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. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, July 27, 2015

The Best of The Blunt Bean Counter - Dealing With the Canada Revenue Agency

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a May, 2011 post on dealing with the Canada Revenue Agency ("CRA") that is as relevant today as it was four years ago. I would not be surprised if many of you have not already received an information request as detailed below. I know I have already received 25 to 30 of these requests to date, in relation to my client's e-filed tax returns.

Dealing With the Canada Revenue Agency

I discuss below, the six typical circumstances by which an individual may end up dealing with the CRA during the year. 

The least worrisome of the six situations is where you initiate contact with the CRA to report a late income tax slip (such as a T3 or T5 slip), or you realize you missed a deduction or credit (such as a donation slip, medical expense or RRSP receipt). These situations are very straight forward and relatively painless. You or your accountant file a T1 adjustment request using form T1-ADJ E to report the additional income or claim the additional expense or credit. You would typically attach the receipt to the form and most of these requests are processed without further query from the CRA.

The second circumstance is where you receive an information request from the CRA. These requests often strike fear into my client's hearts, but are typically harmless. In this situation, the CRA usually sends a letter asking for back up relating to a deduction or credit claimed on the return. Generally these requests by the CRA are to provide support for items such as a donation tax credit, medical expense claim, a child care expense claim, a children's fitness tax credit claim or an interest expense claim. These requests are fairly common and more often than not, relate to personal income tax returns that are e-filed. You have 30 days to respond to these requests, however, time extensions are typically granted if you call the CRA and request such.

The third situation, and a step up on the anxiety meter, is the receipt of a Notice of Reassessment (“NOR”) from the CRA. A NOR may be issued for numerous reasons such as; not responding to an information request, the receipt by CRA of a T3/T4/T5 slip that was not reported in your return, or a reassessment based on an audit or review of your return as discussed below.

The fourth circumstance is typically not pleasant. Under this scenario, the CRA has selected you for an audit, either randomly or because you have come to their attention for some reason. An audit can take the form of a desk audit which is less intrusive or a full-blown field audit. Desk audits are typically undertaken to review a specific item that the CRA finds unusual in nature and you have 30 days to respond.

A full-blown audit could encompass a review of self-employment expenses, significant expense or deduction claims, or a full review of your personal or corporate income tax filings for a specific year or multiple years. In this situation, you will be sent a letter requesting certain information and you will be required to provide such to a CRA auditor. This process could take months, and if the CRA auditor is not satisfied by your documentation, or reasons for claiming certain expenses or deductions, they will issue a revised NOR.

Upon the receipt of the reassessment, you will have to determine, likely in conjunction with your accountant, whether the CRA’s assessment is justified. If you don’t feel it is justified, you need to consider if the amount of reassessed tax is significant enough to warrant the time and energy to fight the reassessment. If you decide to "fight" the reassessment, you and/or your accountant would file a Form T400A Notice of Objection. In this fifth situation, the Notice of Objection would state the facts of your situation and the reasons that you object to the CRA’s reassessment. The objection will then be reviewed (probably months later) by a CRA representative and you can make and support your case as to why the CRA has incorrectly assessed or reassessed you.

It is very important to make sure that you file a Notice of Objection on a timely basis. For an individual (other than a trust) the time limit for filing an objection is whichever of the following two dates is later: one year after the date of the returns filing deadline; or 90 days after the day the CRA mailed the reassessment. For corporations, the time limit is 90 days.

Finally, the sixth and final situation, and last resort, is to go to tax court because your Notice of Objection was not successful. There is an informal tax court procedure if your income tax owing is less than $12,000. Where the income tax owing exceeds $12,000, the process becomes formal and is costly and time consuming.

The above summarizes the various circumstances and situations under which you may deal with the CRA in any given year. Hopefully if you have any contact with the CRA it is only in connection to situation #1 or #2.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, July 20, 2015

The Best of The Blunt Bean Counter - How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 5

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting Part five of my 2014 six part series titled "How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does!" If you have not read this series, the links to each part of the series can be found down the right hand side of my blog, under the retirement section.

