Confessions of a Tax Accountant -2013- Week 2

This week I actually had some income tax returns to review and a few issues arose from those returns. Today I will discuss three of those issues. The first issue is a major pet peeve of mine. That being, how financial institutions misreport or don't adjust their realized capital gain/loss reports for the adjusted cost base reduction on flow-through shares. Another issue that caused some confusion this week was how taxpayers age 60-70 are supposed to deal with CPP contributions. Thirdly, I note a medical expense claim for people who suffer from Celiac disease and are unable to eat gluten. 

Flow-Through Limited Partnership Misreporting

I have discussed the merits of investing in flow-through shares (typically investments in limited partnership units, not shares) on a couple of occasions, including this guest post I wrote for the Retire Happy Blog, titled "How to Save tax with a Flow-Through Shares. As I noted in the guest post, the adjusted cost base ("ACB") of a flow-through share is generally "ground-down" to nil after claiming the initial resource exploration and development expenses. For the purposes of this post, I will ignore that some limited partnerships may allocate capital gains and investment income to the investors such that their ACB will often increase from the ground down nil value. As noted in my introduction, many institutions provide capital gains reports that do not reflect the ground-down ACB and thus, understate their client's capital gains.

This issue is best explained by using an example. Let's assume I purchased 1000 units of the BBC Flow-Through Limited Partnership in 2011 for a cost of $10,000. In 2011 and 2012 I received $10,000 in exploration and development deductions which I wrote-off on my tax return. Assuming the BBC Flow-Through did not allocate me any capital gains or investment income or business income/losses, the ACB of these units at January 1, 2013 is nil. Say the BBC fund is rolled into a mutual fund in 2013 and I then immediately sell the fund for $9,500. My capital gain in 2013 should be $9,500, since I have a nil ACB.

However, I have already received two capital gain summaries for clients where the ACB reflected by the investment institution is relected as the $10,000 initial investment amount, not the ground-down value of zero. Continuing with my example, the summaries have reflected a $500 capital loss, not the actual $9,500 gain. Since my client's may purchase $25,000 to $50,000 of flow-through shares at a time, this error has the potential to be significant.

Our firm is always on the look-out for incorrectly reported capital gains/losses on flow-through shares, as we have seen this issue numerous times over the years. You would think the investment brokers would have internal controls such that the proper amount is reported and accountants don't have to find these errors (which can be easily missed when you have 15 pages of capital gain reporting to scan through). However, what we typically get is a general disclaimer that the institution is not responsible for the accuracy of the capital gain/loss statement, despite the fact they compiled the report.

CPP Contributions for People 60 - 70 Years Old

Over the last couple years, there have been various changes made to the Canada Pension Plan ("CPP") legislation. These changes and the resulting confusion manifested itself last week. I discuss the two issues that arose below.

Self-Employed People

If you are between the age of 65 and 70, receive CPP benefits and earn self-employment income, you have to elect not to contribute to the CPP on your 2012 income tax return. This election is made on Schedule 8. The election remains valid until you revoke the election or turn 70. If you do not make the election, you will be subject to CPP contributions on self-employment income.

Employee

This week I had a client's bookkeeper ask why the CRA had reassessed my client's company for the employer's share of CPP and the client's share of CPP not reported on their 2012 T4, when the client was already receiving CPP retirement benefits.

I informed the bookkeeper that starting in 2012, CPP contributions became mandatory for employees age 60 to 70 who work while receiving a CPP retirement pension. These contributions go toward the new Post-Retirement Benefit (PRB), which is effective January 1 of the year following the employee’s PRB contribution. This additional benefit is added to the employee’s current retirement benefit, gradually increasing his or her retirement income.

However, if you are between 65 and 70 and receiving CPP benefits, you can elect out of CPP by completing form CPT30.

