Tuesday, April 28, 2015

Canadian Taxes A to Z (2015): U is for UCC, V is for V-Day, W is for Withholding Tax, X is for X-Mark, Y is for Year End, Z is for ZBB

Today is the last in the series of Canadian Taxes A to Z (2015) posts. Yes, I know you're sad. I'm sad too. But at least you can look forward to receiving that big tax refund generated through your newfound interest in Canadian tax law. 

I know I'm combing the last six letters of the alphabet into one post, rather than stretching them out into six separate posts. But we're down to the wire in Canadian Tax Filings And Payments are Due Week (CTFAPADW), and I haven't filed my own taxes yet. Plus I do have a law practice to run. So I hope you'll forgive me for the combination of the last six tricky letters of the alphabet. 

U is for for Undepreciated Capital Cost (UCC). It's very important to keep track year to year of your UCC for each capital asset (within each class) that you own. It's not enough to simply know how much you paid for the capital item, and what percentage of depreciation can be claimed each year, since each year the depreciation claimed will be a slightly smaller figure (the same percentage of a lower number), whereas in the first year the depreciation claimed will be a much small number (half the normal depreciation rate) because of the half year rule. Keep all your UCC receipts organized by class, and year of acquisition. 

V is V-Day. No, not Victory Day. No, not Victoria Day. Definitely not Valentines Day. V-Day stands for Valuation Day in tax speak. V-Day is any day when you needed to determine a fixed financial value for something that you'd owned for a while, and planned to own for a while longer, but which didn't have a readily apparent value (like a share price). 

For example, if you bought a commercial property back in the 1960's prior to capital gains being taxable, and then planned to sell it now, you'd need to establish a value for it as of the end of 1971 after which capital gains became taxable. There may be other tax reasons for a V-Day, like making a particular election under the Income Tax Act. In any case, you may need to later defend your V-Day value if challenged by the CRA, so ideally you'll employ a professional to establish a fair market value. 

W is for Withholding Tax. Canadian law stipulates many situations where a payor of money is required to withhold a certain percentage of that money, and instead of paying it over to the person to whom it is owed, must remit it to the government for estimated taxes owning. The most common type of tax withholding is that of employers who are required to withhold a percentage of employee wages as income taxes, with the percentage of withholding rising with the level of the employee's wages. Other kinds of common withholding taxes are those required by financial institutions on RRSP withdrawals, and those required on foreign residents for Canadian income. 

At tax filing time, the government may determine that there was too much or too little withholding, leading to a refund or additional taxes owing. The trick to navigating withholding rules is to try to bring yourself within the conditions where no withholding is required, or to keep the payments you receive below the threshold where a higher level of withholding is triggered. 

X is for .... well ... er .... I don't know what X is for. I've look in the Income Tax Act. I've studied accounting term glossaries. And none are big on the letter X. Perhaps Taxgirl (who gave me the inspiration for all these Canadian taxes A to Z posts) can help out? Her X word this year is 1040X (the name of an IRS form), so that doesn't really help in the Canadian context. In 2014 and 2013 she cited financial terms involving X, but I like her 2012 post the most: X is for X-Mark (Signature): http://www.forbes.com/sites/kellyphillipserb/2012/03/28/taxes-from-a-to-z-x-is-for-x-mark-signature/

Taxgirl quite rightly points out that a tax return in the U.S., just like a return in Canada, isn't valid unless it's signed! It's easy to forget that last step, after putting in all the up front work on the numbers. Electronic returns also need to be "signed" but there are deeming rules that you signed it if you submitted it in the correct way through the electronic portal. 

Y is for Year End. Many organizations (including corporations) have off-calendar fiscal years. Often, the timing of the year-end is to coincide with a time of the year when business is slow and employees are not on holiday, and thus there are more resources available to close the year-end books. Tax consequences of having a non-calendar fiscal year can be to shift some income to a future taxation year, and thus defer tax. 

However, unincorporated individuals operating as sole-proprietors or partners can generally no longer benefit from a permanent income/taxation shift. While they might initially defer some tax in the first year of business, that tends to get picked up in the second year of business (possibly pushing the businessperson into a higher tax bracket by capturing more than 12 months of income). Definitely get professional accounting advice prior to deciding to go with a Year End other than December 31.

