Blog for Financial Literacy - Build the Foundation of Financial Discipline - Just Reconcile the Bank, Baby

November is Financial Literacy month in Canada. Today, many Canadian Bloggers have joined together to support the Blog for Financial Literacy campaign by agreeing to write a post on “My Best Financial Tip”. It is hoped the various “tips” will contribute to raising financial literacy throughout Canada. Kudos to Glenn Cooke of The Term Guy for putting the campaign together. Having put together the Bloggers for Charity campaign last year, I know the time commitment required.

My Best Financial Tip

When I decided to join this initiative, I racked my brain for a unique tip that would show my brilliance and ingenuity. However, the more I thought about it, the more I realized the best tip I can give anyone is to “build the foundation of financial discipline”. The conduit for building financial discipline is reconciling your bank account using Quicken software (no, I don’t get paid for mentioning Quicken or reproducing the image to the right) or a similar product.

I have used Quicken for years and its beauty is its relative simplicity. It is a simple single entry bookkeeping system. By single entry I mean you don’t have to know the debit and credit stuff you ignored in your grade ten accounting class. You just need to input the comings and goings in your bank account, some of which can even be downloaded directly from your bank account.

The first step in a staircase of financial discipline is reconciling your bank account on a monthly basis (weekly is better, but I won’t push my luck), so you know how much money you have earned, how much money you have spent and how much money you have saved. 

Once you get into the routine of inputting and reconciling your bank information, it is easy to take it up a notch and climb the staircase of financial discipline, by using your financial information for budgeting, tax return preparation, debt reduction, investing and retirement planning.

Let’s take a brief look at these benefits separately.

 

Budgeting

Once you have established the routine of reconciling your bank transactions, you will have all the information required to budget. Simply print a spending report for the prior month by itemized categories. Instantly you have a visual of how you spent your money. Knowing where and what you spend your money on is vital in preparing a budget (or your budget can simply be last month's spending report, with revised numbers and objectives just written in ink beside last month's numbers). Once you review your spending for the prior month, set a $ value goal for your next month's spending that is say 5-8% less than the prior month. Using a budget to control your spending is the second step in your financial discipline foundation. At the end of each year, print out your spending report for the calendar year. You will probably feel sick when you realize how much you spent on one or two items throughout the year. For me, each year I get nauseous when I review my automobile costs. The annual document can then be used to budget year over year and should be kept to compare to your next year's annual print-out.

Debt Reduction

As per my blog post Debt - An Ugly four Letter Word, personal debt is the number one problem in Canada. Where debt is not the result of losing a job or having your business fail, it often arises because of reckless spending (not in all cases but in many). That spending can potentially be reined in by creating a budget. The next step in building your foundation of discipline is to use the money saved by budgeting to start to pay down your debt. It should be noted that one of the versions of Quicken has a debt management component.

Income Taxes

Once you have the discipline to reconcile your bank account, you now have all the information you need for income tax. Every income tax season I see deductions and credits thrown out the window because clients have not maintained proper records and/or kept the required documents.

Want to know your deductible child care? Just go to your spending report for the year and look at the amount you spent during the year (you should then ensure you have invoices to support your child care payments). Want to know how many donations you made, just review your yearly spending report and then follow up on any missing donation receipts. The same goes for medical expenses. Review your spending summary for the year and ensure you have medical receipts that match those totals. If you claim employment expenses (your employer must sign a Form T2200), you will have a summary of your deductible employment expenses on your spending report.

Investments

The fourth step in building your foundation of financial discipline is using Quicken or whatever software you choose to track your investments. One of the biggest problems my clients have is tracking the cost of their investments, otherwise known as the adjusted cost base (ACB). By using software and diligently inputting all your investment data, you will always know at the click of a mouse your ACB for any investment. In addition, you can tax plan knowing your unrealized gains/losses, dividend and interest information is neatly laid out and available anytime.

Retirement

One day I decided to try and determine how much money I would need to retire, a daunting task. However, as I thought about it, I realized this was actually a fairly easy task. I printed out my yearly spending report by category for the last two years. I then went through each category determining how these expenses would change when I retired. Certain expenses were quickly eliminated, such as spending on my kids University and lease payments (I intend to stop leasing and purchase a car several years before retiring), while other expenses such as clothing and certain types of insurance would be substantially reduced.

