What Income Tax Rate(s) Should You Use in Estimating Your Estate Tax Liability?

In my last blog post, I discussed that for tax and estate planning purposes, you should estimate your current estate tax liability and then plan how your estate will cover off this liability (which in many cases is an ever growing tax liability). Today, I want to discuss what income tax rate(s) you may wish to use in estimating your estate tax liability.

For clarity, this exercise to estimate your estate tax liability is not meant to be definitive calculation (if you wish a definitive calculation, you will need to engage your accountant and possibly a business evaluator). This exercise is intended to provide you with a starting point, so that you have a number to plan with, whether your intention is for your estate to cover off this potential tax liability by a sinking fund, cash on hand, liquidation of your assets, insurance or some combination of all of the above.

One would think the income tax rate(s) to be used in estimating your estate tax liability would be a straightforward calculation, but there is a little more than meets the eye. Please keep in mind, that I am assuming you are the last spouse to pass-away for this estimated calculation, as if you are the first spouse to die and transfer your assets to your surviving spouse, there is no tax at that point in time.

For RRSPs, RRIFs or any other income related items taxable on death, I usually use the highest current marginal rate of 53.53% (in Ontario). This assumes your estate’s income tax rate is mostly high rate in the year of death. While that is typically the case with most of the people I work with, that may not be your case and you may be able to utilize a lower marginal tax rate, but if you want to be conservative, the highest marginal rate builds in a buffer.

As most people like to think/hope personal marginal rates will not increase much in the future (although many of us thought the same when rates were 45%), they are comfortable using the current 53.53% rate for a future rate on income type items.

Things become trickier when determining the appropriate tax rate to use on capital items. The highest current marginal capital gains rate is 26.76% (in Ontario). However, many people assume capital gains rates are going to increase in the future, so the rate to use is not entirely clear. Thus, I typically provide an alternative estimate using 26.76% and another using 40% assuming a higher future capital gains inclusion rate of 3/4 of the capital gain (as opposed to the current inclusion rate of 1/2 of the capital gain) for capital gains rates on personally held assets. If you do not expect your estate to be at the highest marginal rate on your death, you can use the lower marginal rates; but remember, the inclusion of your RRSP/RRIF value on your death will in many cases move you into a much higher income tax bracket. 

The future capital gains rate is even more complicated for shareholders of private corporations, since their shares are potentially subject to double taxation if proper steps are not undertaken to alleviate this liability. Double taxation can occur where the estate pays tax on the deemed disposition reported on the owner’s terminal tax return, and then the estate pays further tax when it removes the assets from the corporation in the form of dividends to the estate. 

There are two tax planning strategies that can generally eliminate any double tax; however, both techniques have some potential restrictions:

(1) The first is known as a subsection 164(6) loss carryback. In simple terms a loss is created on a share redemption by the estate that reduces or eliminates the capital gain that arose as result of the deemed disposition on death.

(2) The second, known as the pipeline strategy allows the estate to remove the corporate funds generally tax-free. This is achieved by transferring the deceased owner’s shares to a new corporation and using share redemptions and a netting of promissory notes to remove those funds tax-free.

However, a pipeline strategy can be problematic in certain circumstances and the strategy relies upon the CRA allowing such a strategy in the future. This makes determining a future capital gains rate potentially problematic. So, when I prepare my estate tax liability, for private corporations I use a 30% rate as a low-end and a 40% rate as a high-end estimate (Note: unlike above, I am not using the 40% rate because of the prospect of a capital gain rate inclusion increase, but as a dividend rate if a pipeline cannot be undertaken or is partially blocked).

If your private company shares qualify for the lifetime capital gains exemption because they are Qualified Small Business Corporation shares, you will need to factor in the fact that $971,190 (as of 2023) of the capital gain will not be taxable. 

Finally, the tax rate on a private corporation share can also be impacted by corporate attributes such as the Capital Dividend Account and refundable income taxes on hand (NERDTOH and ERDTOH), which again makes it more difficult to determine the appropriate income tax rate. Where your corporation has these tax preference items, your accountant needs to undertake more detailed calculations. 

The question of which tax rates should be used for an estate tax liability estimate is somewhat complicated as discussed above and subject to future taxation legislation and government policy. Thus, as noted above, I personally provide clients with two estimates: (1) Using the highest marginal rate for income items and a 30% capital gains rate and (2) a second more conservative estimate using the highest marginal rate for income items and a 40% capital gains rate. This at least provides a range of their potential future estate tax liability. 

For purpose of this blog, I am hoping/ignoring the possibility that a future government implements an Estate Tax like that in the United States (the estate tax can go as high as 40% Federally subject to exemptions) as that would significantly affect any future tax liability planning.

Finally, as the above discussion is premised on estimates, please ensure you consult your accountant or estate planning specialist for specific estate planning advice and the determination of your estate tax liability. This advice should be obtained earlier rather than later and then reviewed every few years thereafter as personal circumstances change and new legislation is introduced.

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.

It’s Personal Tax Time – How to Get on Your Accountant’s Good Side

Many readers of this blog use accountants to prepare their personal income tax returns. You can take three approaches in working with your accountant. You can provide them with:

1. all the detailed information they request
   
   
2. most of the information, without overly exerting yourself
   
   
3. the minimum information, since you pay good fees

From a client perspective, all these approaches are reasonable to some degree. However, as a retired public accountant of 35 or so tax seasons, I suggest you lean towards approach number one, to the greatest extent you can.