Z is for Zero Based Budgeting (ZBB). Yes, not really a tax term. But like the letter X, there aren't a whole lot of Z tax terms. And zero based budgeting could ultimately affect your tax situation by increasing (or decreasing) your net revenues. The concept was first deployed on a large scale in the private sector by the Texas Instruments corporation in the 1960's in the private sector, and later championed in the public sector by Jimmy Carter (prior to his becoming U.S. president). 

It's another of those looks great on paper, not so easy to practically implement concepts. For any business (or government), the theory goes that instead of a new fiscal year's budget starting with the previous year's budget as a base (and thus being prone to incremental budget creep), each year should start with zero, with every line item being required to be justified all over again year after year. The theory is that ZBB is a great way to eliminate waste. If you can't justify why you've got a budget line, then "poof" you're eliminated. 

The problem with ZBB is the rebuilding a budget every year from the ground up can become an overwhelming, all consuming task. And valuable parts of an organization with less tangible outputs could get snuffed out, to the detriment of the entire organization. 

Monday, April 27, 2015

Canadian Taxes A to Z (2015): "T" is for Terminal Loss

In today's Canadian Taxes A to Z (2015), T is for Terminal Loss. Twenty letters down, six to go!

For some reason, I've always liked the term Terminal Loss. Maybe because it conjures up travel images of train and bus terminals. Perhaps because of its finality. It's another of those "tax terms" that if you're not in the know, you'd never guess at what it means.

When depreciable capital property is sold for a value lower than its undepreciated capital cost (UCC) at the end of a fiscal year, then it can general a terminal loss if there are no other assets left in the class. A terminal loss is fully deductible against other income.

Say you buy a Big Purple Machine, take some depreciation over a couple of years that reduces its UCC to $10,000, but then sell it for only $5,000. Perhaps because Big Purple Machines were an industry fad for a couple of years, but ultimately didn't make anyone any money. Thus the low resale value. If nothing is left in the Big Purple Machine class, you can claim another $5,000 terminal loss deduction for the difference between the UCC and what you sold it for. Pretty good, eh?

But watch out. Terminal Loss has an evil twin called Recapture. If you sell the Big Purple Machine for $11,000, but have already depreciated it to a $10,000 value, and nothing is left in the class, then you wind up with a $1,000 recapture that you've got to include in income!

The moral of the story is to try to sell used business assets for amounts lower than the depreciation you've taken on them. You'll be able to deduct any loss you take, and won't wind up getting stuck with paying taxes on any sale profit.

Sunday, April 26, 2015

Canadian Taxes A to Z (2015): S is for Small Business Deduction

In today's Canadian Taxes A to Z (2015), we finally get to the letter "S". Arguably the most useful of Scrabble letters, and not too shabby from a tax perspective either. S is for Small Business Deduction.

The Small Business Deduction reduces taxes for Canadian Controlled Private Corporations (CCPCs). It unfortunately does nothing for you if you're operating as a sole proprietor or partnership. The reduction is available on the first $500,000 of income. For 2015, it results in a tax reduction of 17% off the base corporate tax rate. This amount is going up by 1/2 a percent every year until 2019, when it will result in a 19% reduction.

This Small Business Deduction is in addition to the already generous 10% Federal Tax Abatement knocked off the base 38% corporate tax rate. What this means is an incredibly low 11% tax rate for 2015, falling to an even more incredibly low 9% by 2015. This rate can make United States taxes look high by comparison.

So what's the catch? First, the corporation must be private (meaning not publicly trading shares) and controlled by Canadian residents. Neither of these are very onerous requirements for incorporated small businesses.

The bigger catch is that you'll get taxed again as an individual when you withdraw income from the corporation, such as being paid as an employee. There are various ways to structure the means through which you pay yourself from the corporation to minimize the taxes paid, but there is always a risk of double taxation: once in the hands of the corporation, and then again when the money passes into your own hands.

