RRSP/RRIF Spousal Transfers on Death - Not so Automatic – Be Careful you don’t Create a Family War

Most people are aware that upon their death, their RRSP/RRIF can automatically transfer tax-free to their spouse’s RRSP/RRIF if their spouse is the beneficiary of their plan. The advantage of this spousal rollover is that the income tax on the value of the RRSP/RRIF is deferred until the surviving spouse passes away.

However, if the surviving spouse has other ideas and does not transfer the proceeds of the RRSP/RRIF to a plan of their own, the possibility exists that they could end up keeping the proceeds of the plan while leaving the related income tax liability to be paid by the deceased’s estate. While this can be an issue for any family, for blended families, this has the potential to ignite World War 3.

I recently attended the Ontario Tax Conference. The participants were lawyers and accountants, most of whom specialize in income tax. I know a room full of accountants and lawyers talking tax, what could be more torturous. However, there was actually a very outgoing and passionate presenter by the name of Christine Van Cauwenberghe of the Investors Group. 

Christine presented the technical details relating to this issue, from the mechanics of the “refund of premiums” to the administrative withholding requirements for financial institutions. But, in simple terms, this is what you need to understand.

When you designate your spouse as the beneficiary of your RRSP/RRIF, they will receive the proceeds of your RRSP/RRIF directly. It will then be his/her responsibility to transfer the entire proceeds to their RRSP/RRIF. If they do that, the bank issues the tax receipts in their name and there are no income tax consequences, end of story. 

However, your spouse has no legal obligation to transfer these funds to their RRSP/RRIF. In fact, where your spouse rather use the funds immediately, does not get along with your natural children or is from a second or third marriage and has his/her own children and/or does not get along with their step-children, they may decide to take the money themselves and not transfer the funds to their plan. In these circumstances, the tax receipt for the RRSP/RRIF will then be issued to the deceased’s estate. While the spouse may be held jointly and severally liable by the CRA for the related income tax, if the estate has enough assets, the CRA will typically go after the estate for the taxes, not the spouse.

In order to avoid this potential minefield, Christine suggests that you designate your estate as the beneficiary of your RRSP/RRIF, with a clause that provides two alternative options:

Option 1: The beneficiary (your spouse) chooses to elect with the executor(s) to have the RRSP/RRIF amount taxed in their own name as a refund of premiums. Under this option, the spouse receives the entire RRSP/RRIF proceeds and typically transfers the proceeds to their RRSP/RRIF and the estate assists in filing an election. The required election form is Form T2019, however, you would probably not want to name a specific form in the will, only that there is an option to elect.

Option 2: If the spouse does not agree to the joint election, then they are only entitled to an allocation of the RRSP/RRIF funds net of the associated income tax liability to be incurred by the estate.

A disadvantage of designating your estate as the beneficiary of your RRSP/RRIF is that the funds will be subject to probate in most provinces. Some people feel that the probate fees (1.5% of the value of the RRSP/RRIF in Ontario) are a relatively small cost in order to prevent the potentially disastrous result of your spouse taking the entire proceeds of your RRSP/RRIF and leaving the estate to pay the related income tax.

If your spouse and children do not get along, or you have a blended family, you may wish to review this issue with the lawyer who drafted your will.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Taxable Employment Benefits

In 2009, the Canada Revenue Agency (“CRA”) set forth many of its administrative policies on taxable benefits in its informational publication Income Tax Technical News No. 40. As many of these issues are still relevant to many employees today, I will summarize a few of these issues in today’s blog posting.

Loyalty Rewards

Everyone wants points, and the CRA used to require employers to impute an employment benefit on their employees T4 where they earned points by charging work expenses. However, since 2009, the CRA does not require your employer to include an income benefit on your T4 if the points are not converted to cash, the plan is not an alternative form of remuneration or for tax avoidance purposes and you use your own credit card and are reimbursed.

If your employer redeems points on their credit card to provide you with personal travel or other personal benefits, the employer is required to include an income benefit equal to the fair market value of the benefits on your T4.

If you are a shareholder of a corporation and use a corporate credit card to accumulate points and use those points personally, we have seen the CRA assess taxable benefits or shareholder benefits.

Gifts and Awards

Employees can receive up to $500 in non-cash gifts for special occasions (birthday, wedding, child birth) and non-cash awards for employment related accomplishments (regardless of the number of gifts) per year.