I say this for two reasons. The first reason is simply the better organized you are, the more time your accountant can spend dealing with minimizing your taxes. The second reason is that many Canadians invest in mutual funds (T3 slip) and limited partnerships (T5013 slip). Both these investments have March 31st deadlines for issuing the T3’s and T5013’s, so clients often have to wait until late March and early April to receive their slips.

Consequently, your accountant’s workload has likely changed substantially over the last five to seven years, such that 45-60% of the client information comes in after say April 7th. In the good old days, that number was likely only 25-35%.

I am not expecting you to shed too many tears about your accountant’s working conditions given the fees you pay them. I am telling you this because the easier you make it for them to work on your return (rather than chase information), the better it is for you.

So, with the theme of be nice to your accountant, I list below some do's and don'ts for providing your tax season information to your accountant. 

I will start with the things you want to avoid doing.

Tax Season Don'ts

1. Do not hand your accountant all your tax slips in the original envelopes 
   
   
2. Do not send your accountant PDF’s of each tax slip as they arrive. If you prefer to use email or your accountant has a portal (in lieu of paper copies), try to send a first batch of as many initial slips as possible. Then make a list of what you think is missing (such as T3’s, T5013’s, straggler donation slips) and send a second batch all these slips. Once that is done, it is fine to send amended or straggler slips one by one 
   
   
3. Do not provide your prior years tax returns and tax slips to your accountant. All tax programs have prior year information carried forward if required and most accountants have paperless systems of prior years slips if a past tax slip is required for any reason 

Tax Season Do's

1. Provide your accountant any investment, capital gains and foreign reporting information provided by your investment advisor
   
   
2. Have your children download their tuition receipts from their University portal
   
   
3. Ensure your have official donation slips for all your donations. If you only have a confirmation of your payment from the internet, that is not an official receipt and you will need to request an official receipt from the organization. If you want to earn a gold star, summarize the donations for your accountant so they have a total to compare against their total. This is definitely more than expected, but it acts as an excellent check and balance, as I have had many variances over the years and a summary provides a quick way to see if the client’s total was off or the accountants total was off.
     
4. If you made a donation of marketable securities (see this blog for more detail), make a note for your accountant. This is something they will likely pick-up, but it can be missed sometimes as the notation on the donation slip is sometimes small or in a corner somewhere and easy to miss.
   
   
5. For any medical expenses, where possible get one summary receipt, such as for a chiropractor or physio etc. Some pharmacies also provide a yearly summary, so you don’t have to provide 34 individual receipts.  
   
   
6. Still with medical receipts, if you are audited by the CRA, they will want to see a medical receipt that reflects payment. I often received the invoice for medical purchases, but not an invoice reflecting payment. You may need to follow-up with the medical practitioner to request a paid receipt (again, if you have several expenses with the same practitioner, get them to do one summary receipt reflecting the services and reflecting payment for those services)
   
   
7. If you have a line of credit with the bank for investment purposes (especially for professionals to fund their capital entitlement), see if your banker can provide a simple summary letter on the financial institution’s letterhead of the total interest expense for 2022
   
   
8.  If you have rental income, summarize your rental income and expenses for the year. Also provide any invoices for any large repair bills so your accountant can determine whether the expense is currently deductible or must be capitalized.
   
   
9. If you sold your home in 2022, provide your accountant the sale information. Also provide the date you purchased your home and the original cost information (although it may not be needed depending upon the circumstances). The above information must be reported to claim the principal residence exemption, or the exemption may be denied, or a substantial penalty levied.
   
   
10. Let your accountant know if anyone in your family has become a non-resident in the current year.
    
    
11. Review your return before it is filed. You know your affairs better than anyone. Do a quick overview of your return to ensure what you expect to be reported and deducted has been reflected accurately. In most cases everything will check-out, but sometimes things are missed or when reviewing your return, you realize you forgot to inform your accountant about some income or deduction for the year.

The above information will cover off much of your return. Many accountants make this easier by providing a checklist for you to organize your tax information. 

While all this organizing may seem like a lot of work when you are paying someone to prepare your return, you want those dollars spent having your accountant working on minimizing your taxes, not chasing down information.

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.

Tax Gain/Loss Selling 2022 Version

In keeping with tradition, I am today posting my annual blog on tax gain/loss selling. I write this blog annually because every year around this time, people get busy with holiday shopping (or at least online shopping these days) and forget to sell the “dogs” in their portfolio and consequently, they pay unnecessary income tax on their capital gains in April. Alternatively, selling stocks with unrealized gains may be beneficial for tax purposes in certain situations.

As I am sure you are more than acutely aware, the stock markets in 2022 have been very weak. Consequently, you may have realized capital losses in 2022 or have unrealized capital losses starring back at your from your investment statement. 

The goods news at this point in time is; if you reported capital gains in 2019-2021, you may be able to carryback any realized 2022 capital losses and/or possibly trigger capital losses on securities with unrealized losses to carryback.

In any event, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options in the next week or two and if you are a DIY investor set aside some time this weekend or next to review your 2022 capital gain/loss situation in a calm, methodical manner. You can then execute any trades you decide are investment and tax effective on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling.

I am going to exclude the detailed step by step capital gain/loss methodology I have included in some prior years blog posts. If you wish the detail, please refer to my 2020 tax loss selling post post and update the years (i.e., use 2021, 2020 & 2019 in lieu of 2019, 2018 and 2017). 

