Bitcoins - From Scandal to Currency Investment and Tax Treatment

A few months ago, one of my Twitter followers @Shane604 tweeted me a question about bitcoins and how to account for them on your tax return. I thought the topic was interesting and noted bitcoins as a subject for a future blog. However, with the recent publicity about the Winklevoss twins (of Facebook fame) becoming significant buyers of bitcoins and the U.S. drug-dealing/hitman incident and subsequent seizure of the Silk Road website (If you have not read about this, in a nutshell, Ross William Ulbricht allegedly used his website Silk Road to sell drugs in exchange for bitcoins. Ulbricht also allegedly financed with bitcoins, a hitman to murder a British Columbia man), bitcoins moved with a bullet (so to speak) to the top of my topic list.

Since I really was only familiar with bitcoins in name, I decided for intellectual curiosity to look deeper into what the heck bitcoins are. I thus asked my firm’s Marketing Manager Jamie Rubenovitch (who is much younger than me and up on this sort of thing -she goes by @writerinplaid on Twitter) to help clue me in. I am still not sure I am "clued in", but at least I now have a conceptual idea of what bitcoins are. By the way, bitcoins are not capitalized according to the Bitcoin website vocabulary.

What are bitcoins?

Jamie told me Bitcoin is a decentralised digital currency, aka online money or virtual tokens, that made its first appearance in 2009. To start accumulating and using bitcoins, you must setup a “wallet”, which means linking your wallet (account) to a physical address or email address. Your wallet then starts generating bitcoins that can be used to pay for any number of products and services that accept bitcoins. For example, online retailers and websites like WordPress accept payment by Bitcoin. You can send and receive Bitcoin payments similarly to how you use PayPal to pay for things online. Bitcoin “money” is exchanged directly through Bitcoin’s peer-to-peer software and bigger and more significant purchases are now beginning to take place with bitcoins, for example realtor fees or even a housing listing in Saskatoon (although the house never sold and the realtor reportedly now does not include bitcoins as a form of payment on his website).

Where do bitcoins Come From and How are they Created?

Despite Jamie's assistance, I was still confused, so I went to the Bitcoin site where they describe how bitcoins work. The site and this video were slightly helpful in my quest of understanding. Jamie went on to tell me that bitcoins aren’t actual money and they’re not backed by anyone or regulated. According to Gizmodo, “Unlike traditional currency, that's backed up by something, (be it gold, silver, or a central bank), bitcoins are generated out of thin air. Through a process called "mining," a little app sits on your computer and slowly—very slowly—creates new bitcoins in exchange for providing the computational power to process transactions. When a new batch of coins is ready, they're distributed in probabilistic accordance to whomever had the highest computing power in the mining process. The system is rigged so that no more than 21 million bitcoins will ever exist—so the mining process will yield less and less as time goes on, and more people sign up.”

Jamie tried to explain this concept of "mining" but I was having trouble coming to grips with what mining means in terms of bitcoins. I thus searched the web some more and found this article by Alex Wawro of PCWorld. I was still murky on the concept until Alex said the following: "The algorithms involved in bitcoin production are far too complex for most non-crypto-nerds to grasp, which is why most people use the term bitcoin mining. It’s analogous to toiling in tough conditions in search of gold. And as with gold, only a limited supply of bitcoins exists." Okay, thank god, you need to be a "crypto-nerd" to understand this. I now felt better; I was not a complete idiot.

So if you are not a crypto-nerd, are we done? The answer is not necessarily yes; as the article goes on to say "At this point, mining for bitcoins is a very bad idea,” says on Vitalik Buterin, head writer at Bitcoin Magazine. “You’ll basically get nothing. The best way to get bitcoins is to buy them on an exchange.” Finally, a concept I can grasp, investing in currencies.

The Value of a Bitcoin

 

So speaking of investing in currencies, the value of 1 Bitcoin has ranged from 10 cents to over $250 and currently stands at around $145. Those who bought 100 Bitcoins at $1 and sold them at their peak at $250, made a nice $25k profit.