Once I knew my anticipated expenses, I could project various retirement scenarios based on longevity. The point being, by having the data readily available, because I was disciplined enough to track the information, I had enough information to at least provide a crude estimate of my retirement needs.

As you can see, building the foundation of financial discipline allows one to progress from just tracking your bank account to determining your retirement needs. However, it all starts from step one, tracking and reconciling your bank account regularly. So as Al Davis would have said, "Just Reconcile the Bank, Baby".

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 - The 2012 Version

At this time of year, articles on tax loss selling become all the rage. Although I wrote a blog post on this topic last November, I was going to write a new post on this topic. However, after re-reading my blog post from last year; I thought to myself, it was really not half-bad, if I do say so myself. Thus, I have decided to just update my post on tax-loss selling from last year to reflect current dates and legislative changes. I have also added a paragraph on the potential capital gain that may arise on donated flow-through shares that were purchased after March 21, 2011.

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 2012 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; although this year, if the USA takes us to the fiscal edge at year-end, before they fall off their fiscal cliff, we all may have some unrealized capital losses closer to Christmas.

This blog post 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 2012 will have to be reported on Schedule 3 of your 2012 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. 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. These are the steps I recommend you undertake:

1. Retrieve your 2011 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 2009, 2010 and 2011 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 2009, 2010 and 2011.

3. For each of 2009-2011, 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 2010 or 2011, review whether you carried back those losses to 2009 or 2010 on form T1A of your tax return. If you carried back a loss to either 2009 or 2010, 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 2009 to 2011, you can potentially generate an income tax refund by carrying back a net capital loss from 2012 to any or all of 2009, 2010 or 2011.

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:

· 2012: realized capital loss of $30,000

· 2011: taxable capital gain of $15,000

· 2010: taxable capital gain of $5,000

· 2009: 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 2012 against the $7,000 and $5,000 taxable capital gains in 2009 and 2010, respectively, and apply the remaining $3,000 against your 2011 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 2011 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 2012 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2011. Alternatively, if you have capital gains in 2012, 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 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 2012 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2012 and 2013, 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 may be other adjustments to the cost base). Assuming you sell the unit in 2014 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 total after-tax proceeds of $27,200 ($18,000 +$9,200 in tax savings) on a $20,000 investment.

Donation of Flow-Through Shares

Speaking 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.

 

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. If you intend to transfer losses this year, you must act quickly to ensure you are not caught by the 30 day hold period and the settlement date issue noted below.

Settlement Date

It is my understanding that the settlement date for stocks in 2012 will be December 24th. 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 2012 by December 24, 2012.

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.

The Income Tax Cost of Working Overtime or Businesses taking on New Clients/Customers

Today, I want to discuss what I consider one of the most nonsensical comments I hear at this time of the year; that being, there is no point in taking on any extra work to make more money, since the Canada Revenue Agency will take most of it away in income taxes. I hear this comment from employees who have been asked to work overtime, self-employed consultants offered new projects and shareholders of corporations who have landed new customers/clients. This comment makes no sense on two levels:

Future Earning Power

From a work/business perspective, your employer will never be happy to hear you are not willing to work extra hours or overtime. Any consultant or corporation that turns away work may have made a costly long-term error when you consider the potential work one client can provide over the course of your business's/corporation's lifetime. From an income tax perspective, even at the highest marginal rate in Ontario, where each additional dollar is taxed at 46.41% (or 47.49% if you make over $500,000) you are still approximately 53% better off, by taking on the extra work.

There are times when work should be turned down. Those may include the following:

• You have so much work that you are overwhelmed and if you take on the new client/customer your service or product will be sub-par and your reputation will suffer.
• You are working so hard that your family life is suffering. In this case the extra dollars may cost you something more important than money.
• The new client does not meet your minimum standards for client acceptance.
• You are financially comfortable and the extra money is relatively meaningless to you; not a realistic reason for most of us.