I decided to re-post this particular blog post because recently there have been numerous articles discussing whether the 4% withdrawal rate is too high (The 4% withdrawal rule is one of the most commonly accepted rule of thumb retirement strategies. Simply put, the rule says that if you have an equally balanced portfolio of stocks and bonds, you should be able to withdraw 4% of your retirement savings each year, adjusted for inflation, and those savings will last for 30-35 years).

One of the reasons retirement experts are concerned about using the 4% rule is that our longevity continues to increase. Longevity is just one of the many factors that can impact not only your withdrawal rate in retirement, but the funding of your nest egg.

Today's post discusses these various factors and how the unpredictable nature of most of these factors, make it virtually impossible to determine a definitive retirement number and is why I say the "Heck if I Know or Anyone Else Does" how much money you need to retire.

Your Longevity - The Ultimate Wildcard

It goes without saying, that if we knew who long we would live, retirement planning would be a lot simpler. Unfortunately, the best we can do is plan based on longevity studies and family medical history. The Vanguard paper I referenced in Part 3 of this series cites such as study by the Society of Actuaries which found:

“there is an 80% chance that at least one spouse will live to age 85, a 55% chance that one will live to age 90 and 25% chance one spouse will reach 95.”

In Canada, the average male lives to approximately age 79 and the average female lives to approximately 84. Based on the above, your retirement planning should at a minimum assume one spouse will live to at least 95 years old.

Inflation – Grasping for the unknown

The rate of inflation can drastically alter your retirement savings and consumption. An economic environment of low market returns and high inflation can severely impact the funds you accumulate to fund your retirement and the real returns you achieve in retirement. Conversely, interest rates tend to rise with inflation, providing a potential buffer if you lock in higher interest rates and inflation subsides (I remember Canada Savings Bonds paying 19.5% interest in 1981 when inflation was around 12.5%, however, inflation was back down to 4.5% by the end of 1983 and many people were very pleased they had CSB's or GIC's paying very high rates of interest for many years). An average inflation rate of 2% will mean that the $50,000 you expect to spend in retirement in 2014 dollars will require approximately $61,000 in spending in 2024.

One of the criticisms of the 4% rule is that the models cumulative inflation adjustment may force you to take larger and larger withdrawals without regard to your actual spending requirements. Substantive evidence for this criticism is provided below by David Blanchett, the head of retirement research at Morningstar in Chicago.

In this Wall Street Journal article by Kelly Greene, Mr. Blanchett said the following about the correlation between spending and inflation. "Pretty much every paper you read about retirement assumes that spending increases every year by [the rate of] inflation." Ms. Greene went on to say that "when he analyzed government retiree-spending data, he found otherwise: Between the ages of 65 and 90, spending decreased in inflation-adjusted terms. Most models would assume that someone spending $50,000 the first year of retirement would need $51,500 the second year (if the inflation rate were 3%). But Mr. Blanchett found that the increase is closer to 1%, which has big implications over decades, 'because these changes become cumulative over time,' he says".

Sequence of Returns – Bull vs Bear Markets upon your Retirement

The various studies that support a 4% retirement withdrawal, included periods of both bear and bull markets. If you are lucky enough to retire at the beginning of a bull market, your retirement funding will be drastically different than if you retire at the beginning of a bear market. William Bergen in his original 1994 article said:

“This is a powerful warning (particularly appropriate for recent retirees) not to increase their rate of withdrawal just because of a few good years early in retirement. Their “excess returns” early may be needed to balance off weaker returns later.”

It is interesting to note that Mr. Bergen showed that even if you started retirement in the great depression or in the recession of 1973-1974 (which also included a period of high inflation); your money would still have lasted over 30 years, because of the power of stock market recoveries.

However, Moshe Milevsky and Anna Abaimova in this report for MetLife (see page 4 of the report, page 7 of the PDF), very clearly reflect the dramatic difference in retirement outcomes you will have when you have negative market returns early in your retirement vs later in your retirement.

In this blog, Wade Pfau states that:

In fact, the wealth remaining 10 years after retirement combined with the cumulative inflation during those 10 years can explain 80 percent of the variation in a retiree's maximum sustainable withdrawal rate after 30 years.”