The Dark Side of Digital Currencies

Bitcoin has received some negative attention for being ideal for illicit business such as gambling, selling drugs, etc. (see Silk Road above), since the currency is both unregulated and untraceable. This makes it easy to spend and sell bitcoins internationally without bank charges or interest rates and also without anyone else ever finding out except the person you’re dealing with. Jamie compares this to a Skype call – it won’t ever appear on your phone bill and no one could tap your phone to catch you on the call – basically no one will ever know you made the call. Likewise, no one will ever know you traded (drugs for) bitcoins as the deal won’t show up on your bank statement and has no paper trace. And just like Skype’s peer-to-peer software, Bitcoin’s peer-to-peer software and digital wallets allow users to trade and sell goods for bitcoins without a physical trace.

Taxes and bitcoins

According to this CBC article, the CRA is aware of bitcoins and states there are two tax rules that apply to Bitcoin transactions depending on the usage:

1. When a purchase or sale of a product/service is made with bitcoins, barter transaction rules apply. Since bitcoins aren’t recognized as a legitimate currency, they’re considered a good that is being exchanged, or bartered, in the transaction. For example, if you sell your consulting services, the sale price (dollar value of the bitcoins paid) is required to be reported as a sale.

2. When bitcoins are bought and sold as a currency investment (aka the Winklevoss twins), the corresponding gains or losses may be considered income or capital depending upon the facts and any profits/losses would be taxable.

@Shane604 had a great follow-up question on Twitter: “Particularly, with an anonymous currency, how will one prove a capital loss or will CRA just deny bitcoin losses”.

I don't have an answer to this question. If bitcoins have been converted into a hard currency there is clear evidence for income tax. But how do you claim a loss if there has been no crystallizing transaction into a recognizable monetary unit? I would suggest the CRA would not allow such a loss without some kind of documentary evidence, which is why Shane's question is very interesting, but also very problematic.

Another question that arises is what is the income tax consequence of someone being issued a bitcoin for mining? What was the bitcoin issued in exchange for, if anything – have you been paid for computing power services and thus are those services taxable? I would suggest the answer is no and bitcoins are more akin to a coupon issued by a retail store, but that is just my interpretation.

Bitcoins are currently a bit of a nefarious concept and thus not mainstream. In addition, with no central issuing agency, the IRS has no ability to exert pressure to obtain confidential information like they did with the Swiss Banks. However, clearly taxation agencies such as the CRA already have bitcoins on their radar and with high profile cases such as Silk Road coming to light, I am sure the legal and taxation authorities will be paying more attention to bitcoins in the 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.

Will You Soon be Able to Buy 100 Shares in Sidney Crosby?

Would you like to buy shares in a young hockey phenom like Nathan MacKinnon, the first pick in last year’s NHL draft? What about owning shares in Andrew Wiggins, the Canadian basketball prodigy who many say is potentially the best player since Lebron James. Well, if Fantex Inc. ("Fantex") has its way, you will soon be able to buy and sell stock linked to a pro athlete as easily as buying shares in Bell Canada.

Fantex announced this week that it is filing an initial public offering for Houston Texans running back Arian Foster. The company has filed a prospectus with the Securities Exchange Commission to raise $10.6 million in an initial public offering priced at $10 a share.

Fantex is reportedly paying Foster $10 million for a 20 percent stake in his future income, including contracts, endorsements and other related business revenue.
"Fantex is bringing sports and business together in a way never previously thought possible," said Buck French, co-founder and CEO of Fantex Holdings. "By building a marketplace that allows customers to buy shares in a tracking stock linked to the value and performance of an athlete brand, Fantex is enabling a new level of brand advocacy through ownership. For the first time, people can now invest real money in a stock linked to the brand of a professional athlete."

Fantex says they intend to sign contracts with players to acquire a minority interest in their brand. They then intend to increase that player's brand value by leveraging their marketing expertise.