Employees can receive a non-cash long service/anniversary award (for at least five year's service) with a total value of $500 or less once every five years. Thus, you cannot receive your first award until you have worked five years, and you cannot receive another award until 5 years later.

Any rewards in excess of $500 become taxable. The annual gifts and long service awards are two separate awards, thus, you can receive both in a year.

Finally, any performance related award (sales target awards) or cash or near cash awards are taxable. The policy does not apply to gifts or awards to non-arm's length employees.

Overtime Meals and Allowances

There will not be a taxable benefit where the following conditions are met:

1. The meal or meal allowance is reasonable (up to $17).

2. The employee works two or more hours of overtime before or after their scheduled hours.

3. The overtime is infrequent (less than 3 times a week) unless as result of an occasional workload requirement such as major repairs or a financial reporting period.

Scholarships and Tuition Fees

For employees, tuition fees and other costs such as books, travel and accommodation that are paid by an employer that lead to a degree or diploma or certification in a field related to your employment are not taxable benefits.  However, if the scholarship or tuition fees are for non-specific employment training, there will be a taxable benefit to the employee.

Where the scholarship or tuition fees are paid for post-secondary education for a family member of an employee, there will be a taxable benefit to the family member (not the employee) receiving the scholarship or tuition.

Where the scholarship or tuition fees paid for a family member are for elementary or secondary education, the taxable benefit is allocated to the employee, not the family member.

Bloggers Note: As my regular readers are aware, I typically answer most questions on this blog. However, due to work related obligations this week, I will not answer any questions on this blog post. I have therefore provided CRA  links within each topic area to assist you with any questions.

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.

Blog for Financial Literacy - Build the Foundation of Financial Discipline - Just Reconcile the Bank, Baby

November is Financial Literacy month in Canada. Today, many Canadian Bloggers have joined together to support the Blog for Financial Literacy campaign by agreeing to write a post on “My Best Financial Tip”. It is hoped the various “tips” will contribute to raising financial literacy throughout Canada. Kudos to Glenn Cooke of Life Insurance Canada for putting the campaign together. Having put together the Bloggers for Charity campaign last year, I know the time commitment required.

My Best Financial Tip

When I decided to join this initiative, I racked my brain for a unique tip that would show my brilliance and ingenuity. However, the more I thought about it, the more I realized the best tip I can give anyone is to “build the foundation of financial discipline”. The conduit for building financial discipline is reconciling your bank account using Quicken software (no, I don’t get paid for mentioning Quicken or reproducing the image to the right) or a similar product.

I have used Quicken for years and its beauty is its relative simplicity. It is a simple single entry bookkeeping system. By single entry I mean you don’t have to know the debit and credit stuff you ignored in your grade ten accounting class. You just need to input the comings and goings in your bank account, some of which can even be downloaded directly from your bank account.

The first step in a staircase of financial discipline is reconciling your bank account on a monthly basis (weekly is better, but I won’t push my luck), so you know how much money you have earned, how much money you have spent and how much money you have saved. 

Once you get into the routine of inputting and reconciling your bank information, it is easy to take it up a notch and climb the staircase of financial discipline, by using your financial information for budgeting, tax return preparation, debt reduction, investing and retirement planning.

Let’s take a brief look at these benefits separately.

 

Budgeting

Once you have established the routine of reconciling your bank transactions, you will have all the information required to budget. Simply print a spending report for the prior month by itemized categories. Instantly you have a visual of how you spent your money. Knowing where and what you spend your money on is vital in preparing a budget (or your budget can simply be last month's spending report, with revised numbers and objectives just written in ink beside last month's numbers). Once you review your spending for the prior month, set a $ value goal for your next month's spending that is say 5-8% less than the prior month. Using a budget to control your spending is the second step in your financial discipline foundation. At the end of each year, print out your spending report for the calendar year. You will probably feel sick when you realize how much you spent on one or two items throughout the year. For me, each year I get nauseous when I review my automobile costs. The annual document can then be used to budget year over year and should be kept to compare to your next year's annual print-out.

Debt Reduction

As per my blog post Debt - An Ugly four Letter Word, personal debt is the number one problem in Canada. Where debt is not the result of losing a job or having your business fail, it often arises because of reckless spending (not in all cases but in many). That spending can potentially be reined in by creating a budget. The next step in building your foundation of discipline is to use the money saved by budgeting to start to pay down your debt. It should be noted that one of the versions of Quicken has a debt management component.