The most important factor to keep in mind in considering whether incorporating your business is going to do much for you from a tax perspective is whether you'll be in a position to shelter net income in the corporation, or will need to withdraw all the profits each year for your own living expenses. If you're able to shelter income, then you'll be able to invest those excess profits after losing only between 9% and 11% of them to tax. So it's kind of like an RRSP, but one where you lose a small amount off the top. Unlike an RRSP, you aren't claiming a deduction for the income you shelter in the corporation, but the effect is the same because you won't personally pay any tax on that income until you take it out of the corporation and place it in your own hands.

While there can be other legal benefits to incorporation, like limiting your personal liability, you should get accounting advice on whether incorporation is really going to save you any money at tax time. It's possible that it might actually cost you money (after increased legal and accounting fees are taken into account) if you aren't able to shelter any income inside the corporation.

Saturday, April 25, 2015

Canadian Taxes A to Z (2015): R is for RRSP, RRIF & RESP

Today in Canadian Taxes A to Z, we come to the letter R. Unlike that stumper letter Q, R presents an embarrassment of riches when it comes to choosing tax-relevant words starting with R. I've chosen to present you with three R acronyms today, because they're all very important to your taxes, and there's sometimes confusion among them when it comes to knowing how they save you on taxes.

Eighteen letters down, eight to go! And only five days left to tax filing deadline. Clearly I'm going to have to double up on posts for a couple of days. And figure out what in the world I'll do with X, Y and Z!

First up, RRSP, probably the best known and understood of the three acronym terms. Most know it stands for Registered Retirement Savings Plan. This (and all the other acronyms) is a tax deferral vehicle, not a tax free vehicle. Meaning, you get to save on tax when you deposit money to it, and the taxman gets you when you later withdraw money from the plan. 

In theory, RRSPs are supposed to save you money in two ways. First, because the dollars you deposit to your RRSP are pre-tax dollars, there are more of them to deposit, and thus more of them available to earn a return on investment. That's probably going to mean you have somewhere between 50% and close to 100% more money invested up front (depending on the level of your marginal tax rate). 

Thus if you've got $100 to invest, and you put it into an after-tax outside of RRSP investment account, you'd really only be investing $75 dollars (if you're paying tax at 25% - many of us pay at a higher rate). If you're able to invest at a 5% annual rate of return, that $75 investment would be worth only $78.75 after one year. Whereas, if you had placed it into an RRSP you'd have $105 after one year. And all the benefits of increased compounding in future years. 

The second way RRSPs may save you money is that when it comes time to withdraw from the plan, you'll be retired, and earning a lower income (and thus be in a lower tax bracket) than when you originally contributed to the plan. The important word to focus on here is "may." Many people don't realize that it's entirely possible they could actually be earning more money later in life than earlier in life, such as if they're collecting a pension and also still working full or part time. Also, the government could decide at some point to raise marginal tax rates. You'll get hit with whatever rate is in force and applicable to your current income at the time you make the withdrawal. The up front tax saving is probably still worth it, but be careful.

RRIFs are essentially forced withdrawal from RRSP plans, starting at age 71. The government won't force you to withdraw too much each year, but your RRSP must be converted to a RRIF by age 71 at the latest, and the withdraws increase as you get older. The idea seems to be to force you to pay some tax on all the RRSP accumulation while you're still alive, rather than leaving it to your heirs to be hit with the tax (which might be at the top marginal rate if all those RRSPs become income to you in the year of your death).

RESPs, in contrast to the other two vehicles, don't result in a tax saving to the person contributing in the year of contribution, but do permit the accumulation of investment returns tax free within the plan, which can then later be withdrawn tax free. 

Both RRSPs and RESPs are subject to annual contribution limits, and tax free withdrawal limits. You can even temporarily get tax free money out of an RRSP for specific purposes, like buying a home, but you'll be required to pay it back. 

It's important to consult an accountant or carefully study Canada Revenue Agency material each year that you intend to contribute to or make a withdrawal from a RRSP or RESP (and withdraw from a RRIF), as the limits, rules and exceptions continually change. But all three remain important tax saving instruments. 

Tuesday, April 21, 2015

Canadian Taxes A to Z (2015): Q is for QuickBooks

In today's Canadian Taxes A to Z, Q is for Quickbooks. Seventeen letters down. Nine to go!