Fantex states in its prospectus that "the offering is highly speculative and the securities involve a high degree of risk". The company also says that because you will only be able trade athlete tracking stocks on the Fantex platform, there is no assurance as to the development or liquidity of any trading market.

The prospectus, located here, has some interesting comments. It includes a Q&A section in which the following two questions are asked:

Q: What happens if Arian Foster is injured or suffers any other illness or medical condition, retires or fails to make an NFL roster?

A: A significant portion of Arian Foster's brand income is dependent on his continued satisfactory performance in the NFL and is not guaranteed. If he retires from the NFL at any time within two years following this offering, other than as a result of injury, illness or medical condition, we may elect in our sole discretion to terminate the brand contract and he will be required to pay us approximately $10.5 million (net of any amounts previously paid to us by him pursuant to the brand contract). Otherwise, if he stops playing in the NFL for any reason, either voluntary or involuntary, his brand income would likely decline. Arian Foster has no obligation to take any actions to generate brand income, and subject to the limited obligation to reimburse us funds as discussed above, he may choose not to do anything to generate brand income following the date on which we pay the purchase price.

Q: What is brand income under the Arian Foster brand contract?

A: Brand income means any amounts that Arian Foster may receive from and after February 28, 2013, subject to specified exceptions, as a result of his activities (including licensing of rights) in the NFL and related fields (including activities in a non-NFL football league), including each of the following: coaching, football camps, television or Internet programming (with respect to which he either performs in the role of a professional or amateur football player, or performs as himself), radio (terrestrial or satellite), motion picture (solely to the extent Arian Foster appears as himself, such as in a documentary, or is an actor in a motion picture playing the role of himself or an amateur or professional football), literary works the subject of which is Arian Foster, publications, personal appearances, memorabilia signings and events, and the use of Arian Foster's name, voice, likeness, biography or talents for purposes of advertising and trade, including without limitation sponsorships, endorsements, merchandising and appearances.

Craig Pirrong a finance professor at the University of Houston’s Bauer School of Business in this Time Sports article discusses how the deal makes sense for Arian Foster. "Foster is hedging. He’s already in his fifth year: the average NFL career lasts 3.5 years, and according to prior research, running backs have even shorter careers. No player takes more of a pounding than the primary ball-carrier. And NFL contracts aren’t fully guaranteed."

I don't think Foster is the type of player you would want to invest in. While he is an established player, a two-time pro bowl selection and to date a solid citizen, he is not a superstar, has limited upside at this point in his career and is not wildly popular. If someone was going to consider investing in a player, I would suggest they would want a young player, who has huge upside, but has only scratched the surface of their potential.

Would you invest in an athlete? Personally, it is not where I would put my investment dollars. But, if you consider the investment a part of your speculative portfolio, it's probably as good as investing in a junior mining company.

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.

Qualifying Spouse Trusts – How do They Actually Work? -Part 2

Today, in the conclusion of her two part guest post on Qualifying Spousal Trusts, Katy Basi discuses how these trusts actually work. I thank Katy for her excellent posts.

Qualifying Spouse Trusts - How do They Actually Work? 

By Katy Basi

In Part 1 of this blog, BBC aficionados were introduced to the idea of leaving their estate to their spouse using a “qualifying spouse trust” or QST ("QST"). This week we look at the degree of protection that a QST can provide to non-spouse beneficiaries, and at methods of ensuring that a QST functions effectively.

In Monday's post, Fred’s will left the residue of his estate to his wife Wilma by way of a QST. The QST provides that any property remaining in the QST upon Wilma’s death is equally divided among Fred and Wilma’s children. How confident are we that the children will actually receive anything from Fred’s will? How protective is this QST?

The degree of protection afforded by the QST to the children (and any other non-spouse beneficiaries) will depend on two main factors:

1) The trustee’s ability to encroach on the capital of the trust for the benefit of Wilma.