I have been informed that the CRA as an administrative concession for 2012 maybe allowing late-filed CPT30's for those aged 65-70 caught by the new 2012 rules. Supposedly, this administrative concession will be applicable only for the transition year 2012. For 2013 and subsequent years, the election must be filed. I will update you when I can confirm this administrative policy or can provide more details.

Medical Expense Claims for Gluten-free Products

For people who suffer from Celiac disease, the Income Tax Act provides a medical expense claim for the incremental costs of purchasing gluten free foods. For example, if a loaf of bread costs $3 and gluten free bread costs $7, you can claim the $4 the difference as a medical expense. Over the year, the additional cost can add up to a significant number. For more details, see this CRA link.

As medical expenses are only creditable to the extent they exceed 3% of your net income, many people who suffer from Celiac disease seem to think the effort to track the incremental costs are in many cases not worth the effort. That is an unfortunate result; however, if you already exceed the 3% threshold, there is no reason not to undertake this tracking exercise.

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.

Is Personal Income Tax Planning a Fallacy for most Canadians?

As a tax accountant, I could make your head spin with all the income tax planning machinations I can undertake for corporate income tax clients in the correct circumstances.

But what about personal income tax planning? In my opinion, for the average middle class Canadian, personal income tax planning is almost a fallacy. Surprisingly, probably to most, personal income tax planning for higher income earning Canadians is also somewhat restricted. However, there are greater planning opportunities available that I discuss below.

I understand the "middle class" has stratified over the years and is not easily definable; but for purposes of this post, I will define middle class as a family, with either one or both spouses earning T4 employment income with a family income between $70,000 to $100,000, with no self-employment income (self-employment provides for some tax planning opportunities).

To be clear, I don’t consider the maximization of personal and family credits, medical expenses credits or charitable tax credits, etc. as tax planning. Although there can be some planning involved, the reality is that in most cases if you purchase an income tax software program, these credits will be maximized automatically for you.

Why do I say income tax planning is a fallacy for the average person? Because other than purchasing a RRSP, for all intents and purposes, there are no significant planning opportunities. Really, think about it. I am sure you have already read several income tax planning tip columns in your favourite newspaper this year; what was the best tip you read? That you can claim your safety deposit box fee? For those who incur employment expenses, maybe you can claim some employee expenses such as your car on your return. 

Even as I review a tax tips column I wrote for Jim Yih’s Retire Happy Blog last year, I am struck by how limited income tax planning is for the average person.

For all you socialists out there, I will tell you that as usual, higher income and higher net worth people do have some personal income tax planning opportunities. But, compared to the planning possibilities my corporate clients have, they are still very limited in nature.

Some personal income tax planning opportunities available to higher income Canadians (and in some cases middle income earners) include:

Income Splitting- For example, the use of a prescribed loan.

Capital loss utilization- See the 3rd paragraph from the bottom of this blog post on transferring capital losses to a spouse.           

Rental Properties – For those with enough disposable income to purchase a rental property, I discuss the income tax implications of purchasing a rental property in this blog post.  

Flow Through Shares- Higher income Canadians often purchase Flow Through Shares to reduce their income tax liability. I discuss this opportunity in this blog post.

Interest deductibility- In this blog post I briefly discuss how to mitigate your income tax exposure when claiming investment interest.

This post is not like an April fool’s joke where you reach the bottom and I provide you with ten great personal income tax planning tips. Unfortunately, all I can tell you is that for most Canadians, the personal tax planning joke is on you.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Tax-Loss Selling-Everything you always wanted to know but were afraid to ask

I would suggest that the best stock trading decisions are often not made while waiting in line to pay for your child’s Christmas gift. Yet, many people persist in waiting until the third week of December to trigger their capital losses to use against their current or prior years capital gains. To avoid this predicament, you may wish to set aside some time this weekend or next, to review your 2011 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 well in advance.