You have three options in respect of capital losses realized in 2022:

1. You can use your 2022 capital losses to offset your 2022 realized capital gains

2. If you still have capital losses after offsetting your capital gains, you can carry back your 2022 net capital loss to offset any net taxable capital gains incurred in any of the three preceding years

3. If you cannot fully utilize the losses in either of the two above ways, your can carry your remaining capital loss forward indefinitely to use against future capital gains (or in the year of death, possibly against other income)

Tax-Loss Selling

I would like to provide one caution about tax-loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes with the intention of re-purchasing those stocks, and one or two of the stocks take off during the 30-day wait period—raising the cost to repurchase far in excess of their tax savings.

Thus, you should only consider selling your "dog stocks" that you and/or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock. Your advisor may be able to "mimic" the stocks you sold with similar securities for the 30-day period or longer or utilize other strategies, but that should be part of your tax loss-selling conversation with your advisor.

Identical Shares

Many people buy the same company's shares (say Bell Canada for this example) in different non-registered accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their non-registered accounts but ignore the shares they own of Bell Canada in another account. Be aware, you must calculate your adjusted cost base over on all the identical shares you own in all your non-registered accounts and average the total cost of your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell is higher in one of your accounts, you cannot pick and choose to realize a gain or loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares.

Superficial Losses

One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchases an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and is added to the cost base of the new shares acquired.

Transferring Losses to a Spouse who has Capital Gains

In certain cases you can use the superficial loss rules to transfer a capital loss you cannot use to your spouse. This is complicated and should not be undertaken without first obtaining professional advice.

Tax-Gain Selling

While most people are typically looking at tax-loss selling at this time of year, you may also want to consider selling stocks with gains to net-off against capital losses, for marginal tax rate planning, charitable purposes (see below) or other reasons.

Donation of Marketable Securities

If you wish to make a charitable donation, a great way to be altruistic and save tax is to donate a non-registered marketable security that has gone up in value. As discussed in this blog post, when you donate qualifying securities, the capital gain is not taxable and you get the charitable tax credit. Please read the blog post for more details. 

Settlement Date

It is important to ensure that any 2022 tax planning trade is executed by the settlement date, which my understanding is the trade date plus two days (U.S. exchanges may be different). See this excellent summary for a discussion of the difference between what is the trade date and what is the settlement date. The summary also includes the 2022 settlement dates for Canada and the U.S. which are both December 28th this year.

Corporations - Passive Income Rules

If you intend to tax gain/loss sell in your corporation, keep in mind the passive income rules. This will likely require you to speak to your accountant to determine whether a realized gain or loss would be more effective in a future year (to reduce the potential small business deduction clawback) than in the current year.

Summary

As discussed above, there are a multitude of factors to consider when tax gain/loss selling. It would therefore be prudent to start planning now with your advisors, so that you can consider all your options rather than frantically selling at the last minute.

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.

Tax Gain/Loss Selling 2021 Version

In keeping with my annual tradition, I am today posting a blog on tax-loss selling, except this year, I changed the title to tax gain/loss selling (to include some planning for stocks with capital gains). I am posting on this topic again because every year around this time, people get busy with holiday shopping (or at least online shopping these days) and forget to sell the “dogs” in their portfolio and consequently, they pay unnecessary income tax on their capital gains in April. Alternatively, selling stocks with unrealized gains may be beneficial for tax purposes in certain situations.

Hopefully, based on the strong stock markets of both 2020 and 2021, you do not have many unrealized capital losses. However, the last half of 2021 has been very sector oriented and you may have stocks that were hit on the sector rotation. In fact, in a November 22nd Globe and Mail article by Tim Shufelt, he noted that 17% of S&P/TSX composite stocks were down by at least 10% year to date. That was before the large market drop on Black Friday.

In any event, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options by next week and if you are a DIY investor set aside some time this weekend or next to review your 2021 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.

I am going to exclude the detailed step by step capital gain/loss methodology I usually include in this post. If you wish the detail, just refer to last year's post and update the years (i.e., use 2021, 2020 & 2019 in lieu of 2020, 2019 and 2018). 

You have three options in respect of capital losses realized in 2021:

1. You can use your 2021 capital losses to offset your 2021 realized capital gains

2. You can carry back your 2021 net capital loss to offset any net taxable capital gains incurred in any of the three preceding years

3. If you cannot fully utilize the losses in either of the two above ways, your can carry your remaining capital loss forward indefinitely to use against future capital gains (or in the year of death, possibly against other income)

Tax-Loss Selling

I would like to provide one caution about tax-loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes with the intention of re-purchasing those stocks, and one or two of the stocks take off during the 30-day wait period—raising the cost to repurchase far in excess of their tax savings.

Thus, you should first and foremost consider selling your "dog stocks" that you or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock. Your advisor may be able to "mimic" the stocks you sold with similar securities for the 30-day period or longer or utilize other strategies, but that should be part of your tax loss-selling conversation with your advisor.

Identical Shares

Many people buy the same company's shares (say Bell Canada for this example) in different non-registered accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their non-registered accounts but ignore the shares they own of Bell Canada in another account. Be aware, you must calculate your adjusted cost base over on all the identical shares you own in all your non-registered accounts and average the total cost of your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell is higher in one of your accounts, you cannot pick and choose to realize a gain or loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares.

Superficial Losses

One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchases an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and is added to the cost base of the new shares acquired.

Tax-Gain Selling 

While typically most people are looking at tax-loss selling at this time of year, you may also want to consider selling stocks with gains for the reasons discussed below.