Marginal Income Tax Rates Increase, "Marginally"

Secondly, I just want to make sure everyone understands the marginal income tax rate issue (use the Ontario rates listed below to follow). If you were going to make $80,963 this year, but take on say $4,000 in extra work that results in your income going from $80,963 to $84,963, you will be taxed at 39.41% on that extra $4,000 of income, meaning you will keep 60.59% of the extra income. To put that in perspective, the last dollar you had made before the new work was taxed at 35.39%, meaning you kept 64.61%. Thus, the new work really only raised your marginal income tax rate 4.02%, not enough tax in my opinion to turn down work unless you meet one of the criteria above.

If you were making $130,000 before you took on a new job for $10,000, the first $2,406 of the extra income is taxed at 43.41% (income between $85,415 to $132,406 is taxed at 43.41%), the same rate as the last dollar you made before the income on the new job was taxed. The excess income over $132,406 will be taxed at 46.41%, or 3% higher than your last paycheque was taxed.

It is interesting to note that according to Statistics Canada, the average Canadian salary for 2010 was $49,553. Using the Ontario 2012 marginal rate chart below, that means that the average Canadian employee taking on extra work will be paying tax at the rate of 31.15% on their next $19,000 or so of extra earnings. Of course, the 31.15% rate will vary from province to province; but I use the Ontario rate just to give an approximate marginal tax cost.

I would suggest that anyone who turns down new work because they feel they will be taxed too heavily really does not understand the way the marginal income tax rates work and is making a big mistake. Some people may argue it is the cumulative income tax burden that breaks the camel's back, not the marginal rate. While I understand that argument, in my opinion, work should only be turned down where you meet any of the criteria I list above.

2012 Combined Income Tax Rates Ontario

                               

Tax Bracket                  Marginal Rate*

Up to $39,020                     20.05%

$39,020 - $42,707                24.15%
$42,707 - $68,719                31.15%
$68,719 - $78,043                32.98%
$78,043 - $80,963                35.39%
$80,963 - $85,414                39.41%
$85,414 - $132,406              43.41%
$132,406 - $500,000            46.41%
Over $500,000                     47.97%

* Includes all surtaxes                   

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.

Are Money and Success the Same Thing? Part 2

In my blog post yesterday, I left you to contemplate some very insightful definitions and interpretations of success and how you would answer the question; are money and success the same thing? After re-reading those definitions and interpretations, my answer is that money and success are not one and the same.

However, that being said, I acknowledge that there is also a thread that closely connects success and money in many circumstances, such that the distinction is often blurred. Thus, today I thought I would expand the question to include not only are money and success the same thing, but can money bring you success or success bring you money? For those that feel I should be true to the original premise and question, I apologize for the re-phrasing, but hey, it's my blog :).

I believe there are circumstances where money can certainly help buy or leverage success while in other situations, money may derail success. On the flip side, there appear to be circumstances where success brings you money.

So let’s look at money and success in five of the key aspects of all our lives: family, career, health, spiritualism and impact on society. 

Family

I agree with John Maxwell’s definition of success noted in yesterday's blog, or at least a variation of it. When it comes to family, love and affection are familial success, not money. Nevertheless, we know families can be torn apart because of money; often because money is very tight, but surprisingly often when there is too much money in the family.

With respect to family, money and success are clearly not the same thing. In respect of my re-phrased question, money will not bring you familial success, but in some circumstances, too much or too little money can tear away at the fabric of love and affection. Familial success in my opinion has little bearing on monetary success.

Career

If we are honest with ourselves, career success often leads to money and thus, this is the one aspect of our lives where I can see how a number of people equate money with success. Yes, there are many people for whom the job is the key and money is only secondary. But when we chat about someone, the first topic is usually about their job, which leads us wonder how much money they make. Or alternatively, John makes so much money as a lawyer, he must be successful.

I definitely think there is some truth in Wayne Dyer's comments noted in my blog yesterday where he says  “Successful people make money. It's not that people who make money become successful, but that successful people attract money. They bring success to what they do.” 

Thus, in the case of a career, even if you don’t agree money and success are one in the same, I think you will agree, there are career related circumstances where money can buy success or success can lead to money.