If you're running any kind of business that takes in more than a few thousand dollars a year in revenue, you should be thinking about electronic bookkeeping. Quickbooks is likely the leading small business electronic bookkeeping program, though it certainly isn't the only one. To be frank, it's featured in my title today because there aren't a whole lot of tax terms that start with the letter Q. And electronic bookkeeping will make your accountant and the Canada Revenue Agency happy, because you'll be able to defend any kind of later audit of your books be presenting well organized and balanced ledgers.

Accountants hate the "shoebox" school of bookkeeping, because it's very difficult to figure out based on a shoebox of papers exactly how much money you made after expenses for tax purposes. With electronic bookkeeping, each expense and revenue is precisely accounted for long before the accountant starts working on your taxes.

The main small business alternative to Quickbooks is Simply Accounting. Simply is a Canadian product, whereas Quickbooks comes out of the U.S. Medium and larger businesses use different (and much more expensive) bookkeeping and inventory control programs produced by other vendors, but for the small business world Quickbooks and Simply are the two leaders.

Good old Microsoft Excel spreadsheets can also serve you well, so long as they're properly set up for double entry bookkeeping. I used them for several years when starting my law practice.

Even old school double entry hand written ledger bookkeeping can still work, but it's a lot of hassle to find and fix mistakes. I know a few lawyers whose bookkeepers still use the method, but it comes with some inherent risks.

There are other software programs out there which sound like bookkeeping solutions, but aren't, even though they may have other nifty features. For instance, Canadian FreshBooks has a great cloud-based invoicing and billing program. But it's not a bookkeeping program, notwithstanding the use of the word "Books" in its name. Maybe one day it will do bookkeeping, but for now lacking a double entry systems and required ledgers means you can't get a full picture of your business financials from it.

There's also personal finance software out there, one of the most popular being Quicken from the Intuit makers of Quickbooks. It does a great job with household finances. Just don't confuse it with bookkeeping software.

Monday, April 20, 2015

Canadian Taxes A to Z (2015): P is for Principal Residence Exemption

Today, P for for Principal Residence Exemption. Sixteen letters down. Ten to go!

The principal residence exemption may be the best tax break going for Canadians who own a home. As I've mentioned under earlier alphabet letters, you've usually got to pay tax on capital gains just like on income gains (though at half the normal rate). However, any capital gain on your principal residence is tax free. With home values in Canada generally rising at much faster rates than investment values, this can be a very profitable exemption!

Prior to 1981, each spouse in a couple could designate a principal residence for the purpose of the exemption. So one could choose the cottage, and one the city home, and no one would pay tax on capital gains on either of them. However, since that time couples can only have one joint principal residence.

A couple could pick the cottage as the principal residence if they wish to avoid tax when it comes time to sell it, but for the years of its designation they would lose the exemption on their city home. So designating the cottage would probably only make sense if it had experienced a larger capital gain during the relevant period than the city home. For a couple with a tiny city condo and a palatial waterfront cottage, picking the cottage sale to be tax free would make sense. But for most people, the city home is going to have risen more in value because it was more expensive to begin with. Picking the cottage as the principal residence would help defer tax payments for a while if it is sold prior to disposition of the city home, but if you plan to sell the city home at any time in the future the taxing of its capital gain would eventually catch up with you.

The most important requirement of the principal residence exemption is that the home must have been your principal residence for the entire time you owned it, not just at the time you are selling it. Otherwise, you'll need to take a percentage of a capital gain exemption equivalent to how long the home was your principal residence as compared to the total amount of time you owned the home.

Sunday, April 19, 2015

Canadian Taxes A to Z (2015): O is for Offence

Today, "O" is for offence. We've got 15 letters down, and 11 to go in our 26 letter tax race. 

Offence is a generic term used to refer to a lot of different contraventions of regulatory legislation in Canada which don't qualify as "crimes." Generally, you only find crimes in the Criminal Code or Controlled Drugs and Substances Act. So contraventions of the Income Tax Act are usually termed "offences."

It's important to distinguish between getting just a little too creative in your tax accounting which leads to you making statements in your tax return which the CRA won't accept but which don't amount to offences, and outright lies or obstruction which may potentially lead to offence charges against you. Make a few math errors, make an honest mistake about claiming a deduction you erroneously thought you were entitled to, have some bookkeeping errors leading to you claiming too much mileage on your vehicle? The CRA might administratively penalize you for any of these errors by charging you interest on the tax balance owing and assessing civil penalties. But it's unlikely any of these mistakes will lead to allegation of offences. 