2) The identity of the trustee.

The QST must provide that all income be paid or payable to Wilma. Of course, the trustee can invest the QST in assets producing high amounts of income, or no income at all. (In the latter case, the trustee should be cautious about a potential claim by Wilma.)

As to capital, the QST can provide that:

(i) no one is entitled to the capital of the QST during Wilma’s lifetime (very protective but also very inflexible),
(ii) the trustee can encroach on the capital for Wilma’s benefit under limited circumstances (eg for medical reasons), or
(iii) the trustee has full discretion to encroach on the capital for Wilma’s benefit, even if the encroachments exhaust the trust prior to Wilma’s death.

Clearly, the broader the encroachment power, the greater the likelihood that there will be minimal property remaining in the trust upon Wilma’s death.

A broad encroachment power can still be protective, depending on the identity of the trustee. If Wilma is the sole trustee of a QST with a broad encroachment power, we are back in “just trust me” territory. We are relying on inertia/laziness for protection – Wilma can pull all of the funds out of the QST, but we’re hoping that she doesn’t get around to it!

It would be more protective to name an independent trustee, or Wilma and an independent trustee, jointly, to manage the QST and make encroachment decisions. In my view, some flexibility is necessary re capital encroachment – Wilma could have major medical needs and require some (or even all) of the capital of the QST for very legitimate reasons.

At this point in my explanation of QSTs, many of my clients revert back to the “just trust me” option (no doubt thanking their heavenly stars that they didn’t go to law school), while others go ahead with the QST structure.

For the latter group, it is imperative to note that only assets falling under the will are grabbed by the QST. Therefore, joint assets (which are inherited by right of survivorship, and not under the will) and assets with completed beneficiary designations (eg RRSPs, RRIFs, TFSAs, life insurance, pensions) do not fall into the QST.

It is often necessary to split joint investment accounts (ie create two investment accounts, one in Fred’s name, and one in Wilma’s name) in order to make the QST structure viable. There is often no point in having a spouse trust containing only $20,000, as a trust tax return must be filed every year, and the QST funds must be held in a separate, segregated account which may also incur fees.

Splitting joint accounts is viewed with horror by the probate tax-avoidance crowd, as Wilma may have to then probate Fred’s estate and pay probate tax on his investment account. I am not terrified by this concept, as I view it more as a prepayment of half of the probate tax bill when Fred dies. If the account were maintained as a joint account, probate tax would be payable on the entire account upon Wilma’s death in any event – so we’re just paying half of the probate tax early (this is a very simplified analysis, of course!)

Finally, let’s get to the income splitting benefits of a QST. QSTs are often recommended not for any of the protective reasons mentioned above, but because the QST is a separate taxpayer that has access to the marginal rates of tax. In other words, Wilma can elect to have some or all of the income of the QST taxed in the QST, and essentially income split with her QST (which seems only fair, since she can no longer income split with dead Fred).

However, the federal budget in March of this year indicated that marginal rates for testamentary trusts (which would include QSTs) may soon be a relic of the past. We are waiting for draft legislation to be released, but the idea of inserting a QST purely to income split may be dying a slow, tortured death – we will have to wait and see. [Mark comment: As per this government consultation paper, it is proposed that testamentary trusts will only be allowed a low rate of tax for 36 months].

Income splitting aside, if you or your clients like the idea of their cold, dead hands controlling their assets long after their death, and can live with some complexity in their estate planning, a QST may be just the ticket.

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.

Katy Basi is a Barrister and Solicitor with her own practice, focusing on wills, trusts, estate planning, estate administration and income tax law. Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@katybasi.com. More articles by Katy can be found at her website, katybasi.com.

Qualifying Spousal Trusts – What are They and Why do we Care?

Last week I noted the concept of a qualifying spousal trust in my post on "When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications". The creation and use of spousal trusts can be very complicated, so I thought this week, I would have Katy Basi, an estate expert break down the topic. I just had no idea 88 Fingers Louie and brontosaurus burgers would be that integral to the explanation.

