TAX LETTER December 2006 YEAR-END TAX PLANNING IDEAS

Document Sample
TAX LETTER December 2006 YEAR-END TAX PLANNING IDEAS Powered By Docstoc
					                                        TAX LETTER

                                        December 2006


                         YEAR-END TAX PLANNING IDEAS
                     WOULD YOU LIKE SOME TAX-FREE INCOME?
                             AROUND THE COURTS


YEAR-END TAX PLANNING IDEAS                      calculated at the highest marginal rate. If
                                                 your taxable income for 2006 (after all
It’s December, and time to think of some tax     deductions) exceeds $118,286, the charitable
planning ideas. If you wait until your tax       donations credit is worth the same as a
return is due next April or June, it will        deduction. If your taxable income is lower,
generally be too late to change your tax         then the donations credit is better than a
situation for this year.                         deduction.

Below, in no particular order, are some ideas    In British Columbia, for example, if you
and tips which may be useful to you before       have $70,000 of taxable income, additional
year-end.                                        income is taxed at 31.15%, while each dollar
                                                 of charitable donation saves you 43.7%.
1. Charitable Donations
                                                 In fact, if you are not in the top tax bracket,
Charitable donations have to be made by          you can benefit by receiving income and
December 31 to be counted for this year.         donating the excess to a charity. This may be
                                                 possible if you already volunteer for a
Charitable donations receive special tax         charity. If the charity pays you for your
assistance. Once your donations exceed $200      volunteer work, and you donate the income
per year, they give you a tax credit
back to the charity, your tax bill will go       current fair market value. If you are
down.                                            considering making a donation to a charity,
                                                 and you have some securities that have gone
For example, suppose you are in the 31%          up in value, donating the securities will be
tax bracket in British Columbia and you have     very tax effective.
already made over $200 in donations this
year. If the charity pays you $10,000 for
work you have done for it, your tax bill will
go up $3,115. If you donate the same
$10,000 back to the charity, your tax bill
will go down $4,370. The net is a saving of
$1,255 after tax. (The numbers in other
provinces will differ slightly, but the same
principle applies generally.)

Of course, the income has to represent real
work you have done for the charity, and
your donation must be voluntary. The
charity also has to determine whether you
are an employee or an independent
contractor. If you are an employee, the
charity must issue you a T4 and may have
to withhold some tax at source. If you are an
independent contractor, you may be able to
deduct expenses from your “business
income”, providing you with further tax
savings. Professional advice may be useful in
making this determination.

An even simpler route is to have the charity
reimburse you for expenses you incur as a
volunteer (e.g., travel and parking costs).
Such reimbursements, provided they are
reasonable, are not taxable to you. You can
then donate the reimbursed amount back to
the charity and get a tax credit.