However for more blatant actions (or inactions) like "forgetting" to file tax returns for ten years, ignoring repeated information demand letters sent to you by the CRA, and understating your real income by $100,000 are all good ways to be accused by the CRA of offences. Since the Income Tax Act is a regulatory statute, you can be liable for most of its offences (other than tax evasion) even if you didn't wilfully intend to commit the offence. Thus it's a bit like speeding on the highway: you might not have intended to drive 40 km over the limit, but if you got a bit distracted and your foot got a little heavy on the gas, saying you didn't mean to speed isn't going to help you in court. Same with taxes: saying you didn't mean to forget about filing your tax returns and ignore all those demand letters the nice people at the CRA sent to you won't really help you when you're charged with an offence. 

The CRA tends to have a fairly high offence charging threshold. Meaning, they'd much rather go after you for more minor contraventions through administrative means by imposing administrative monetary penalties, rather than hauling you into court on offence charges. So not filing your return for a year or two, or "forgetting" to report $10,000 in income on your return isn't likely to lead to you facing an "offence." But don't file for many years, or forget to report a few hundred thousand dollars on your return, and you might wind up with a court date. 

Sometimes the CRA's charging threshold will be lowered if there are other aggravating features of tax misconduct. For instance, if your non-reporting income is from a criminal sources, the CRA might charge you even if it's only a few thousand dollars that are unreported. 

The message here is that the best way to avoid any allegations of tax offences is to avoid any hint of impropriety when filing your return. I'm not suggesting that with sound accounting advice you shouldn't push the envelope in aggressively claiming deductions. Just be sure you can later defend those deductions when challenged, certainly don't "forget" about any income, and make sure you file your return on time, year after year, even if you can't afford to pay your full tax bill. tThe CRA will make payment arrangements, and the prescribed rate of compound interest remains a quite reasonable 5.1%. 

Friday, April 17, 2015

Canadian Taxes A to Z (2015): N is for Non-Refundable Tax Credit

Today, N is for non-refundable tax credit. Fourteen letters down, twelve to go!

Why the qualifier "non-refundable" and not just the term "tax credit"? Because some tax credits can actually result in the government sending you a cheque, such that in a way you make a profit off the credit. Non-refundable credits can at best reduce your payable tax to zero, but you'll never get a dollar back directly from the government (unless you've overpaid your tax instalments or deductions, leading to a refund).

You can receive non-refundable tax credits against both federal and provincial payable income taxes. The credit equals a "base amount" times the applicable tax rate. So, for example, the spousal credit can net you a $1699 credit federally, and an even greater $1821 credit against Alberta provincial tax, but only a tiny $423 credit against Ontario provincial tax.

Some non-refundable taxes credits can be claimed by either spouse. Usually it will be the higher earning spouse who claims the credit. These include:
  • amount for infirm dependants 18 or older;
  • public transit amount;
  • children's fitness amount;
  • children's arts amount;
  • home buyer's amount;
  • adoption expenses;
  • caregiver amount;
  • tuition and education amounts.
The Dividend Tax Credit for Canadian Dividends is an important one for investors, as it effectively reduces the tax rate payable on dividend income. But foreign dividends don't qualify for the dividend tax credit. And even within Canadian dividends, there is a split between:
  • Canadian public corporations which are eligible for the enhanced dividend tax credit (commonly known as "eligible dividends";
  • Canadian-controlled private corporations (CCPCs) which are eligible for the regular or small business dividend tax credit.
You'll probably be able to figure out many of the available personal non-refundable tax credits yourself when completing your return, but if you've got significant investments then getting the advice of an accounting professional would be prudent. In either case, make sure you carefully go over the fairly lengthy laundry list of available non-refundable credits to ensure you don't miss one you might benefit from!

Thursday, April 16, 2015

Canadian Taxes A to Z (2015): M is for Marginal Tax Rate

Okay, so maybe I was the marathon runner who shot out the gate a little too fast. Managing to knock off post after post, day after day, in the Canadian Taxes A to Z (2015) odyssey, only to start to slow down as the mid-alphabet range of the race was entered.