Donation of Marketable Securities

If you wish to make a charitable donation, a great way to be altruistic and save tax is to donate a marketable security that has gone up in value. As discussed in this blog post, when you donate qualifying securities, the capital gain is not taxable and you get the charitable tax credit. Please read the blog post for more details. 

2022 Budget

While I don’t comment on rumours and conjecture, there are many tax commentators who feel there is a good chance the capital gains inclusion rate will increase from 50% to a higher rate in a future budget. If you are in that camp, you may wish to lock in capital gains at the lower rate. As no-one knows if the capital gains rate will change, you need to review this with your advisor as the sale will be taxable immediately, even if you buy-back the same security (there are no superficial gain rules).

Settlement Date

It is important any 2021 tax planning trade be made by the settlement date, which my understanding is  the trade date plus two days (U.S. exchanges may be different). See this excellent summary for a discussion of the difference between what is the trade date and what is the settlement date. The summary also includes the 2021 settlement dates for Canada and the U.S.

Corporations - Passive Income Rules

If you intend to tax gain/loss sell in your corporation, keep in mind the passive income rules. This will likely require you to speak to your accountant to determine whether a realized gain or loss would be more effective in a future year (to reduce the potential small business deduction clawback) than in the current year.

Summary

As discussed above, there are a multitude of factors to consider when tax gain/loss selling. It would therefore be prudent to start planning now with your advisors, so that you can consider all your options rather than frantically selling at the last minute.

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.

Do You Have To File Taxes for Someone Who Died?

Thinking about taxes on a yearly basis is not fun. When dealing with the death of a loved one, it can make a challenging situation even more of a headache and forces one to face the only real certainties in life; death and taxes. In this blog post, I will walk you through the tax returns an executor needs to file at the time of death, allowing you to ease the stress of an already difficult experience.

Before tackling the filing of the tax returns, make sure that there is a legal representative in place, and that all authorities have been notified. These authorities include the Canada Revenue Agency (CRA), Service Canada, and the deceased person’s financial advisors and institutions. Once those initial steps have been taken, it is time to turn your attention to the tax returns and forms that come into play after a death.

Before I get to the returns that must be filed on death, I would like to thank Christopher Bell of BDO Canada for his assistance with this blog post. A quick backstory. Assisting with this blog post was one of the final things Chris did as a senior tax accountant before he changed career paths from income tax to digital project management. In a related story, I am now persona non grata with our tax department.

Final personal tax return

A final return must be filed for all taxpayers in Canada after they die. This return is a personal tax return (known as the "terminal return") just like in every other year and is filed from January 1st of that year up to and including the date of death, but there are some special rules that need to be followed when filing this return. Please note: that unless otherwise noted, this blog post assumes the tax return is being prepared for a single person who passed away or the last to die spouse.

The first thing to keep in mind is that income paid to the deceased will need to be prorated between the final return and the estate return (discussed below) based on the date of death. For example, some investment income slips such as T5's may be issued for the calendar year, but if the date of death was say July 31st, you need to prorate the income from January 1st to July 31st for the terminal return and from August 1st to December 31st for the estate return. If you are unsure whether the amount was prorated, you should confirm with the issuer of the income slip.

Capital assets

The Income Tax Act deems all capital assets of a taxpayer to be disposed of immediately before the death of a taxpayer and considers the proceeds from selling these items to be received at that time at fair market value (referred to as a deemed disposition). Based on the cost of these assets, this deemed disposition may result in a capital gain or a capital loss. For example, if you own 100 shares of a bank stock that cost $30 and are worth $50 at death, the deemed capital gain is $2,000 ($50 - 30 x 100 shares).

The exception to these rules is when assets are transferred to a surviving spouse or common law partner. The deemed disposition is then deferred to the earliest the surviving spouse sells the shares or dies. In some cases, it may make sense to “elect out” of the automatic tax-free transfer of capital property to the surviving spouse noted above. Tax planning for the death of the first spouse was discussed in greater detail in this blog post along with the related administrative headaches (many of these administrative issues also apply upon the death of the last surviving spouse).

Under this election, it may be tax effective to trigger taxable capital gains on the final return of the deceased spouse, as the election may reduce the amount of tax paid overall. This is usually limited to circumstances where the deceased spouse had a very low tax rate, had unused capital losses carried forward or had alternative minimum tax carryforward, among a few other possibilities. The election is made on a security-by-security basis at the fair market value.

In some circumstances it may make sense to elect to trigger a capital loss or losses at death instead of a capital gain. This would be for example to offset capital gains on the terminal return.

If there are capital losses on the final return, you can go back up to three taxation years prior to the death of the taxpayer and claim them against capital gains that tax would have previously been paid on using Form T1A.

Alternatively, if there is a net capital loss in the year of death, you can apply these losses against other income on the terminal return. You must first reduce the net capital loss by any capital gains deductions the deceased had previously claimed to date, and the remainder can be reported as a negative capital gain on Line 127 of the tax return.

These topics surrounding capital gain and losses are quite complex and are best discussed with a trusted advisor.

Pensions

Where the deceased was single or a surviving spouse, the fair market value of the RRSP or RRIF is deemed to be received immediately before death and is considered income on the terminal return.

Where there is a surviving spouse or common law partner, you can generally avoid these taxes on death by naming the surviving spouse or common law partner of the deceased as the beneficiary of the RRSP/RRIF, and then to file an election for the assets held in the plan to be transferred to the beneficiary’s RRSP or RRIF on a tax-deferred basis.

