highly regulated, respected and well capitalized companies to offer the best-in-class service providers. Jean-Pierre can be contacted at 416-214-5000. The company’s website is https://www.integris-mgt.com/.

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

Monday, December 1, 2014

Tax Planning Strategies to Minimize the Old Age Security Clawback

Question: How does an accountant enrage a sweet, mild mannered genteel grandmother?

Answer: Tell her some or all of her Old Age Security (“OAS”) payments were clawed-back on her tax return.

One lesson I have learned over the years is that whether a senior is a multi-millionaire or just well to do, they consider their OAS payment as sacred and any tax planning that causes even one dollar to be clawed-back may result in a tirade against their shell-shocked accountant.

I can only surmise that people feel they are entitled to so little in retirement related payments that they feel it is very unfair to have any of it taken away. I also think some people mistakenly think they have paid taxes to fund the Old Age Security program; however, that is a common misconception. The plan is funded out of the general revenues of the Government of Canada, which means that you do not directly pay into the OAS plan.

In any event, it is prudent for you and/or your accountant to plan to minimize any OAS clawback and that is my topic for today.

Old Age Security


The OAS is a monthly payment available to most Canadians 65 years of age (will gradually increase from 65 to 67 over six years, starting in April 2023). The eligibility requirements are here:

The maximum monthly OAS payment is currently $563.74 (October to December).

For 2014, you must reimburse all or part of your OAS pension if your net individual income exceeds $71,592 (including the OAS pension). The total amount of this reimbursement is equal to 15% of your net income (including the OAS pension) that exceeds $71,592. The full amount of OAS will be repaid when net income exceeds approximately $117,700.

Avoiding the Clawback


Split Income Election


For most people, the best income splitting technique available, and the most effective way to reduce your income, and thus reduce your OAS clawback, is to elect to split pension income (pension income includes most types of pension income, excluding OAS, CPP/QPP). The election is made by filing Form T1032, “Joint Election to Split Pension Income” with you and your spouse’s annual tax returns. CPP can be split also, but a request must be made to Service Canada (Pension sharing form ISP-1002A)

Income Sources


Not all income is treated equally. Only ½ of your capital gains are taxed, while interest income is fully taxable. Dividends are a strange animal as they are subject to a dividend gross-up (38% for public co. dividends) which causes your income to be increased. Thus, dividends can be detrimental for OAS planning purposes; however, the dividend tax credit tail should not solely wag the investment decision.

Holding Company


If you transfer your non-registered investments into a Holding Company (a rollover tax election form needs to be filed), you will no longer earn this income personally and you may reduce or eliminate your holdback. This sounds like a sexy solution, however it often comes with complications. First of all, you will most likely have to pay an accountant to prepare financial statements and tax returns, which will eat up around half your OAS savings. In addition, upon your death, or upon the death of your spouse if you leave your assets to them, you will have a deemed disposition of your Holding Company shares. That means your estate must pay tax on the value of your holding company at death. This may cause a double tax on death that can often only be alleviated by undertaking some complicated tax planning.

However, you may be able to plan around the double tax issue as discussed by Tim Cestnick in this article

To quickly paraphrase Tim’s plan; you transfer your investments into a Holdco and take back an interest free loan. Each year the Holdco declares a dividend to you equal to the full amount of the after-tax earnings of the company. It is important to note the dividend is payable, not actually paid. To cover your yearly cash requirements, you repay your interest free loan as required. Depending upon your financial situation and longevity, at some point the loan is paid off and the company then begins to actually pay the declared dividends, but this could be 15-20 years from now.

When you pass away, your heirs become the owners of the Holdco. The investments can then be distributed from the company in the form of the declared and unpaid dividends and may allow for some income tax savings. More importantly, the value of the company’s shares at the time of your death may have minimal value because the dividend liability owing by the company may be around the same value as the investment assets. This significantly reduces the double tax issue.

This planning is complicated and before you undertake Tim’s plan, you should consult your accountant to ensure the plan makes sense based on your personal circumstances.

A Holdco also is very effective if you have significant US assets, as the Holdco assets are not subject to US estate tax.

Finally, if you have a separate will for your Holdco (at least in Ontario) you can minimize your probate fees.

TFSA


If you have not maximized your TFSA, you should transfer non-registered money that is generating taxable income into your TFSA, to the extent of your unused contribution limit.

Alter Ego Trust


Alter Ego Trusts are special trusts that can only be created by individuals 65 or over. During the individuals lifetime they must be the only person entitled to receive the income of the trust and the individual creating the trust must be the only person entitled to receive the assets of the trust prior to the death of the individual. There is also a similar concept known as a “joint partner trust” with pretty much the same rules, for married or common law partners.

Where you have non-registered assets throwing off significant interest and dividend income that is causing an OAS clawback, it may make sense to transfer these assets to an Alter Ego Trust to reduce your clawback. Generally the transfer of these assets to the trust is tax-free.

However, since the income earned on these assets will be taxed at the highest marginal rate in the Alter Ego Trust, you have to consider whether the OAS clawback savings and other advantages (probate protection), outweigh any extra income tax costs (i.e.: is the extra tax payment a result of having all this income tax at the highest rate, less than the OAS you get to now keep by moving those assets into the trust).

I have outlined various strategies above that may be used to reduce your OAS clawback. However, I caution you; the complications and extra costs of some of these strategies need to be compared to the actual OAS savings they produce, as I have found that many clients over 65 want fewer complications in their life, not more. Consequently, you may face a tug of war between complicating your financial life or just accepting an OAS clawback.

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.