Today, 14 letters down, 12 to go! I'm past the half-way point. And promise to finish prior to tax deadline time.

To know your marginal tax rate is to know how many cents of every dollar you make will stay in your pocket if you continue to earn more income throughout the year. The reason we don't just use the term "tax rate" without the word "marginal" is because we don't use a flat tax system in Canada (nor does any country with a "progressive" tax system).

Marginal tax rate is the percentage rate that will be applied to the next dollar you earn. To take Ontario as an example, your combined federal and provincial tax rate on the first $40,922 you earn is 20.05%. That doesn't mean you'll necessarily lose that much of your income, since you'll be entitled to various deductions, but the "margin" bump up to the next tax bracket (24.15%) happens when you earn more than $40,922.

The top bracket in Ontario of 49.53% kicks in at over $220,000 in net income (there are several in between brackets). Meaning you get to keep just slightly over 50 cents of every dollar you earn. A lot of countries now try to keep their top marginal rates under 50%, since they saw that income tax rates which used to range about 80% at the top end simply encouraged a flight of the wealthy (and their capital) to lower tax jurisdictions.

Other provinces have different rates at different marginal brackets. The finishing top marginal tax rates tend to be somewhat similar among the provinces, but may kick in much sooner than in Ontario. In Quebec, for example, on the first $41,935 of income you pay at a rate of 28.53% (almost 50% higher than in Ontario). The top marginal rate of 49.97% is very similar to Ontario's top rate, but kicks in at $138,587 income, much sooner than Ontario's top marginal rate.

The other thing to know about marginal tax rates in Canada is that you only pay tax on capital gains at 50% of the normal rate. So even if you're in the top tax bracket, your marginal tax rate for capital gains would only be 24.76%. You'll also get a bit of a tax break on marginal rates for Canadian dividend income.

Some think it unfair that those with active income (from employment or self-employment) pay taxes at a higher rate than those with passive investment gains. But like a lot of things tax, that's just the way it is. Not unlike it being potentially unfair that those whose primary owned residence goes up massively in value pay no tax at all on those capital gains, whereas those who rent get no similar tax break.

Monday, April 13, 2015

Canadian Taxes A to Z (2015): L is for Listed Personal Property

Today, L is for Listed Personal Property. Most Canadians, even those who run businesses, will never have heard of Listed Personal Property (LPP). But if you're a "collector" you're probably all too familiar with its taxing limitations.

Like Capital Cost Allowance (CCA), LPP is a term unique to the Income Tax Act, rather than one in common accounting use. LPP is personal chattels (meaning not real estate) that usually appreciated in value over time. Most chattels depreciate, and thus you can claim CCA on them. You can't claim CCA on LPP.

LPP includes:
  • prints, etchings, drawings, paintings, sculptures and other similar works of art;
  • jewellery;
  • rare folios, manuscripts and books;
  • stamps;
  • coins. 
Profits on the sale of LPP are reportable capital gains. However, the base value of CPP for capital gains purposes is $1000. So if you buy stamps for $700, and sell them for $1200, you only have a $200 capital gain to report (the increase from the $1000 deemed based value). 

LPP losses can only be used to offset other LPP gains, not other income. 

What this all means is that you can't invest crazy sums in art, hoping that it will create all sorts of losses for you when you go to sell it that you can deduct against other income. Likewise, you can't spread high end art all over your office, hoping to depreciate its value as regular CCA. Though less expensive pieces should be deductible as regular office expenses. 

Sunday, April 12, 2015

Canadian Taxes A to Z (2015): K is for Know Your Income

Yeah, Yeah, so I needed to stretch a bit today to find a "K" word. In the U.S., Tax Girl has a huge advantage for some of these tricky letters in writing her [American] Taxes A to Z for Forbes because the I.R.S. seems to love appending letters to the end of its endless list of forms and instruments. Like 401K fund. I mean, really, how easy it that to find a "k" tax word to write about! ( I concede she has to come up with new letters every year, whereas this is my first time around, but still).

In Canada, I can't even find an appropriate "K" word to talk about in a dictionary of accounting, far less in the Income Tax Act. But K does stand for knowledge. And as we all know, knowledge is power. In the tax context, and otherwise.