If the spouse is not named as the beneficiary of the RRSP/RRIF, the estate representatives can generally elect on the final return for the tax-free transfer to still happen as long as the RRSP/RRIF funds are left to the spouse under the terms of the will. Please seek professional advice in this situation.

Tips to complete the final personal tax return

• You can still elect to split pension income on the final tax return, so long as the deceased and their spouse or common law partner previously jointly elected to do so on their tax returns prior to death.
• All assets held in the name of the deceased are deemed disposed of at death, including personal items such as jewelry, paintings, and boats. There are special rules around these assets that need to be considered and should be discussed with your financial advisor.
• RRSPs and RRIFs can also be transferred tax free to financially dependent children or grandchildren under 18 in certain circumstances.
• TFSA accounts are fully tax free to the beneficiaries; however, any income earned between the date of death and the distribution is taxable to the beneficiary.
• TFSA accounts can also be transferred to the spouse or common law partner of the deceased tax free, and the account will continue to exist. The survivor can also elect to transfer the amount to their TFSA if they prefer to not maintain two accounts, as this is considered a qualifying transfer.
• Any unpaid amounts (including bonuses, dividends, etc.) must be accrued up to the date of death. This amount can be included either on the final return or on the return for rights or things, which we discuss a little later in the post. There is sometimes a benefit to filing this separate return, but it is circumstantial and should be discussed with a financial advisor.
• You will need to send a copy of the death certificate in along with the final return, so keep a copy at hand.

Final return due date

The due date of the final return depends on when the person passed away. See the below chart for the due date of the final return.

Date of death	Tax return due
January 1 to October 31	April 30
November 1 to December 31	6 months after the date of death
If the deceased or their spouse/common law partner operated a sole proprietorship in the year of death:
January 1 to December 15	June 15
December 16 to December 31	6 months after the date of death

The surviving spouse’s return will always be due April 30 or June 15 respectively, meaning that no extra time is granted to file their return despite the death of the other person.

Optional returns

You may choose to file optional returns to report income that you would normally report on the final return. The benefit of doing this is that you can reduce the total taxes owing by the deceased by claiming certain tax credits and using lower marginal tax rates. It is best to consult a trusted advisor to discuss this type of planning in detail.

There are three types of optional returns:

Return for rights or things

The return for rights or things covers amounts that were payable to the deceased at the date of death and, had the person not passed away, would have been paid to them and included in their income. This return enables the representative to report the asset values at the time of death. Some examples of assets that would be listed on this return are:

• Unpaid salary, commissions, and vacation pay
• Dividends declared prior to death
• Old Age Security benefits that were payable to the deceased
• Unmatured bonds coupons and bond interest that was unpaid
• Work in progress for professionals operating as a sole proprietor

This return is due at the later of 90 days after the CRA sends the notice of assessment or reassessment for the final return and one year after the date of death.

Return for a partner or proprietor

This return is filed for a person who was a sole proprietor or partner of a business prior to death. This return is only filed if:

• the business’ fiscal year-end does not end on December 31; and
• the person died after the year-end of the business but before the end of the calendar year.

If this return is filed, it would cover the period from the first day of the business’ new year to the date of death. If a legal representative chooses not to file this return, the business income would instead be reported on the final return. This return is due on the same date as the final return.

Return for income from a graduated rate estate

This return can be filed if the deceased received money from a graduated rate estate (GRE) prior to death. This return is rarely filed, and the income is normally included on the final return. This return is due on the latter of April 30 (or June 15 if the deceased was a sole proprietor) and six months after the date of death. If you want to know more about this, we recommend you refer to a blog we previously posted, written by Howard Kazdan here for some background information, but you should contact your professional advisor for detailed guidance.

Estate Returns (T3 Return)

In addition to the returns noted above, the estate of the deceased must file T3 tax returns each year until the estate is wound up. Typically, the returns are filed based on a year starting from the day after the date of death and ending one year later, although you may elect to have a December 31 year-end for these returns as well. Estate returns and any balance owing are due within 90 days of the year-end of the trust. Winding up an estate could take several years and is a lengthy topic on its own.

Even if the estate is wound up quickly, the executor may file at least one estate return (the “executor’s year”). And there may be tax advantages to filing even when it is not mandatory. One is having income earned in the estate taxed at graduated personal rates (instead of the higher marginal rates of the beneficiaries) – basically, a way to effectively have another return on death for the income earned in the first year of an estate.

When filing the first T3 return after the death, make sure to include a copy of the will.

Clearance certificate (Form TX19)

If you are serving as the legal representative for a deceased taxpayer or trustee of an estate, getting a clearance certificate is advisable prior to distributing any assets from the estate. A clearance certificate is issued by the CRA upon request, and certifies that either the liabilities payable to the CRA have been paid or security has been accepted in place of payment. If a legal representative chooses not to obtain a clearance certificate, they could be held personally liable for the amounts outstanding up to the value of the assets that were paid out. I previously wrote a blog specifically on clearance certificates, which you can read here.

Reduce the stress with a plan

As you can see, there is a lot to do with taxes at the time of a person’s death, and the sooner you begin to organize and plan for it, the smoother the process will go. A lot of the stress that goes along with filing these returns can be mitigated through proper estate planning and having trusted financial advisors in place to guide you and your loved ones through the process. On top of this, having a good plan in place will ensure that you avoid unnecessary probate and income tax, which will save you money.

Plan to Sell Your Business? You may be Interested in this Survey! 

