In October, I provided RateHub.ca (an excellent mortgage site) with the following literacy tip for their Facebook page: “Don’t confuse financial literacy with the ability to execute financial, monetary and income tax transactions.” I admit, this tip was a little harsh in tone, but I continue to see more and more misguided souls who think they are tax, legal and financial experts because they have read an article or two, in a blog or book. This issue has arisen in part, because DIY (“Do it Yourself”) investors have become emboldened as some (definitely not all) have been able to successfully manage their own investment portfolios using index funds and “Couch Potato” strategies.
The DIY movement which preaches self-sufficiency for your financial affairs is in my opinion causing many people to consider themselves multi-disciplinary experts when they only have an understanding of a small part of the issue, which can result in costly legal, tax or financial miscues.
I see two distinct issues here.
1. Too many people believe everything they read (especially what they read on this blog :).
2. Most tax and legal related information is general in nature. The writers often do not provide the technical details that can make or break a tax or estate plan because of space constraints and because they need to keep the articles "readable". I have noted significant tax planning errors in the popular “Financial Makeover” that many newspapers publish on the weekend. These errors reflect that even financial planners over-step their expertise and think they are also tax planners and lawyers.
With respect to business and self-employment income, people tend to make some outrageous claims for their home office (that could impair their principal residence exemption) and auto usage that are red flags for the CRA. In addition, they often claim non-deductible expenses such as clothing and life insurance.
For those people with rental properties, I’ve seen people make a mess in the structuring of the initial ownership, their reporting of the personal use of the property (if any) and how they report large repairs (they claim capital expenses as repairs and repairs as capital expenses).
I have written extensively about probate and property transfer landmines, that DIYers set-off when undertaking their own estate planning.
If you transfer property to anyone other than your spouse, you have a deemed sale for tax. I have seen people transfer cottages, stocks, principal residences (not typically an issue upon transfer, but an issue after transfer in that the tax-free status of your home is lost on the portion transferred). You should never be a DIY tax planner when you transfer property of any kind, the tax traps are extensive.
Cocktail parties tend to breed DIY estate planning experts who inform anyone within shouting distance to transfer property to their family members to avoid probate fees. I call this double martini/double trouble advice. The problem is that the CRA does not recognize these transfers where you don’t also transfer the beneficial ownership (real ownership) and thus, a property transfer “for show” does not legally reduce your probate fees on death (at least in the CRA's eyes. Some estate planners are less concerned as they say the provinces do not look into the history of ownership). Even if you feel the transfer is effective for probate purposes, these transfers are not effective for income tax purposes. More importantly, from an estate perspective, these transfers often become catalysts for family litigation. Children litigate over whom mom and dad actually left the property to; where their parents only transferred the property to one of their children for the sake of simplicity, such as putting a child's name on a joint bank account.
In 1994, the government eliminated the $100,000 capital gains exemption, but allowed an election to “bump-up” the value of property you owned at that time up to $100,000. Although this was widely reported in the press, you would not believe how many clients I have picked-up since 1994 that did not make the election on property that had appreciated significantly, typically their cottage or other real estate investments. This omission has cost many people approximately $25,000 in tax that need not have been paid.
Another election that is commonly missed by DIYers is the 45(2) election where you change the use of your home to a rental property. Without this election, you are deemed to sell your home at the time you change its use. While typically this does not result in any income tax at the time (as your principal residence is tax-free), by not making the election, you may owe income tax on the future sale of your home that may have been avoided by making the election.
DIY legal errors are often errors of omission as much as errors of commission. I discuss two of those areas below.
DIYers love to incorporate their own companies. It is cheap and fairly easy to do. The problem is that they almost always limit the share attributes which often requires articles of amendment in the future and may also create problems on the sale of the corporation. In addition, many "DIY lawyers" issue common shares to themselves and their spouses, but almost always never consider discretionary shares that provide for the payment of all or a portion of the dividends to a lower income spouse for income splitting purposes (I will have a future blog on this topic). In the rare circumstance that they do consider discretionary shares, they often do not create the distinction in classes necessary for discretionary shares.
There are many do it yourself will kits. While these kits may ensure you have a legal will, they are simple in nature and in many cases, your life is not as simple as ticking a few basic boxes. I truly cannot comprehend
why anyone with any assets of a substantial nature would not pay for a proper will and power of attorneys for both your competency and financial affairs. This does not even account for the fact in certain provinces you can have a second will to avoid probate on the value of your private corporation, amongst other items.