Thus, prudent planning would be to start your retirement following a bear market :).

Registered vs. Non-Registered Accounts

The allocation of your retirement funds between registered (RRSPs, LIRAs, Pensions, etc.) and non-registered accounts (bank, investment, TFSA, etc.) will have a significant impact upon your cash flow in retirement. If you consider all the money in those accounts as capital, the capital in the registered accounts is fully taxable, meaning that if you are a high income tax rate taxpayer, you may be paying as much as 46% or higher upon the withdrawal of those funds. For non-registered accounts, the withdrawal of capital is tax free. This issue raises the much debated question of TFSA vs. RRSP as you accumulate your retirement nest egg and for those who own corporations, the issue of salary vs. dividend (see my three part series "Salary or Dividend? A Taxing Dilemma for Small Corporate Business Owners" from last year on this issue and my 2014 Update). The drawdown of your RRSP/RRIF and/or funds from your holding company in a tax effective manner requires a detailed analysis of your specific situation and cannot be addressed here in a generic manner; however, suffice to say, it is an important cash flow issue. 

Home Sweet Home

Some planners suggest you try and exclude your home from your retirement savings and have it serve as a back-up for any retirement shortfall. However, for many people, part of their retirement will include at least the incremental benefit of downsizing their home. For others, their retirement will only be funded by selling their home and moving into an apartment or reverse mortgaging their home.

Spending in Retirement - Sharpen your Pencil

If you are diligent about this process, you should be able to at least determine a ballpark number for your anticipated spending upon retirement. The spending wildcard for many people is travel. Good health will allow for years of travel, while poor health will not only restrict how much you can travel, but could lead to significant medical costs. In a perfect retirement model you would factor in greater spending as you begin retirement and smaller spending as you grow older. In addition you need to consider occasional and lump sum expenditures.

The aforementioned David Blanchett suggests many peoples spending in retirement maybe overstated by as much as 20% in traditional retirement models. Mr. Blanchett details these views in a very interesting paper on “Estimating the True Cost of Retirement”.

You may also wish to consider your spending in context of the three stages of retirement Michael Stein CFP came up with in his book “The Prosperous Retirement, Guide to the New Reality". In his book Michael suggests there are 3 stages of retirement:

Go-Go Stage- Retirees maintain the same lifestyle and their spending remains fairly constant with their spending pre-retirement, essentially because they still consider themselves “young” and travel extensively.

Slow-Go Stage - Stein says that between the ages of 70-84, your budget will decline 20-30% as your body is not quite able to keep up with your mind and your intended activities or you just become weary of airports and trains.

 No-Go Stage - As you reach 85+, health issues tend to cause you to restrict travel and you are tied to a certain place, be it your home or a retirement home.

Pensions - The Older you are, the more you Appreciate them

If there is one thing this series has revealed to me, is that I truly underestimated the worth of a defined benefit pension plan. I had never really considered the possibility of purchasing an annuity in retirement, however, the more calculations I undertook, the more I realized that without a company pension plan, it may be prudent to consider purchasing at least a small annuity in my retirement. Moshe Milevsky and Alexandra MacQueeen suggest that annuities should be used to “pensionize” part of your retirement funds and that it may be worth the piece of mind to forgo potential growth of your nest egg to provide some comfort that you will not outlive your retirement funds.

If you have a pension plan that covers off most of your retirement spending needs, you are afforded the freedom to take greater equity risk in retirement; since you can withstand stock market swings, knowing your day to day costs are covered off by your pension. Those without a pension face the dilemma of whether to annuitize some portion of their retirement funds or not.

Healthcare coverage - Will we be Fully Covered in 25 Years

As Canadians, we assume we will always have full medical coverage. But who knows if the government will have the money in twenty-five years to support a top-heavy population. In addition, if your health deteriorates and you require private care, all your retirement funds could be eaten up by those costs.

Interest Rates – Will they ever Rise?

People have been expecting interest rates to rise for several years. Many of those same people now think the US government will be forced to keep rates low for the foreseeable future. Selfishly, higher interest rates would be welcomed by many people in or near retirement. A spike in interest rates would likely cause some disgruntled stock market investors to re-allocate their equity investments to fixed income instruments.