If you’re a financial executive or business owner, here's your chance to share insight on how you plan to sell your business. My colleagues at BDO are conducting a survey in partnership with Financial Executives International Canada. The survey will be open until November 27 and will generate research to be released in 2020. Take the survey here.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Tax-Loss Selling - 2018 Version

In keeping with my annual tradition, I am today posting a blog on tax-loss selling. I am doing it again because the topic is very timely and every year around this time, people get busy with holiday shopping and forget to sell the “dogs” in their portfolio and as a consequence, they pay unnecessary income tax on their capital gains in April.

Additionally, while most investment advisors are pretty good at contacting their clients to discuss possible tax-loss selling, I am still amazed each year at how many advisors do not discuss the issue with their clients. So, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options.

For full disclosure, the following two comments are the only new items to consider that are different from last year's version.

1. The stock markets in 2018 have been much weaker than the last few years and you may unfortunately have "more opportunity" to sell stocks with unrealized losses to reduce your current year capital gains or carryback the losses to any of the last 3 years to recoup some of the tax you paid on gains you previously realized.

2. If you intend to tax-loss sell in your corporation, keep in mind the new passive income rules are applicable for taxation years beginning after 2018 and you should speak to your accountant to determine whether a realized loss would be more effective in a future year (to reduce the potential small business deduction clawback) than the current year.

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 2018 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.

I would like to provide one caution in respect of tax-loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes, with the intention of re-purchasing those stocks and one or two of the stocks take off during the 30 day wait period and the cost to repurchase is far in excess of their tax savings. Thus, you should first and foremost consider selling your "dog stocks" that you and/or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock. It should be noted your advisor may be able to "mimic" the stocks you sold with similar securities for the 30 day period or longer or utilize other strategies, but that should be part of your tax loss-selling conversation with your advisor.

This blog post will take you through each step of the tax-loss selling process.

Reporting Capital Gains and Capital Losses – The Basics

All capital gain and capital loss transactions for 2018 will have to be reported on Schedule 3 of your 2018 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 (unless you are filing for a deceased person. In that case, get professional advice as the rules are different). 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 suggest you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2017 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information is also easily accessed online if you have registered with the CRA My Account Program.

2. If you do not have capital losses to carryforward, retrieve your 2015, 2016 and 2017 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 2015, 2016 and 2017.

3. For each of 2015-2017, 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 2016 or 2017, review whether you carried back those losses to 2015 or 2016 on form T1A of your tax return. If you carried back a loss to either 2015 or 2016, 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 2015 to 2017, you can potentially generate an income tax refund by carrying back a net capital loss from 2018 to any or all of 2015, 2016 or 2017.

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:

· 2018: total realized capital loss of $30,000

· 2017: taxable capital gain of $15,000

· 2016: taxable capital gain of $5,000

· 2015: 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 2018 against the $7,000 and $5,000 taxable capital gains in 2015 and 2016, respectively, and apply the remaining $3,000 against your 2017 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 2017 taxable capital gains, you may want to consider whether you want to sell any other stocks with unrealized losses in your portfolio so that you can carry back the additional 2018 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2017. Alternatively, if you have capital gains in 2018, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

Identical Shares

Many people buy the same company's shares (say Bell Canada) in different accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their accounts, but ignore the shares they own of Bell Canada in another account. However, be aware, you have to calculate your adjusted cost base on all the identical shares you own in say Bell Canada and average the total cost of all your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell are higher in one of your accounts, you cannot pick and choose to realize a loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares, not the higher cost base shares.

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 (be aware; although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks and you must discuss any purchase with your investment advisor). 

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 2018 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2018 and 2019, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $10,700 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 2020 for $18,000 you will have a capital gain of $18,000 (subject to any other adjustments) and 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 $28,700 ($18,000 +$10,700 in tax savings) on a $20,000 investment.

Donation of Marketable Securities

If you wish to make a charitable donation, a great way to be altruistic and save tax is to donate a marketable security that has gone up in value. As discussed in this blog post from two weeks ago, when you donate qualifying securities, the capital gain is not taxable. Read the blog post for more details.

Donation 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.

Disappearing Dividend Income

Every year I ask at least one or two clients why their dividend income is lower on their personal tax return. Typically the answer is, "oops, it is lower because I sold a stock early in the year that I forgot to tell you about". Thus, if you manage you own investments; you may wish to review your dividend income being paid each month or quarter with that of last years to see if it is lower. If the dividend income is lower because you have sold a stock, confirm you have picked up that capital gain in your calculations.

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

In certain cases you can use certain provisions of the Income Tax Act to transfer losses to your spouse. As these provisions are complicated and subject to missteps, you need to engage professional tax advice.

Settlement Date

It is my understanding that the settlement date for Canadian stock markets in 2018 will be December 27th, as the settlement date is now the trade date plus 2 days (U.S. exchanges may be different). Please confirm this date with your investment advisor, but assuming this date is correct, you must sell any stock you want to crystallize the gain or loss in 2018 by December 27, 2018.

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 waiting in line with your kids to see Santa the third week of December.

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.

Terminal Income Tax Return Planning – Capital Gains and Losses

Today, I am going to discuss tax planning in respect of capital gains and losses on the final tax return (“terminal return”) of a deceased person. While a slightly morbid topic, many of you likely have been named as an executor in your parents, siblings or friends wills and today's discussion will provide you some basic understanding of one of the more important issues when filing a terminal return.