Another idea to consider is donating publicly-
traded shares or mutual fund units to a
charity. If you do this, you do not report
any capital gain on the securities, but the
donation is valued for tax purposes at its
2
You can claim charitable donations up to         2005. The new rules provide an enhanced
75% of your “net income” for tax purposes.       Dividend Tax Credit on dividends paid by a
Net income is basically your income after        public corporation. The enhanced credit also
most deductions, but before claiming the         applies to dividends from a Canadian-
capital gains deduction (capital gains           controlled private corporation that has paid
exemption) or any loss carryovers from           tax at the high corporate rate (beyond the
other years.                                     level where the small business deduction
                                                 applies).
Note that, under rules announced in
December 2003 but not yet enacted into law,      (As noted in our September 2006 issue, draft
donations of property are valued at your         legislation to implement these changes was
cost of the property, if you acquired the        released on June 29, 2006. The legislation
property within the past 3 years or if you       has now been included in Bill C-28, which is
acquired it for the purpose of donating it.      expected to be passed by Parliament this
This latter “purpose” rule applies only if       month.)
you acquired the property within the last
10 years. (This rule does not apply to           A Canadian-controlled private corporation
publicly-traded securities or certain other      that has paid tax above the small business
property.) This prevents the so-called “art      deduction level in recent years will have a
flip” schemes which used to attract many         General Rate Income Pool, or “GRIP”. This
taxpayers, who would purchase art for less       pool can be used to pay you dividends for
than its appraised value and then donate the     which you will receive the enhanced
art to a charity for a high-value tax receipt.   dividend tax credit, so that your tax cost of
                                                 the dividend goes down.
2. Owner-manager remuneration
                                                 Regular dividends are included in your
If you own a small business that is              income with a 25% gross-up (i.e., 125% of
incorporated and has a December 31 year-         the dividend is included in your income).
end, you will want to make year-end              The federal dividend tax credit is then 2/3 of
decisions about paying yourself (or family       the gross-up, and there is a provincial credit
members) a bonus to reduce the corporation’s     as well. For dividends from a public
income. Traditionally, private corporations      corporation, or from a private corporation’s
have “bonused out” their income over the         GRIP, the income inclusion is 145% of the
small business deduction threshold, which is     dividend, and the federal dividend tax credit
$300,000 until the end of 2006 (it becomes       is 11/18ths of the 45% gross-up, and again
$400,000 in 2007).                               there is a provincial credit. While the
                                                 numbers can be confusing, the net effect is to
The calculation changes somewhat this year       reduce substantially the tax you pay on such
because dividends from income taxed at the       dividends.
high rate will now be taxed at a lower rate in
your hands, due to the new rules on the          The precise calculations and decisions about
taxation of dividends announced in November      owner-manager remuneration will need to
                                                                                            3
take into account provincial tax, the              Agency (CRA) after you filed your 2005
provincial dividend tax credit, your other         return in the spring of 2006. Your maximum
sources of income, how soon you need to            contribution room for 2006 is:
extract the funds, future changes in personal
and corporate tax rates, the corporation’s              18% of your 2005 earned income
need to retain cash in the business, and other        (maximum $18,000 if your 2005 earned
considerations. Although the calculations can               income exceeded $100,000)
be complex, it is worth paying attention to                           minus
this issue before year-end.                                  your pension adjustment
                                                                       plus
3. RRSP contributions                                any contribution room from earlier years
                                                                    since 1991
If either you or your spouse are not yet 69               that you have not yet used up.
this year, then you can normally make
contributions to a registered retirement savings   Your deadline for contributions for 2006 is
plan (RRSP) and deduct them from your              March 1, 2007. However, if you have any
income for tax purposes. Your RRSP                 excess cash you should consider planning for
contribution limit for 2006 is based on your       your 2007 contribution as well. You can
2005 “earned income” as well as your               make that contribution any time after
pension adjustment (reflecting future              January 1, 2007. Putting funds into an RRSP
pension credited to you in 2005 from your          will allow them to grow tax-free, rather than
being a member of a company pension plan).         you having to pay tax on any interest that
“Earned income” is generally your income           you earn during the year.
from:
                                                   Consider also a contribution to a spousal
•   employment                                     RRSP. (This also applies to a common-law
•   carrying on business (but not through a        partner or same-sex partner even if you are
    corporation unless the corporation pays        not legally married.) Your maximum deductible
    you a salary; dividends or shareholder         contribution is the same regardless of whether
    benefits are not “earned income”)              you contribute to your RRSP or your
•   net rental income (after expenses) from        spouse’s, or some combination of the two. If
    real estate                                    your spouse is likely to have lower income
•   CPP disability pension                         than you in future years, then a spousal
•   research grants                                RRSP contribution will allow your spouse
•   taxable spousal or child support payments      to take the income out down the road (once
    (note that child support is taxable only if    the third year has passed from when you
    the support order or agreement dates           make any spousal contributions). Your
    before May 1997).                              spouse will then pay tax on that income at a
                                                   lower rate than you would if you withdrew
Your available RRSP contribution room              the funds from your own RRSP.
should be printed on the Notice of Assessment
that you received from the Canada Revenue
4
A spousal RRSP is also useful if you are      4. Trigger capital losses
already over 69 but your spouse is younger.
Once you reach the year in which you          Capital gains are half-taxed; that is, half of
turn 69, you cannot contribute to your own    the gain is included in your income as a
RRSP and must convert your RRSP to an         taxable capital gain. Capital losses can be
annuity or a registered retirement income     claimed only against capital gains (and can be
fund (RRIF) from which you draw income        carried back three years and forward
every year. However, you can still make       indefinitely against such gains).
contributions to a spousal RRSP if your
spouse is under 69 at year-end.               If you have capital gains this year — for
                                              example, from selling some shares for a gain
                                              earlier in the year — you may wish to trigger
                                              capital losses by selling securities that have
                                              gone down in value.