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

Reporting Capital Gains and Capital Losses – The Basics

All capital gain and capital loss transactions for 2011 must be reported on Schedule 3 of your personal income tax return. You then subtract the total capital gains from the total capital losses and multiply the total net capital gain/loss by ½. That amount becomes your taxable capital gain or net capital loss for the year. If you have a taxable capital gain, the amount is carried forward to the tax return jacket on Line 127. For example, if you have a capital gain of $120 and a capital loss of $30 in the year, ½ of the net amount of $90 would be taxable and $45 would be carried forward to Line 127. The taxable capital gains are then subject to income tax at your marginal income tax rate.

Capital Losses

If you have a net capital loss in the current year, the loss cannot be deducted against other sources of income. However, the net capital loss may be carried back to offset any taxable capital gains incurred in any of the 3 preceding years, or, if you did not have any gains in the 3 prior years, the net capital loss becomes an amount that can be carried forward indefinitely to utilize against any future taxable capital gains.

Planning Preparation

I am posting this blog earlier than most year-end capital loss trading articles because I believe you should start your preliminary planning immediately. (Tim Cestnick also agrees with early planning and he beat me to this topic with his article last week). These are the steps I recommend you undertake:

1. Retrieve your 2010 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information may also be accessed online if you have registered with the Canada Revenue Agency.

2. If you do not have capital losses to carryforward, retrieve your 2008, 2009 and 2010 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 2008, 2009 and 2010.

3. For each of 2008-2010, 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 2009 or 2010, review whether you carried back those losses to 2008 or 2009 on form T1A of your tax return. If you carried back a loss to either 2008 or 2009, 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 2008 to 2010, you can potentially generate an income tax refund by carrying back a net capital loss from 2011 to 2008, 2009 or 2010.

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:

· 2011: realized capital loss of $30,000

· 2010: taxable capital gain of $15,000

· 2009: taxable capital gain of $5,000

· 2008: 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 2011 against the $7,000 and $5,000 taxable capital gains in 2008 and 2009, respectively, and apply the remaining $3,000 against your 2010 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 2010 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 2011 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2010. Alternatively, if you have capital gains in 2011, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

Creating Gains when you have Unutilized Losses

Where you have a large capital loss carryforward from prior years and it is unlikely that the losses will be utilized either due to the quantum of the loss or because you are out of the stock market and don’t anticipate any future capital gains of any kind (such as the sale of real estate), it may make sense for you to purchase a flow-through limited partnership.

Purchasing a flow-through limited partnership will provide you with a write off against regular income 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 2011 for $20,000, you would get approximately $20,000 in tax deductions in 2011 and 2012, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $9,200 in taxes. When you sell the unit, a capital gain will arise. This is because the $20,000 income tax deduction reduces your adjusted cost base from $20,000 to nil (there will be other adjustments to the cost base). Assuming you sell the unit in 2013 and you have a capital gain of say $18,000, the entire $18,000 gain will be eliminated by your capital loss carry forward. Thus, in this example, you would have proceeds of $27,200 on a $20,000 investment. For a more detailed analysis of flow-thoroughs including the investment risk, see this blog I wrote for the Retire Happy Blog.

Superficial Losses

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

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

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

Settlement Date

It is my understanding that the settlement date for stocks in 2011 will be December 23, 2011. 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 2011 by December 23, 2011.

Summary

As discussed above, there are a multitude of factors to consider when tax-loss selling. It would therefore be prudent to start planning now, so that you can consider all your options rather than frantically selling via your mobile device while sitting on Santa’s lap in the third week of December.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How to Save Tax with Flow-Through Shares

Flow-Through Limited Partnerships are marketed as income tax shelters by many investment advisors. They are however, investments in junior resource companies, with the associated risk. Today I provide the ABC’s of these often misunderstood tax-assisted investments in a guest blog titled How to Save Tax with Flow-Through Shares I wrote for Jim Yih of the Retire Happy Blog .

The Retire Happy Blog was the winner of the Globe and Mails Canada’s Best Personal Finance Blog contest, a well deserved honour and is definitely a blog worth checking out if you have not already done so.

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.