General Rules

When a person passes away, they are deemed under the Income Tax Act (“Act”), to have disposed of their capital property immediately prior to their death. In English, this means you are taxed as if you sold all your capital property the moment before you died and thus, your estate must recognize any capital gains or losses caused by this phantom disposition. For example, say a person had 100 shares of ABC Co. which they bought at $10 in 2010 and at their date of death, the stock was trading at $18. They would have a deemed capital gain of $800 ($18-10 x 100 shares) even though they never had sold the stock before they passed away.

The most typical examples of capital property are stocks, cottages and rental properties (I have assumed the real estate is capital property and not inventory, which it could be if your business is real estate development).

There is one main exception to the deemed disposition rule. Where you are married or live common law and have left your property to your spouse, there is an automatic spousal rollover such that these assets can be transferred to your surviving spouse with no immediate tax consequences and the deemed disposition can be deferred until the death of the surviving spouse.

The rest of this discussion involves planning where the deceased person has a spouse. If this is not the case in your particular circumstance, you can stop reading unless you want some general knowledge or will be an executor in the future.

Electing Out of The Automatic Spousal Rollover

The Act contains an interesting provision that allows a person’s legal representative to elect out of the automatic spousal rollover noted above. The election which is done on a property-by-property (or share by share) basis is typically undertaken for the following two reasons.

1. To trigger capital gains

2. To trigger capital losses

Triggering Capital Gains

You may wish to trigger a capital gain for the reasons I list below:

1. The deceased person is in a low-income tax bracket and by triggering capital gains, you utilize their marginal tax rates.

2. The deceased person was a small business owner and their shares are eligible for the Qualifying Small Business Corporation tax exemption of $848,252.

3. The deceased person had capital losses or non-capital losses that would be “lost” if you do not trigger additional income (be careful with this one, as per #2 below, the capital losses can be deducted against income in the year of death in certain circumstances, so don't waste them).

4. The deceased person has donation or medical credits that will not be utilized without additional income being generated.

It is important to note, not only is the election beneficial for the reasons listed above, but there is a significant additional benefit. Where you elect to trigger a capital gain, the cost base of the capital property to the surviving spouse is increased to the fair market value of the property elected on. So, for example, if an executor elected out of the automatic spousal rollover on the 100 shares of ABC Co. the adjusted cost base of the shares to the surviving spouse would now be $1,800 (100 shares x $18 market value at death) instead of $1,000

Triggering Capital Losses

Although slightly counter intuitive, a legal representative may wish to trigger a capital loss. There are two reasons for this:

1. Any net capital loss triggered can be carried back against capital gains reported in the prior 3 years.

2. The representative can also choose to apply the capital losses against any other income on the terminal return and the preceding year. This means the capital loss can be applied against not only capital gains, but regular income if the capital losses are greater than any capital gains on the terminal return and prior years return. The one constraint is that if the deceased had claimed their capital gains exemption in prior years, the loss carryback is reduced by the prior capital gains exemption claim and may wipe out the benefit of option #2.

Tax planning for a terminal tax return is very complicated and I have simplified the above for purposes of discussion. If you are an executor for a will, I strongly urge you to seek professional advice to guide and assist you through the various tax implications and options.

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.

Confessions of a Tax Season Accountant - Determining the Adjusted Cost Base of Your U.S.Securities

Last week I received an avalanche of tax returns, as my clients finally received their T3 and T5013 tax slips (although many are now being amended). Driving to work to prepare all these returns was problematic, as the weather in Toronto was terrible. While snow in April is not what you hope for, the upside for an accountant is; my friends cannot call me on each hole of the golf course to torment me while I am working away doing tax returns. But I digress.

While preparing returns last week, I only found one noteworthy issue to discuss; that being the tracking of the adjusted cost base of U.S. stocks and securities. This issue rears its ugly head when filing terminal tax returns (the final return in the year of death) and for anyone who sells U.S. stocks and receives a capital gain/loss report solely in U.S. dollars.

What is the Adjusted Cost Basis of Your U.S. Securities? Your Guess is as Good as Mine

Unfortunately, over the past 15 months or so, I had a couple clients pass away. As discussed in this blog post, when you die, there is a deemed disposition of the capital property you own on death (unless you have a surviving spouse to whom you transfer your property under your will, although you can elect out of  this provision on a security by security basis). My issue has been obtaining the historical purchase dates of the U.S. stocks to determine the deemed disposition gain for these client's U.S. stock holdings.

For example. Say a client purchased IBM at $40 in their U.S. portfolio years ago when the exchange rate was say $1.05. The converted Canadian cost base is $42 ($40x1.05). Let’s assume the stock price upon the date of their death was $150. If the exchange rate on death is $1.30, the deemed proceeds are $195, and the capital gain should be $153 ($195-42).

However, in two cases where I had a client pass away, all I was provided with from the investment manager/institution was a U.S. cost base of $40 and a U.S. fair market value of $150. If I just convert both the $40 cost and $150 value at death at say $1.30, this would result in a capital gain of $143 instead of the correct $153. Where the U.S. stocks have been purchased with the current advisor, typically they can at least provide me with the purchase dates and sometimes they can run a new report with the converted $Cdn ACB. Where stocks were initially purchased by the client on their own or with another advisor, it is almost impossible to get the original purchase date unless the executor can find the original purchase documents.

The standard reasoning provided by reporting entities for not having this information is that the stocks were transferred to them and they don’t have the historical cost. I can live with that explanation, but query why when U.S. stocks are purchased by the manager or institution, they do not in many cases automatically track and convert to a $Cdn ACB? Another of life’s little tax mysteries.