Qualifying Spousal Trusts- What are They and Why do we Care?

By Katy Basi

Whenever I am drafting wills for spouses, I’m usually on the receiving end of both a quizzical look, and a moment of silence, near the beginning of the first meeting.

My clients level a quizzical look at me when I tell them that their plan of leaving everything to each other, and then to their children, means that they are creating “just trust me” wills.

To illustrate this point, we run the scenario of Fred dying and leaving everything to Wilma. After a suitable period of grieving, Wilma marries Barney (I’ve assumed that Betty divorced Barney years ago and has been living it up in Cuba). In Ontario, marriage revokes a will, so Wilma is intestate. Understandably alarmed, she runs to her nearest estates lawyer and draws up a new will, leaving everything to Barney. Wilma is concerned about Barney, as he not skilled at saving for retirement and will need funds in his old age if Wilma predeceases him.

Hmmm. That’s when the moment of concerned silence arrives. Back when Fred and Wilma made their original wills, they were trusting each other to “do the right thing” in the future. Sometimes that works out! Sometimes, not so much.

How can we address this issue? There are three main options:

1) Call up a family lawyer. The family lawyer can draft a marriage contract requiring Fred and Wilma to keep their current estate plan regardless of future circumstances. This is a relatively expensive and time-consuming option, especially if the only goal is to manage estate issues.

2) Create “mutual wills”. Mutual wills are essentially wills where Fred and Wilma promise not to change their wills in the future. I do not recommend mutual wills – they are fraught with legal uncertainty, and litigation abounds when mutual wills are in play.

3) Create “qualifying spouse trusts” (“QSTs”) in Fred and Wilma’s wills.

Let’s say that the residue of Fred’s estate was left to Wilma in a QST. If Fred dies first, a trustee (usually but not always the executor) will hold the residue in trust for Wilma. If there are funds left in the QST at Wilma’s death, it is Fred’s will that determines the distribution of the funds (not Wilma’s!) Upon Wilma’s death, Fred’s will instructs the trustee to divide the remaining funds among their children. This is starting to sound like a good idea!

A QST is a special kind of trust, with beneficial tax effects. When Fred dies, he is considered, for tax purposes, to have disposed of all of his assets at fair market value, and he will be taxable on any capital gains triggered by this disposition. There is an exception to this rule if Fred leaves his assets to Wilma, or to a QST. Fred is then considered to have disposed of his assets at his cost for tax purposes (so that no gain is triggered upon Fred’s death), and the QST is considered to have acquired the assets at that same cost. When Wilma dies, the QST will be considered to have sold its assets at fair market value, finally triggering any accrued capital gains. More or less, these are the same tax effects as if Fred had left the residue of his estate directly to Wilma.

So….we can use a QST in Fred’s will to provide for Wilma’s needs and take care of their children, without being disadvantaged from an income tax point of view. But how do we ensure that the QST functions effectively to protect Fred’s estate? On Wednesday, in Part 2 of this blog post I will address this issue and other practical questions such as how to ensure that the QST applies to the right assets.

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.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estate planning, estate administration and income tax law. Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@katybasi.com. More articles by Katy can be found at her website, katybasi.com.

Plutus Award Nomination and Looking for an Accounting Practice

Plutus Nomination

I want to thank everyone who nominated me for a Plutus Award in the category of “Best Tax-Focused Personal Finance Blog”. It is an honour considering the other great blogs in the different categories and I really appreciate your votes and support for The Blunt Bean Counter blog!

This is the second year in a row I have been nominated in this category and though I am just a little Canadian tax blog up against some large and formidable U.S. based blogs (including Forbes Magazine), I am happy to be waving the Canadian flag.

Accounting Firm Acquisition

On another note, since I know there are lots of accountants who read this blog, I figured I may as well unabashedly use this forum to make it known that my firm Cunningham LLP is looking to acquire an accounting firm.