Income Taxes

Once you have the discipline to reconcile your bank account, you now have all the information you need for income tax. Every income tax season I see deductions and credits thrown out the window because clients have not maintained proper records and/or kept the required documents.

Want to know your deductible child care? Just go to your spending report for the year and look at the amount you spent during the year (you should then ensure you have invoices to support your child care payments). Want to know how many donations you made, just review your yearly spending report and then follow up on any missing donation receipts. The same goes for medical expenses. Review your spending summary for the year and ensure you have medical receipts that match those totals. If you claim employment expenses (your employer must sign a Form T2200), you will have a summary of your deductible employment expenses on your spending report.

Investments

The fourth step in building your foundation of financial discipline is using Quicken or whatever software you choose to track your investments. One of the biggest problems my clients have is tracking the cost of their investments, otherwise known as the adjusted cost base (ACB). By using software and diligently inputting all your investment data, you will always know at the click of a mouse your ACB for any investment. In addition, you can tax plan knowing your unrealized gains/losses, dividend and interest information is neatly laid out and available anytime.

Retirement

One day I decided to try and determine how much money I would need to retire, a daunting task. However, as I thought about it, I realized this was actually a fairly easy task. I printed out my yearly spending report by category for the last two years. I then went through each category determining how these expenses would change when I retired. Certain expenses were quickly eliminated, such as spending on my kids University and lease payments (I intend to stop leasing and purchase a car several years before retiring), while other expenses such as clothing and certain types of insurance would be substantially reduced.

Once I knew my anticipated expenses, I could project various retirement scenarios based on longevity. The point being, by having the data readily available, because I was disciplined enough to track the information, I had enough information to at least provide a crude estimate of my retirement needs.

As you can see, building the foundation of financial discipline allows one to progress from just tracking your bank account to determining your retirement needs. However, it all starts from step one, tracking and reconciling your bank account regularly. So as Al Davis would have said, "Just Reconcile the Bank, Baby".

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.

Tax Loss Selling - The 2012 Version

At this time of year, articles on tax loss selling become all the rage. Although I wrote a blog post on this topic last November, I was going to write a new post on this topic. However, after re-reading my blog post from last year; I thought to myself, it was really not half-bad, if I do say so myself. Thus, I have decided to just update my post on tax-loss selling from last year to reflect current dates and legislative changes. I have also added a paragraph on the potential capital gain that may arise on donated flow-through shares that were purchased after March 21, 2011.

I would suggest that the best stock trading decisions are often not made while waiting in line to pay for your child’s Christmas gift. Yet, 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 2012 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; although this year, if the USA takes us to the fiscal edge at year-end, before they fall off their fiscal cliff, we all may have some unrealized capital losses closer to Christmas.

This blog post will take you through each step of the tax-loss selling process. In addition, I will provide a planning technique to create a capital gain where you have excess capital losses and a technique to create a capital loss, where you have taxable gains.

Reporting Capital Gains and Capital Losses – The Basics

All capital gain and capital loss transactions for 2012 will have to be reported on Schedule 3 of your 2012 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 am posting this blog earlier than most year-end capital loss trading articles because I believe you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2011 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 2009, 2010 and 2011 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 2009, 2010 and 2011.

3. For each of 2009-2011, 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 2010 or 2011, review whether you carried back those losses to 2009 or 2010 on form T1A of your tax return. If you carried back a loss to either 2009 or 2010, 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 2009 to 2011, you can potentially generate an income tax refund by carrying back a net capital loss from 2012 to any or all of 2009, 2010 or 2011.

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:

· 2012: realized capital loss of $30,000

· 2011: taxable capital gain of $15,000

· 2010: taxable capital gain of $5,000

· 2009: 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 2012 against the $7,000 and $5,000 taxable capital gains in 2009 and 2010, respectively, and apply the remaining $3,000 against your 2011 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 2011 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 2012 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2011. Alternatively, if you have capital gains in 2012, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

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.

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 2012 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2012 and 2013, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $9,200 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 2014 and you have a capital gain of say $18,000, 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 $27,200 ($18,000 +$9,200 in tax savings) on a $20,000 investment.

Donation of Flow-Through Shares

Speaking 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.