While for those who are self-employed, "know your expenses" is also an important point, for ALL Canadians "know your income" is the fundamental principle for getting your taxes right and avoiding hassles from the CRA. In Canada's self-reporting, self-assessment system, you tell the government how much you made and how much tax you owe, rather than the government telling you.

It's easy to forget about all your sources of income. Lots of us have several jobs in the course of a taxation year. Maybe a series of consecutive full time jobs that are seasonal. Maybe several concurrent part time jobs that equal a full time income. Perhaps a little bit of independent contractor work. Plus some interest income from investments. And a capital gain from an empty lot that you inherited years ago, and just never got around to selling until this year.

All those income numbers need to be added up if you're to know your true income. You're supposed to get T4 slips from employers telling you how much you made, and what kind of deductions (like taxes paid in advance) that they took off. But sometimes employers might forget to send you a T4; or the T4 might get lost in the mail because you moved. It's your job to track down all the T4s you need to complete your taxes. The CRA won't like the excuse that you never reported that $25,000 of tree planting income because you never received a T4 for it.

Same with self-employment. It's your job to keep track of how much you made. Don't guess. You might overreport income just as easily as under report it. With overreporting, you'll pay more tax than you deserve to pay. Whereas with underreporting, you'll be hit with all sorts of interest and penalties by the CRA.

Lastly, with capital gains or investment income, you likewise can't just "forget" to report it. You need to know how much you made.

When I was practicing as a Federal Crown tax prosecutor in the Toronto area I prosecuted a family who had jointly pooled their savings to buy some vacant investment farm land that had future development potential. They sold the property ten years later for a six million dollar profit. Smart and prudent, right?  Not if all of the family investors then "forget" to report the capital gains as income on their respective tax return. That's a lot of tax evasion.

So know your gross income from all sources. That's the starting point for completing your tax return. Only once you know your gross income, can you do your damnedest to take advantage of all legally available deductions to make your net income (and thus your tax burden) as small as possible.

Saturday, April 11, 2015

Canadian Taxes A to Z (2015): J is for Journal Entry

Sorry to leave you all hanging there for a few days, after a good run of daily blog posts! I accepted a new First Degree Murder defence case which needed some undivided attention, and took priority over these posts (yes, I do a couple of types of litigation other than tax law).

But nonetheless, only 19 days left until T-Day in Canada, so I've got some catching up to do.

I'm also discovering that the deeper one goes into the alphabet forest, the tricker it is to come up with good lettered tax terms. But today I do have an important one for anyone who has self-employment income. Today, J is for Journal Entry.

No, not as in travel journal, or dear diary kind of journal. But the kind of bookkeeping journal entry that will save you if you're ever challenged about your income or expenses by the CRA, because it presents a complete roadmap of your business financial transactions over the relevant taxation year(s).

A journal entry is a fundamental accounting concept, but one which most of the general public won't have heard of. The reason you need to know about it if you run your own business is that through it you can prove when, why, and how much money was received or paid out from your business. A journal based on the double entry bookkeeping system requires that the dollars of debits always equals the dollars of credits. This balancing out is the double check we all need. It'll save you from both missed transactions and transposed numbers.

Usually, each journal entry will contain the date, account name, and amount to be debited or credited. I also recommend a brief explanation of the transaction. Journals can be maintained by hand, on an electronic spreadsheet (like Excel), or in bookkeeping software like Quickbooks or Simply Accounting. If you don't have journals, you don't have bookkeeping records.

Some small business people believe what accountants pejoratively call the Shoe Box Method to be perfectly adequate for tax time. Into one shoebox, you toss over a 12 month period all the receipts for things you bought for the business. Into another shoebox, you toss all your sales receipts for the money you've collected from your customers. Then, at tax time, you toss both those boxes at your accountant, and hope for the best.                                                                                                                                                                                              
With the Shoe Box Method, there are no journals. In fact, there aren't really any "books." Just some scraps of disorganized paper. They're a big pain to add up, and can lead to inaccurate tax filings that don't withstanding later CRA audit scrutiny.