                                              Make sure the transaction is completed in
                                              time for it to settle before the end of the
                                              year. Depending on your broker, the
                                              security and the market on which it is
                                              traded, the settlement date may be from one
                                              day to several days after you instruct your
                                              broker to complete the sale.

                                              You should also ensure that you are not
                                              caught by the “superficial loss” rules. If you
                                              (or an “affiliated person”, which includes a
                                              corporation you control) acquire the same
                                              (or identical) securities within 30 days of
                                              selling them, then your capital loss will be
                                              disallowed.

                                              There are numerous other special rules for
                                              capital gains and losses. This is just a general
                                              overview.

                                              5. Pay your instalments

                                              If you have instalments to pay for the year,
                                              and you have not been paying them as per
                                              the notices you receive from the CRA during
                                              the year, now would be a good time to catch
                                              up. If you wait until April, you will owe
                                                                                        5
four months additional interest, and possibly    There are a number of types of income or
penalties, on the late instalments.              benefit which are not subject to tax under the
To avoid interest from applying, instalments     Income Tax Act. To the extent you can get
should be paid on March 15, June 15,             one of these, you won’t need to report the
September 15 and December 15. Prepaid or         income or pay tax!
“early” instalments earn credit (called
“offset interest”) against interest that
applies to late instalments for the same year.

You are allowed to calculate instalments
based on any of three methods, without
interest applying. The instalments can total
your tax payable (on income from which tax
is not withheld at source) for this year, or
for last year, or based on the amounts that
the CRA advises you. The CRA’s notice to
you for March and June is based on the
amounts you paid two years ago, and then
for September and December the suggested
instalments are adjusted so that the total for
the year equals the amount you paid last year.

If you have not been paying your
instalments, you should estimate as best as
you can the tax that will be owing for the
year on your self-employment and investment
income (and other sources from which tax is
not withheld). You should then make a
catch-up instalment payment as soon as
possible, to reduce interest charges.

Where interest does apply to late
instalments, it is calculated at 9%,
compounded daily. (The rate changes each
quarter.) You do not get interest on overpaid
instalments, other than as an offset to late
instalments for the same year as explained
above.

WOULD YOU LIKE SOME
TAX-FREE INCOME?

6
Here are some of the kinds of income that
are not taxed, based on the provisions of the     •   Income of a “status Indian” earned on a
Income Tax Act, CRA Interpretation Bulletins          reserve. If you aren’t a status Indian, this
or court decisions:                                   exemption doesn’t help you!

•   Strike pay from a union. (Supreme Court       •   Payments for foster care and similar in-
    of Canada, 1990 decision in Fries v. The          home care that you provide.
    Queen) A union’s cash gift to a member
    is also tax-free.                             •   Welfare and similar social assistance
                                                      payments. These must be reported as
•   Damages or compensation for personal              income, but an offsetting deduction is
    injury, including structured settlements          available when calculating taxable
    and awards from a provincial Criminal             income.
    Injuries Compensation Board.
                                                  •   Workers’ compensation benefits. These
•   Compensation for mental or emotional              must be reported as income, but an
    damage at the workplace, such as                  offsetting deduction is available when
    harassment of an employee, or for                 calculating taxable income.
    human rights violations.
                                                  •   Grants under government programs,
•   Lottery or other gambling winnings,               unless the program has been prescribed
    unless you are so organized and active in         in the Income Tax Regulations as taxable,
    your gambling that it constitutes a               or it relates to your business.
    “business” from which you could deduct
    losses if you lost money.                     •   Reimbursements       of   expenses     to
                                                      volunteers, and reimbursements to parents
•   Television game show prizes, even                 for the cost of transporting students to
    where the taxpayer trained to develop             school when a school board discontinued
    expertise in the subject matter.                  bus service.