Inheritances - No One Plans for an Inheritance do They?

Baby boomers will inherit a massive amount of money in the next twenty or so years. However, the size of individual inheritances will fluctuate widely based on the longevity of their parents. I wrote a blog a while back on whether you should plan for an anticipated inheritance. I suggested that if you are certain you will inherit money, you should at least consider factoring a discounted amount of your potential inheritance into your retirement planning.

Lifestyle in Retirement

For Canadians who live in large cities, have expensive homes and lifestyles, an easy solution to an underfunded retirement is to downsize/sell your home and move to a less expensive city. Whether you are willing to do that is another question.

Evolving into retirement - Keeping the Income Stream Alive

Stan Tepner, CPA, CA, MBA, CFP, TEP, First Vice-President & investment advisor with CIBC Wood Gundy and an advisor to some of my clients, told me "he often finds many people consider retirement an absolute event. One day you are working and the next you’re golfing". He adds "that more and more people 'evolve' into retirement. They may shift into part-time employment or self-employment. This shift may be required for financial reasons or because you wish to keep your mind sharp. Either way, the extra income will assist in funding your retirement needs, especially if you have a savings shortfall because of poor market returns or you have just miscalculated your actual retirement needs".

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, July 13, 2015

The Best of The Blunt Bean Counter - Cottages - Cost Base Additions, are They a New CRA Audit Target?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a May, 2012 blog on cost base additions to your cottage. You may want to print this out and read it while you have a beer at your cottage next weekend and then search your cottage for all your missing receipts :)

Cottages - Cost Base Additions, are They a New CRA Audit Target?

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

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

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

Income Tax Issues

Before I charge ahead with this post, I think a quick income tax primer is in order. Prior to 1982, a taxpayer and their spouse could each designate their own principal residence (“PR”) and each could claim their own principal residence exemption (“PRE”). Therefore, where a family owned a cottage and a family home, each spouse could potentially claim their own PRE, one on the cottage and one on the family home, and accordingly the sale of both properties would be tax-free.

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

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

1. If your cottage was purchased prior to 1972, you will need to know the fair market value (“FMV”) on December 31, 1971; the FMV of your cottage on this date became your cost base when the CRA brought in capital gains taxation.

2. In 1994 the CRA eliminated the $100,000 capital gains exemption; however, they allowed taxpayers to elect to bump the ACB of properties such as real estate to their FMV to a maximum of $100,000 (subject to some restrictions not worth discussing here). Many Canadians took advantage of this election and increased the ACB of their cottages.

3. Many people have inherited cottages. When someone passes away, they are deemed to dispose of their capital property at the FMV on the date of their death (unless the property is transferred to their spouse). The person inheriting the property assumes the deceased's FMV on their death, as their ACB. 

The Principal Residence Exemption

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

Putting together the pieces of the ACB Puzzle

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

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

Finally, most people have made various capital improvements to their cottages over the years. For income tax purposes, these improvements are added to the ACB you have determined above. Examples of capital improvements would be the addition of a deck, a dock, a new roof or new windows that were better than the original roof or windows, new well or pump. General repairs are not capital improvements and you cannot value your own work if you are the handyman type. I would argue however, that the cost of materials for a capital improvement would qualify if you do the work yourself.

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

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

The Audit Issue

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

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

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

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

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

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

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

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

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

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

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

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

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

Bloggers Note: Here is a link to an excellent BDO tax memo titled "Calculating cottage capital gains: have you accumulated all eligible costs? " which you may also wish to read. 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, July 6, 2015

Gone Golfing for the Summer

Bigwin Island Golf Club - 6th hole
This summer for the second year in a row, I will be posting a “Best of The Blunt Bean Counter” blog each week, so I can spend some time golfing and enjoying the good weather (crossing my fingers).

Now you may be asking yourself if I am being a little presumptuous thinking I have enough quality blog posts to run another series of my "best of". But that is the benefit of being a blogger in cyberspace; you can be delusional thinking all your blogs are great reads :).

Anyways, I hope you have a great summer and I will see you with some new blog posts (many based on your suggested topics) in September.