 

Creating Capital Losses-Transferring Losses to a Spouse Who Has Gains

In certain cases you can use the superficial loss rules to your benefit. As per the discussion in my blog Capital Loss Strategies if you plan early enough, you can essentially use the superficial rules to transfer a capital loss you cannot use to your spouse. A quick blog recap: if you sell shares to realize a capital loss and then have your spouse repurchase the same shares within 30 days, your capital loss will be denied as a superficial loss and added to the adjusted cost base of the shares repurchased by your spouse. Your spouse then must hold the shares for more than 30 days, and once 30 days pass; your spouse can then sell the shares to realize a capital loss that can be used to offset your spouse’s realized capital gains. Alternatively, you may be able to just sell shares to your spouse and elect out of certain provisions in the Income Tax Act. However, both these scenarios should not be undertaken without first obtaining professional advice. If you intend to transfer losses this year, you must act quickly to ensure you are not caught by the 30 day hold period and the settlement date issue noted below.

Settlement Date

It is my understanding that the settlement date for stocks in 2012 will be December 24th. 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 2012 by December 24, 2012.

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 sitting on Santa’s lap in the third week of December.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Income Tax Cost of Working Overtime or Businesses taking on New Clients/Customers

Today, I want to discuss what I consider one of the most nonsensical comments I hear at this time of the year; that being, there is no point in taking on any extra work to make more money, since the Canada Revenue Agency will take most of it away in income taxes. I hear this comment from employees who have been asked to work overtime, self-employed consultants offered new projects and shareholders of corporations who have landed new customers/clients. This comment makes no sense on two levels:

Future Earning Power

From a work/business perspective, your employer will never be happy to hear you are not willing to work extra hours or overtime. Any consultant or corporation that turns away work may have made a costly long-term error when you consider the potential work one client can provide over the course of your business's/corporation's lifetime. From an income tax perspective, even at the highest marginal rate in Ontario, where each additional dollar is taxed at 46.41% (or 47.49% if you make over $500,000) you are still approximately 53% better off, by taking on the extra work.

There are times when work should be turned down. Those may include the following:

• You have so much work that you are overwhelmed and if you take on the new client/customer your service or product will be sub-par and your reputation will suffer.
• You are working so hard that your family life is suffering. In this case the extra dollars may cost you something more important than money.
• The new client does not meet your minimum standards for client acceptance.
• You are financially comfortable and the extra money is relatively meaningless to you; not a realistic reason for most of us.

Marginal Income Tax Rates Increase, "Marginally"

Secondly, I just want to make sure everyone understands the marginal income tax rate issue (use the Ontario rates listed below to follow). If you were going to make $80,963 this year, but take on say $4,000 in extra work that results in your income going from $80,963 to $84,963, you will be taxed at 39.41% on that extra $4,000 of income, meaning you will keep 60.59% of the extra income. To put that in perspective, the last dollar you had made before the new work was taxed at 35.39%, meaning you kept 64.61%. Thus, the new work really only raised your marginal income tax rate 4.02%, not enough tax in my opinion to turn down work unless you meet one of the criteria above.

If you were making $130,000 before you took on a new job for $10,000, the first $2,406 of the extra income is taxed at 43.41% (income between $85,415 to $132,406 is taxed at 43.41%), the same rate as the last dollar you made before the income on the new job was taxed. The excess income over $132,406 will be taxed at 46.41%, or 3% higher than your last paycheque was taxed.

It is interesting to note that according to Statistics Canada, the average Canadian salary for 2010 was $49,553. Using the Ontario 2012 marginal rate chart below, that means that the average Canadian employee taking on extra work will be paying tax at the rate of 31.15% on their next $19,000 or so of extra earnings. Of course, the 31.15% rate will vary from province to province; but I use the Ontario rate just to give an approximate marginal tax cost.

I would suggest that anyone who turns down new work because they feel they will be taxed too heavily really does not understand the way the marginal income tax rates work and is making a big mistake. Some people may argue it is the cumulative income tax burden that breaks the camel's back, not the marginal rate. While I understand that argument, in my opinion, work should only be turned down where you meet any of the criteria I list above.

2012 Combined Income Tax Rates Ontario

                               

Tax Bracket                  Marginal Rate*

Up to $39,020                     20.05%

$39,020 - $42,707                24.15%
$42,707 - $68,719                31.15%
$68,719 - $78,043                32.98%
$78,043 - $80,963                35.39%
$80,963 - $85,414                39.41%
$85,414 - $132,406              43.41%
$132,406 - $500,000            46.41%
Over $500,000                     47.97%

* Includes all surtaxes                   

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.