•   Gifts (provided they are not disguised        •   Damages for breach of an employment
    employment income or business                     contract before it began.
    income).
                                                  •   Compensation for damage to business
•   Capital gains on your principal                   operations in some circumstances.
    residence, subject to various rules that
    ensure that your family has only one          •   U.S. social security disability benefits.
    “principal residence” at a time. However,
    if you build a home to sell, but move in      •   Certain employment benefits (see CRA
    first, this exemption will not be available       guide T4130, available on cra.gc.ca),
    because your gain will be business profit,        including:
    not capital gain.
                                                                                                  7
    — your      employer     paying    for        — child care provided at the workplace
      counselling services related to your          for all employees and managed by
      mental or physical health                     the employer
    — employer contributions to a private
      health care plan such as a drug plan        — uniforms required for employees, or
      or dental plan                                special or protective clothing
                                                  — employee discounts on merchandise
    — employer contributions to a registered        and subsidized meals, normally not
      pension plan, deferred profit-sharing         below the employer’s cost
      plan, or disability insurance plan
      (when you receive benefits from             — social events costing up to $100 per
      these plans, you are taxed on them if         employee and available to all
      your employer made contributions to           employees
      them)
                                                  — transportation passes for bus, rail
    — certain allowances, such as reasonable        and airline employees (except where
      car allowances within certain limits,         travelling on a space-confirmed basis).
      and travel expense reimbursements
      while working away from home             AROUND THE COURTS

    — two non-cash gifts worth up to $500      Charity must disclose names of donors
      per year, and two non-cash awards
      worth up to $500 per year, subject       The Income Tax Act has rules prohibiting
      to certain restrictions                  CRA auditors from going on “fishing
                                               expeditions” to find information about
    — certain   benefits    for     disabled   taxpayers.
      employees, including transportation,
      parking and attendant services           Normally, an auditor is entitled to demand
                                               from a taxpayer any information or
    — board and lodging at a “special work     documentation necessary to determine
      site” or a remote location               whether the taxpayer has paid the correct
                                               amount of tax.
    — items which are considered to
      primarily benefit the employer, such     If, however, the auditor is looking to find
      as cell phones, computers, home          information about other taxpayers (not the
      Internet     service,     convention     one being audited), the auditor is required to
      attendance, professional membership      obtain a Court Order from a judge permitting
      dues and tuition reimbursement,          the auditor to demand information about
      depending on the facts                   “unnamed persons”.




8
The Courts have been considering the
question of whether the CRA is entitled to
obtain information from charities about their
donors. Charities issue tax receipts which
entitle their donors to substantial tax
savings.

In October 2006, the Federal Court of
Appeal issued its decision. A CRA auditor
had obtained a list of donors who had
participated in a particular “forgivable loan”
program that this foundation had operated,
and the CRA had proceeded to reassess the
donors to deny their charitable donation
credits.

The Federal Court had ordered that these
reassessments be cancelled because the
auditor had not obtained a Court Order
allowing the auditor to demand information
about unnamed persons. However, the
Federal Court of Appeal overturned this
decision. The Federal Court of Appeal ruled
that the auditor was entitled to obtain this
information in the normal course of the
audit, and that the reassessments of the
donors were valid.

Thus, it is now established that CRA
auditors can demand lists of donors from
charities, and can use those lists to reassess
taxpayers who are considered to have
received excessively high tax receipts.

                          ***

This letter summarizes recent tax developments and tax
planning opportunities; however, we recommend that you
consult with us before embarking on any of the suggestions
contained in this letter, which are appropriate to your own
specific requirements.




                                                              9

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:5
posted:3/30/2012
language:English
pages:9