Often I must play detective and try to somehow determine when these stocks were purchased which is either extremely time consuming or not possible given the lack of records.

Many of you may have this same issue if you have a U.S. stock portfolio with an investment advisor or financial institution and your yearly realized report is provided only in U.S. dollars. How do you know what your adjusted $Cdn cost base is? I suggest that in order to alleviate this problem, you ask your advisor to provide you on an annual basis with the $Cdn adjusted cost base of your U.S. stocks whether they have to push a button or have their assistant do it on a spreadsheet. You pay for this. If you are a DIY investor, you should ensure you note the foreign exchange date down for every U.S. or foreign stock purchase.

Long story short, this a significant reporting issue while you are alive and after you pass away.

Note: I am sorry, but I do not answer questions in late April due to my workload, so the comments option has been turned off. Thus, you cannot comment on this post and past comments on other blog posts will not appear until I turn the comment function back on.

This is my last post (although I may post a guest blog) for a couple weeks, so see you in May.

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.

Tax Loss Selling - 2017 Version

In keeping with my annual tradition, I am today posting a blog on tax loss selling. I am doing it again because the topic is very timely and every year around this time, people get busy with holiday shopping and forget to sell the “dogs” in their portfolio and as a consequence, they pay unnecessary income tax on their capital gains in April.

Additionally, while most investment advisors are pretty good at contacting their clients to discuss possible tax loss selling, I am still amazed each year at how many advisors do not discuss the issue with their clients. So, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options (if you must initiate the contact, consider that a huge black mark against your advisor).

For full disclosure, there is very little that is new in this post from last year's version. Similar to last year, when there were rumours that the 2017 Federal budget may change the inclusion rate on capital gains from 1/2 to 3/4, I know some people are considering taking gains as they have seen where the Liberal government is going with taxation policies and they feel it is just a matter of time until the capital gains inclusion rate is changed. I have no knowledge of whether such a change is on the table, however, it would not surprise me at this point, although, to be honest, nothing taxation wise from this government would surprise me. It is also interesting to note the change as to how the settlement date for stock trades is determined, see the second last paragraph of this post for the details.

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 2017 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. As the markets have been surprisingly strong (at least to me) this year, hopefully you don't have very many stocks with unrealized capital losses you can sell to use the losses against capital gains you have realized in 2017 or that you can carryback to one of the last 3 years.

I would like to provide one caution in respect of tax loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes, with the intention of re-purchasing those stocks and one or two of the stocks take off during the 30 day wait period and the cost to repurchase is far in excess of their tax savings. Thus, you should first and foremost consider selling your "dog stocks" that you and/or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock.

This blog post will take you through each step of the tax-loss selling process.

Reporting Capital Gains and Capital Losses – The Basics

All capital gain and capital loss transactions for 2017 will have to be reported on Schedule 3 of your 2017 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 (unless you are filing for a deceased person. In that case, get professional advice as the rules are different. I will post on this issue in 2018). 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 suggest you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2016 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information is also easily accessed online if you have registered with the CRA My Account Program.

2. If you do not have capital losses to carryforward, retrieve your 2014, 2015 and 2016 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 2014, 2015 and 2016.

3. For each of 2014-2016, 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 2015 or 2016, review whether you carried back those losses to 2014 or 2015 on form T1A of your tax return. If you carried back a loss to either 2014 or 2015, 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 2014 to 2016, you can potentially generate an income tax refund by carrying back a net capital loss from 2017 to any or all of 2014, 2015 or 2016.

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:

· 2017: realized capital loss of $30,000

· 2016: taxable capital gain of $15,000

· 2015: taxable capital gain of $5,000

· 2014: 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 2017 against the $7,000 and $5,000 taxable capital gains in 2014 and 2015, respectively, and apply the remaining $3,000 against your 2016 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 2016 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 2017 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2016. Alternatively, if you have capital gains in 2017, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

Identical Shares

Many people buy the same company's shares (say Bell Canada) in different accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their accounts, but ignore the shares they own of Bell Canada in another account. However, be aware, you have to calculate your adjusted cost base on all the identical shares you own in say Bell Canada and average the total cost of all your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell are higher in one of your accounts, you cannot pick and choose to realize a loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares, not the higher cost base shares.

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 (be aware; although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks and you must discuss any purchase with your investment advisor). 

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 2017 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2017 and 2018, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $10,700 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 2019 for $18,000 you will have a capital gain of $18,000 (subject to any other adjustments) and 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 $28,700 ($18,000 +$10,700 in tax savings) on a $20,000 investment.

Donation 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.

Disappearing Dividend Income

Every year I ask at least one or two clients why their dividend income is lower on their personal tax return. Typically the answer is, "oops, it is lower because I sold a stock early in the year that I forgot to tell you about". Thus, if you manage you own investments; you may wish to review your dividend income being paid each month or quarter with that of last years to see if it is lower. If the dividend income is lower because you have sold a stock, confirm you have picked up that capital gain in your calculations.

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

In certain cases you can use certain provisions of the Income Tax Act to transfer losses to your spouse. As these provisions are complicated and subject to missteps, you need to engage professional tax advice.

Settlement Date

It is my understanding that the settlement date for Canadian stock markets in 2017 will be December 27th, as the settlement date has changed from the old trade date +3 days, to the trade date plus 2 days (U.S. exchanges may be different). 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 2017 by December 27, 2017.

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 waiting in line with your kids to see Santa the third week of December.

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.