My advice; do not be seduced by your own financial literacy and overreach your expertise. Just accept that professional advice is often a necessary evil.
The DIY movement which preaches self-sufficiency for your financial affairs is in my opinion causing many people to consider themselves multi-disciplinary experts when they only have an understanding of a small part of the issue, which can result in costly legal, tax or financial miscues.
I see two distinct issues here.
1. Too many people believe everything they read (especially what they read on this blog :).
2. Most tax and legal related information is general in nature. The writers often do not provide the technical details that can make or break a tax or estate plan because of space constraints and because they need to keep the articles "readable". I have noted significant tax planning errors in the popular “Financial Makeover” that many newspapers publish on the weekend. These errors reflect that even financial planners over-step their expertise and think they are also tax planners and lawyers.
DIY Tax Experts
Below, I have some common tax related issues that arise with DIYers.
Personal Tax Returns
If you have a simple tax return with a few T4, T5 and RRSP slips, I have no issue with you doing your own return; although you can still easily be caught by elections and one-time events you may not be aware of. However, if you have self-employment income or rental income, in many cases, being a DIY tax expert can be penny-wise and pound foolish.
With respect to business and self-employment income, people tend to make some outrageous claims for their home office (that could impair their principal residence exemption) and auto usage that are red flags for the CRA. In addition, they often claim non-deductible expenses such as clothing and life insurance.
For those people with rental properties, I’ve seen people make a mess in the structuring of the initial ownership, their reporting of the personal use of the property (if any) and how they report large repairs (they claim capital expenses as repairs and repairs as capital expenses).
Probate and Estate Planning
I have written extensively about probate and property transfer landmines, that DIYers set-off when undertaking their own estate planning.
If you transfer property to anyone other than your spouse, you have a deemed sale for tax. I have seen people transfer cottages, stocks, principal residences (not typically an issue upon transfer, but an issue after transfer in that the tax-free status of your home is lost on the portion transferred). You should never be a DIY tax planner when you transfer property of any kind, the tax traps are extensive.
Cocktail parties tend to breed DIY estate planning experts who inform anyone within shouting distance to transfer property to their family members to avoid probate fees. I call this double martini/double trouble advice. The problem is that the CRA does not recognize these transfers where you don’t also transfer the beneficial ownership (real ownership) and thus, a property transfer “for show” does not legally reduce your probate fees on death (at least in the CRA's eyes. Some estate planners are less concerned as they say the provinces do not look into the history of ownership). Even if you feel the transfer is effective for probate purposes, these transfers are not effective for income tax purposes. More importantly, from an estate perspective, these transfers often become catalysts for family litigation. Children litigate over whom mom and dad actually left the property to; where their parents only transferred the property to one of their children for the sake of simplicity, such as putting a child's name on a joint bank account.
Elections and One-Time Events
In 1994, the government eliminated the $100,000 capital gains exemption, but allowed an election to “bump-up” the value of property you owned at that time up to $100,000. Although this was widely reported in the press, you would not believe how many clients I have picked-up since 1994 that did not make the election on property that had appreciated significantly, typically their cottage or other real estate investments. This omission has cost many people approximately $25,000 in tax that need not have been paid.
Another election that is commonly missed by DIYers is the 45(2) election where you change the use of your home to a rental property. Without this election, you are deemed to sell your home at the time you change its use. While typically this does not result in any income tax at the time (as your principal residence is tax-free), by not making the election, you may owe income tax on the future sale of your home that may have been avoided by making the election.
DIY Legal Experts
DIY legal errors are often errors of omission as much as errors of commission. I discuss two of those areas below.
Incorporation
DIYers love to incorporate their own companies. It is cheap and fairly easy to do. The problem is that they almost always limit the share attributes which often requires articles of amendment in the future and may also create problems on the sale of the corporation. In addition, many "DIY lawyers" issue common shares to themselves and their spouses, but almost always never consider discretionary shares that provide for the payment of all or a portion of the dividends to a lower income spouse for income splitting purposes (I will have a future blog on this topic). In the rare circumstance that they do consider discretionary shares, they often do not create the distinction in classes necessary for discretionary shares.
Wills
There are many do it yourself will kits. While these kits may ensure you have a legal will, they are simple in nature and in many cases, your life is not as simple as ticking a few basic boxes. I truly cannot comprehend
My advice; do not be seduced by your own financial literacy and overreach your expertise. Just accept that professional advice is often a necessary evil.
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.