Cunningham has purchased 5 practices over the last fifteen years or so. We’re looking for firms in the Toronto and very closely surrounding areas only. We typically look for practices with billings between $300,000 to $1,000,000 that have minimal internal bookkeeping and have billing rates that can be supported by a mid-size firm.

So, if you’re looking to sell or retire, or are part of a young partnership and would like to join a larger entity (or know someone who fits any of those descriptions), please contact me by email at bluntbeancounter@gmail.com

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications - Part 2

On Monday, I addressed deemed dispositions, automatic spousal rollovers and the reasons behind spouses deciding not to have mirror wills. Today, I look at the income tax liability and liquidation issues that arise when spouses do not leave all their assets to each other.

Tax Liability

The debts of an estate are paid from the residue the estate. This can be problematic where the intention is to leave a certain amount of money to a spouse and the rest to say the children of a first marriage. For example, an RRSP will transfer to your surviving spouse tax free, but the assets left to the estate for the benefit of the children will be subject to tax and the children will only get the net proceeds. This result is often not the intention of a parent who ignores the tax aspect of their legacy.

Often wills leave specific assets to certain beneficiaries and the residual of the estate to others. For example, if a son is the beneficiary of a specific asset, let's use a cottage, the son gets the cottage and the estate has the tax liability for the deemed disposition of the cottage. Again, that is not the intention of the deceased who assumes his son will be responsible for the tax liability on the cottage.

Lynne Butler of the blog Estate Law Canada says “It's possible to draft a will to state that the person receiving an asset should also pay the tax bill associated with the asset, but almost nobody ever does that. I think more people would do that if they were only aware that it was possible.”

In order to ensure you don’t “stick” your estate with a large tax liability, you may wish to consider Lynne’s advice when drafting any will, but especially where spouses have different wishes.

Liquid vs Illiquid Assets

As discussed on Monday, the deemed disposition rule can result in the estate being left with a large income tax liability; the ability to pay that liability is a function of the liquidity of the remaining assets. Where spouses have different wishes on death, your estate planning needs to consider if you are leaving the estate and/or your spouse with enough liquid assets to pay the deemed income tax liability.

For example, say Sue and her spouse Edward have equal ownership in a rental property. But Sue wants to leave her estate to her children from her first marriage while Edward wants to do likewise to his children from his first marriage. If Sue were to pass away first, there would be a deemed disposition of her 50% ownership in the rental property. Because much of Sue’s wealth is tied up in the rental property, it may be problematic for the estate to pay the income tax liability on her deemed disposition without liquidating the real estate to pay the income tax liability and Edward may not be amenable to doing such.

In situations such as these, where spouses have different wishes, they need to consider ways their estate can pay their final tax liability without a forced liquidation of assets. One possible solution is the use of insurance. Many people purchase insurance to cover their anticipated income tax liability on their death. Another alternative where there are significant liquid assets is to ensure the estate always maintains enough cash to cover any potential income tax liability on death.

Plan

Where spouses have different wishes upon death, the income tax consequences can get ugly. While in good health, spouses either independently or jointly, need to review these consequences with their accountant(s) or lawyer(s) to ensure they have considered the possible consequences and have a plan.

Next week, I will continue with this somewhat morbid theme and post a two-part guest blog by Katy Basi on "qualifying spousal trusts". Katy will discuss how they work and why you would consider using them. Katy is back by popular demand after guest posting on New Will Provisions for the 21st Century in respect of RESPs and Digital Assets.

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.

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications

You must admit, nobody has as many uplifting titles for their blog posts as I do. I have previously had such cheery titles as “Stress Testing Your Death” and “Is it Morbid to Plan for an Inheritance”. So today, in keeping with my "Morbid Mark" theme, I will discuss the tax implications that can occur when one spouse passes away, and does not will all of their assets to their surviving spouse.