Health

Striving for money can affect one’s health, be it striving for enormous wealth or enough to just support your family. Alternatively, money may relieve stress (no need to work hard) and buy you better health care.

In this circumstance, I think it is clear money and success are not the same thing. Having money won’t mean you’re successful in health, aka healthy, happy, active (whatever other words you think defines healthy), the only affect money can have on successful health is that it may enable you to buy the best healthcare possible. We all know the best healthcare does not guarantee successful health, but in very selected cases, money may buy you health because of the access to care money provides.

In the end, Bob Marley said it best. On his deathbed he told his son Ziggy, “Money can’t buy life”.

Spirituality

This is one case where money is meaningless. People’s spirituality comes from deep inside and money means nothing. However, it is somewhat ironic that when looking for money to build the addition to the church, synagogue or mosque, the first line of attack are those parishioners with money.

Impact on Society

Many people have a positive impact on society by giving their time for the greater good through volunteering. However, other people with money leverage their money to achieve real or perceived success through philanthropic deeds associated with money, such as building a hospital. Some people feel that is not true success, it is just a donation of money, while others would argue building a new hospital is a true success, regardless of whether the person just wrote a cheque or wrote a cheque and volunteered their time.

I think in this situation, money and success are not one in the same, but money can clearly have a positive impact on society and therefore, promote a form of success.

Conclusion

Wow, this blog post just kept going. If you are still with me, give yourself a gold star. So after rephrasing and rambling on over 1400 words, have we learned anything? I have learned (as I worked out this little philosophical debate in my head) that money and success are not one and the same, but do impact one another. Meaning in certain circumstances, money can influence success, and success can determine how much money you have.

On that note, I wish success to you all; however the heck you define it.

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.

Are Money and Success the Same Thing?

Moneyville runs a weekly feature called Fame and Fortune, where famous people discuss various financial lessons they have learned and provide financial advice. The last question is always “Are money and success the same thing?” In the columns I have read, I do not ever recall a featured guest answering yes to this question. Yet, the fact that the question is asked insinuates that some people feel the answer is yes. I would further suggest, that we all have met people who we think would answer yes to this question; or should answer yes, based on their actions.

In my opinion, the brevity of the Moneyville column forces a cliché answer from most of the guests. The guests typically say things such as “money is fleeting” or “money does not buy love” or “people should not be defined by their money”. However, this simple question is actually very complex when you peel back the layers. Success can be defined and interpreted in so many ways. I believe that money and success are not one and the same, but are so closely intertwined in some circumstances, that money may allow you to buy certain variations of success, while in other situations it can derail success.

Today, I will not get into how we look at money, a topic I discussed in a July 2011 blog post, but will focus solely on the success side of the question.

What is Success?

The definition of success is elusive. If you ask 100 people, you would probably get 100 different answers as to how they define success. So I turn to some famous and less famous people and their definitions and interpretations of success (and money) are as follows.

Ralph Waldo Emerson, a famous American essayist and poet, wrote this poem about success (although there is some debate if he indeed wrote this poem):

"What is success?
To laugh often and much;
To win the respect of intelligent people
and the affection of children;
To earn the appreciation of honest critics
and endure the betrayal of false friends;
To appreciate the beauty;
To find the best in others;
To leave the world a bit better, whether by
a healthy child, a garden patch
Or a redeemed social condition;
To know even one life has breathed
easier because you have lived;
This is to have succeeded."

John Wooden, considered by many as the greatest basketball coach ever, had this definition, “Success is peace of mind, which is a direct result of self-satisfaction in knowing you made the effort to do your best to become the best that you are capable of becoming."

According to John Maxwell, an evangelical Christian author, success is when “Those who know you the best love you the most.”

A less spiritual interpretation of money and success is provided by American author and motivational speaker Wayne Dyer who states, “Successful people make money. It's not that people who make money become successful, but that successful people attract money. They bring success to what they do.”

Finally, and I am not sure who said this, but another more financial oriented definition of success is “The world defines success in terms of achieving one's goal, acquiring wealth, status, prestige and power.”