Deemed Disposition Upon Death

Upon death, you are deemed to have disposed of your capital and non-depreciable property (typically your principal residence is tax-free) for proceeds equal to the fair market value (“FMV”) of the assets immediately before death. If the FMV of any property is greater than the original cost of that property, your executor must report a capital gain on your income tax return for the year of death (known as a terminal return).

For example, if John passed away on September 1, 2013 and he owned shares of Bell Canada worth $40 on September 1st, that he had purchased for $28 several years ago, his estate must report a deemed capital gain of $12 per share on his terminal return. The same would hold true for a rental property, which may also have additional potential issues, such as the recapture of capital cost allowance (depreciation).

Automatic Spousal Rollover

There is an exception to the deemed disposition rule, where the property passes to the deceased spouse, common-law partner or a "qualifying spousal trust". In this situation, the transfer takes place at the adjusted cost base (ACB) of the property, not the FMV of the property and the deemed capital gain is deferred until the spouse or common-law partner dies; or the property is disposed of by the spouse or common-law partner. So if John was married to Mary and left everything to her in his will, the Bell Canada shares would transfer to Mary tax-free at a cost base of $28.

In the good old days of Ozzie and Harriet, the automatic provision was fairly standard. People stayed married and both spouses would usually have mirror wills, leaving all or most of their property to each other.

Today, with the high rate of divorce, second families and spouses who have independent thoughts, it is not that unusual for spouses to have different wills or wills in which they only leave some assets to their current spouse.

Where spouses have different wishes in their wills and don’t leave all their property to their surviving spouse, the deemed disposition rules noted above come into effect. The resultant income tax liability can in some cases be large and where assets are not liquid, the payment of those taxes can sometimes be problematic.

Why Would Spouses Have Different Wishes

There are a myriad of reasons why spouses may not have mirror wills or leave all their assets to each other. Here are some common reasons:

1. Second families- A testator may structure their will to only leave a certain amount to the surviving spouse, or to a spousal trust for their surviving spouse so they can leave other property and monies directly to their children from the first marriage; this triggers the deemed disposition rules on the property left to their children.

2. Black Sheep Children -One spouse may have an issue with one of their children and be concerned their surviving spouse will turn around and leave money to the black sheep child when they pass away.

3. DINKS – The “double income no kids” cohort often have other family members they wish to benefit from their estate, such as parents, siblings, nieces and nephews. They are confident that their surviving spouse has enough assets of their own and will not need a large inheritance in order to have a prosperous retirement. According to estates lawyer Katy Basi “The wills that we draft for childless testators are often long and sometimes quite complicated. The tax implications of the estate plan need to be carefully considered.”

4. Charitable Wishes – Spouses often have different charitable views. One spouse may want to leave a significant portion of their wealth to charity while the other does not. In this case, the concern is not an income tax issue, as the donation(s) eliminate most of the tax liability, but the issue becomes a question of whether assets must be liquidated to enable the executor to make the donations in the will.

As I have been told my blog posts are too long, I will stop here today. On Wednesday, I will discuss the income tax implications, liquidity concerns and planning issues when spouses don't leave all their assets to each other.

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.

Five Ways to Make a Charitable Donation

On Monday, I vented about the First-Time Donor’s Super Credit, an income tax program created to incentivize Canadian’s to make charitable donations. Today, I get off my soapbox and discuss alternative ways to make charitable donations and the related income tax consequences.

Cash Donations

Where an individual makes a charitable donation of cash, there is a federal non-refundable tax credit of 15% on the first $200 of donations. For donations in excess of $200, the non-refundable tax credit increases to 29%. In addition, the provinces provide provincial tax credits. In Ontario, for many people, the actual tax savings for a donation will range from approximately 40% to 46% of your actual donation, for any

donations in excess of the $200 limit.

Thus, for many Canadian’s, the tax credit obtained when making a donation is close to almost one-half of the actual donation made; not a bad tax savings vehicle, especially when you factor in the altruistic aspect of helping those less fortunate than you.