I have been told by other bloggers that the average reader only pays attention for 400 words (I assume my readers are not average, since I breach the 400 word limit regularly) and since I am already over 600 words, I will stop here. However, tonight, when you are relaxing in your La-Z-Boy recliner (ignore the screaming kids and barking dog), contemplate how you would answer the question of whether money and success are one and the same? I will conclude my thoughts tomorrow.

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.

Legislative Update on Personal Service Businesses and Limited Liability Professional Partnerships

On Wednesday, Jim Flaherty, Minister of Finance, tabled a Notice of Ways and Means Motion to implement outstanding technical tax amendments. Included in the amendments are changes to the taxation of Personal Service Businesses (“PSB's”) and professional limited liability partnerships.

PSB's

My blog of January 24, 2012, “Is Your Corporation a Personal Service Business?” generated significant interest amongst many “incorporated employees”. I keep getting asked about the status of the legislation, so today; I thought I would provide an update. The Notice of Ways and Means has introduced an amendment for PSB’s which essentially means that the general rate reduction of 13% currently available to PSB’s will be removed. The Federal tax rate will thus increase to 28% from the current 15%. For Ontario, you will tack on an additional 11.50%, bringing the corporate income tax rate to 39.50%. If you have filed previously as a PSB, your rate would have been 26.50%. If you have filed as a non-PSB with income eligible for the small business deduction, your rate would have been 15.5%.

Clearly this amendment is punitive. The amendment states that it applies to taxation years that begin after October 31, 2011. Thus, this legislation is now as good as passed, so if you have not already considered this legislation in planning, you should do so for any year-end that began after Oct 31, 2011.

Professional Limited Liability Partnerships

The CRA takes the position that the income earned during the fiscal year is not added to a partner's adjusted cost base (“ACB”) until the first day of the following year. However, any partner draws reduce the ACB in the current year. Thus, if you draw $10,000 and make $40,000, your ACB in the current year is negative $10,000, even though you are truly net $30,000. Where you are a limited liability partner, you have a deemed disposition when you have a negative ACB. For example, in the case above, you would have to report a $10,000 capital gain.

This provision was intended to deal with limited partners such as those in a tax shelter. However, it has caught full-shield limited liability partnerships for various professionals. However, the Notice of Ways and Means has introduced an amendment for professional partnerships that will allow the income earned in the current year to be considered in the ACB calculation, such that the negative ACB issue should be alleviated.

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.

Cohesive Professional Advice

I have written a couple times about how important it is to ensure a client’s investment advisor, lawyer, insurance agent, banker, business consultant and accountant integrate their advice into one efficient coordinated plan. A plan that takes into account the client’s investment, retirement, income tax and successions needs. 

I have noted that when advisors operate in silos, only the client suffers. Even worse are situations where advisors operate at cross purposes, often trying to protect their own fiefdom and fees.

Thus, when Adrian Spitters, a senior Financial Planner with Assante and the blogger behind The Retiring Boomer blog, offered to write a guest blog on the importance of cohesive advice amongst professionals, I jumped at his offer.

In his blog below, Adrian discusses several situations in which the joint efforts of his clients team of professionals, prevented some potentially disastrous legal results and produced some significant income tax savings. Without further ado, on to Adrian’s blog.

Cohesive Advice

by Adrian Spitters

"Most Canadians find that they lack the financial knowledge, or the time required, to  research all the options available to them and to make the important financial decisions they need to make at critical points in their lifetimes." Individuals, who decide to forgo advice and think they can do it on their own, may find themselves ill-prepared for some of the most important financial and life changing decisions they will encounter in their lifetimes; especially since many of these significant decisions are complex and require cohesive planning from several professionals.

There are a lot of good financial, legal, accounting and insurance advisors to choose from. However, some are lone cowboys that focus on what they do best and give good advice, but rarely consult with their clients other advisors to understand how their recommendations affect their client’s overall financial well-being. This can lead to problems down the road.

For example, I had a client who resisted undertaking a detailed financial plan and financial check-up. Unfortunately, only when he took ill, did he relent and provide me all his financial documents (personal and business).