Donations of Public Securities

If you incur a capital gain on the sale of a stock or bond, the income tax rate on that gain at the highest marginal income tax rate is approximately 23%. However, if you donate securities, such as a stock or bond, listed on a prescribed stock exchange, the taxable portion of the capital gain is eliminated and the net after-tax cost of the donation is reduced substantially.

For example, if a high rate Ontario taxpayer (not super-rate) sells a stock for $3,500 that has an adjusted cost base of $500, they would owe approximately $700 in income tax on the capital gain the following April. If they donate the gross proceeds of $3,500, the donation would result in income tax savings of approximately $1600 when they filed their return next April. The net after-tax cost of the donation is $2,600 ($3,500 value of shares/donation less the $1,600 donation tax savings plus the $700 capital gains tax)

However, if the taxpayer donated the stock directly to a charity, the organization would receive $3,500, the taxpayer would receive a refund of approximately $1600 and they would owe no taxes on the capital gain, making the net after-tax donation cost only $1,900.

Clearly, where you have a stock or bond you intend to sell and you plan on donating some or all of the proceeds;  a direct contribution of the security to a charity is far more tax efficient.

Donation of Flow-Through Tax Shelters

Prior to March 22, 2011, you could also donate your publicly listed flow-through shares to charity and obtain a donation receipt for the fair market value of the shares. 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 very complicated), if you paid $10,000 for any post March 22, 2011 flow-through shares, only the gain in excess of $10,000 will now be exempt and the first $10,000 will be taxable.

If you are considering donating flow-through shares to charity, ensure you speak to your accountant as the rules can be complex and you may create an unwanted capital gain.

Donations on Death

Many people are hesitant to make substantial donations while alive, as they are concerned they may require those funds to pay for medical care or to cover their day to day living expenses. However, they fulfill their altruistic wishes by making a large donation(s) on their death. In general, donation bequests made in your will are deductible on your final terminal tax return, with no limitation. The requirements for supporting these donations can be found on page 16 & 17 of the CRA guide, T4011, Preparing Returns for Deceased Persons 2012.

The guide says “Support the claims for donations and gifts with official receipts that the registered charity or other qualified done has issued, showing either the deceased’s name, or the deceased’s spouse’s or common-law partner’s name".

Your executor can also claim charitable donations made through your will as long as they can support the donations. The type of support you have to provide depends on when the registered charity or other qualified donee will receive the gift:

•  For gifts that will be received right away, provide an official receipt.

• For gifts that will be received later, provide a copy of each of the following;

- the will
– a letter from the estate to the charitable organization that will receive the gift, advising of the gift and its value; and
– a letter from the charitable organization acknowledging the gift and stating that it will accept the gift.

Private Foundation

Private Foundations are beyond the scope of today’s post, although, I may discuss this topic in the future. However, for purposes of today’s blog post, I just want to note that wealthy individuals may wish to consider the use of a private foundation. These foundations are typically funded with a large initial charitable contribution (which is a creditable charitable donation as per the general discussion above). The foundation is often formed to create a sense of family philanthropy and donation decisions are often made as a family. Foundations are heavily administered by the CRA and must abide by a number of tax rules, including minimum donation disbursement requirements.

Your Time

If you give your time and effort to a charity, you cannot receive a charitable donation for your time or any services your provide (see this link). Therefore, I have not included time as of the five ways to make a charitable donation. However, in many ways, it is the best charitable contribution you can make. As someone who has been a Big Brother, granted wishes to various children through the Make-A-Wish program and been on other charitable boards, giving of your time can be very self-satisfying, while helping others in need. Whether you make cash contributions or not, you should consider giving your time and effort to your favourite charity.

As I circle back to my post on Monday, in my opinion, the income tax benefits already in place and the satisfaction of helping others in need should be sufficient incentive to make a charitable donation. We should not require a “super credit” to consider making a donation in the first place. But as I stated, if this credit helps even a few people get in touch with their more charitable sides, then I can’t fault it.