With his permission, I had a tax lawyer that I work with review his legal documents, as I had some concerns. The lawyer noted there was a $500,000 cash gift clause in his will that was potentially at cross purposes with an Alter Ego Trust that had been set-up previously. He asked my client if his intention was to give his wife $500,000 through his estate and an additional $500,000 from his Alter Ego Trust. My client replied that he only intended to give his wife $500,000 in total.

It turns out that years ago when my client remarried, he had a new will drafted that gave his new spouse a life interest in the home and $500,000 cash from his investment portfolio. As the years passed, it became apparent his only son and new wife did not see eye to eye. To deal with this situation, my client’s accountant recommended he settle an Alter Ego Trust.

My client then met with a new lawyer to create the Alter Ego Trust. He instructed the lawyer that it was his intention to give $500,000 of his estate to his spouse and the rest of his estate to his son. The lawyer, unaware that a $500,000 provision for his wife already existed in his original will, wrote this provision into the Alter Ego Trust. This resulted in a potential $1,000,000 obligation to his spouse, while potentially leaving his son out in the cold, which was not his intention. The new lawyer then redrafted the will to reflect the actual wishes of my client.

Another example of the benefit of cohesive advice is a client couple who wanted to retire and sell their respective 25% interests in a company that they owned with another couple. I had some concerns about certain assets reflected on the company's balance sheet, so I recommended to my clients that they have the financials reviewed by a lawyer and an accountant that I work with to determine if my concerns were well-founded and whether they had any recommendations. My client's agreed to the review. When the tax lawyer and accountant reviewed the company financials, they discovered that the company owned a condominium and also had a corporate insurance policy with significant cash value. As a result, the company did not meet the requirements of a qualified small business corporation (QSBC) and neither shareholder was entitled to their $750,000 lifetime capital gains exemption as the company was currently constituted.

Since the value of the company was approximately $1,200,000 and the shares had no adjusted cost base, the additional income tax owing would have been in the neighbourhood of $250,000 if the company could not be restructured to qualify for the capital gains exemption. However, we were able to work with their accountant and lawyer to restructure and purify their company by selling the condominium. I also arranged to have their insurance agent transfer the insurance policies form the company into their personal names. This process took two years and once the offending assets were removed they found a buyer to purchase their company shares. While there were some costs and taxes involved in selling the condominium and transferring the insurance policies out of the company into their personal names, these costs were minimal compared to the approximately $250,000 in combined tax savings to the shareholders.

In the process of working with this client, the accountant that I worked with discovered that their partners owned a holding company. He noted that the company had two $450,000 insurance policies on each of the partners. He had the insurance agent we work with review the policies. The agent found that the policies were owned by the company, the insurance payments were made by the company and the beneficiaries were the insured couple. This posed a significant tax liability should either of the insured die. When a company makes payments on an insurance policy on behalf of the insured and the insured’s estate receives the proceeds; the proceeds are taxable to the estate (Bloggers note: if the shareholders reported a personal taxable benefit for the insurance paid by their corporation on their behalf, the CRA typically does not deem the insurance proceeds taxable, although some professionals think the proceeds are taxable even if a benefit was reported).

To correct this, our insurance agent arranged to have my client’s insurance agent change the beneficiary of the policies form the insured’s estate to the company. This way the insurance proceeds will be received by the company tax free, and can then be paid as a dividend to the surviving shareholder tax free through the corporation’s capital dividend account. Soon after the changes were made the husband passed away and the spouse received the full $450,000 insurance proceeds tax free, saving her almost $220,000 in taxes.

These real life examples help illustrate the importance of seeking advice from a cohesive team of professionals, who work together to understand your complete financial picture. Otherwise you may find yourself inadvertently, negatively impacting your financial well-being.

Adrian Spitters, FSCI, CFP, FMA, is a Senior Financial Planner with Assante Capital Management Ltd in Abbotsford, BC. Adrian has extensive business experience that includes over two decades of helping individuals, business owners, professionals, and high-net worth families. For further information please visit http://www.assante.com/advisors/aspitters/ or contact Adrian at aspitters@assante.com

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.