With journal entries, you can figure out almost instantly how much money you netted in a given month or year, because your debits and credit are all summarized in front of you. What this means for tax time is that you'll know how much tax you owe by plugging your journal summary numbers into tax preparation software (or turning them over to your accountant). You still need those individuals receipts as back up documents, but the journals tell the real tale.

I'm not suggesting that journals are super easy to keep up to date by spending 30 minutes on a Sunday afternoon doing a little data entry while watching the game. It's definitely possible to keep your own books, but my suggestion is to turn them over to an external bookkeeper. No need to hire someone full or part-time. Quality bookkeepers can be had in Ontario from about $35 to $90 an hour, depending on where you live (bookkeepers cost more in big cities) and whether you employ an independent bookkeeper (cheaper, but less supervision) or use one who is an employee of the accounting firm you use (more expensive, but more supervision). Regardless of how you do it,  just make sure that you keep some official journals.

Read More on How a Tax Lawyer Could Help You

Tuesday, April 7, 2015

Canadian Taxes A to Z (2015): I is for Input Tax Credit

Today, I is for Input Tax Credit (ITC). Nine down, 17 to go!

Input tax credits are what makes GST/HST so good for business. You only need to remit to government the amount of GST/HST you collected from clients, minus the amount you paid out for inputs into your business.

Assuming you're in a business where you sell more than you purchase (always the preferred economic situation), you wind up effectively getting your supplies tax free! And who doesn't like that.

The thing that I find most confuses businesses about ITCs is how to calculate them, since the government gives you three main optional ways. Plus there are some special rules on ITCs for vehicles, aircraft, and capital property.

For passenger vehicles, you are limited to claiming an ITC on the first $30,000 of the vehicle cost, and the vehicle needs to be used 90% or more for business purposes. Otherwise, the ITC claim is proportionate to the business use (down to a low of 10%). Aircraft aren't limited to the $30,000 cap (fortunately, unless you're in the market for a kite), but are still subject to the business/personal use ITC percentage rules.

For capital real property, if you're a GST/HST registrant buying property (like an office building) from a GST/HST registrant, no tax money usually needs to change hands. Instead, the purchaser will self-assess, provide a certificate to the vendor of the registration and self-assessment so that the vendor doesn't need to demand the tax at the time of closing, and then it all becomes "a wash" since the purchaser can at the end of year claim an ITC equal to the tax payable (but not actually paid) on the purchase.

The trick here is to make sure you register for the GST/HST if you're planning to buy real property subject to GST/HST. If you don't, you'll get stuck forking over the tax to the vendor, because you won't be able to claim an ITC.

As for methods of calculation, you may have three choices:

1. The Quick Method. This is the only method which let's you actually make a profit on ITCs (though you need to report the profit as income). There are quite a few limitations as to who can use this method according to type of business and total sales, so consult your accountant. I can't use it, for instance, because lawyers (and some other professionals) are explicitly excluded. It works best for those who collect lots of GST/HST, but don't buy many inputs (and thus don't generate many ITCs).

It's a percentage method based on your total sales rather than the actually GST/HST paid on supplies, and could lead to you having an extra $1000 in your pocket at the end of the year. The accountants at Grant Thornton have prepared a useful summary for considering whether to use the Quick Method: www.grantthornton.ca/resources/.../Election_to_use_Quick_Method.pdf

2. The Simple Method. This is the method that I and a lot of other business of moderate size use. There are yet again eligibility limitations on the size of revenues and total cost of supplies. The advantage is that instead of separately reflecting the tax paid on every purchase in your bookkeeping records, you simply add up all ITC eligible business expenses (including GST/HST paid) and multiply the total by a particular fraction factor (depending on the rate of tax in your jurisdiction), which will give you an average of ITCs available to be claimed. Regular limiting rules on things like being only able to claim 50% GST/HST on restaurant meals (because they are only 50% tax deductible) still apply.

3. The Regular Method. This method is the most painful of all, as it requires you to add up all the GST/HST you paid out, and deduct it from the GST/HST you collected. Subject, as usual, to various exceptions and qualifications. This could lead to your bookkeeper trolling through thousands or tens of thousands of receipts to extract the tax paid. But it's still worth doing so, because every dollar in GST/HST you pay out, is usually one less dollar you need to remit to the CRA.

Read More About How a Tax Lawyer Could Help You

Monday, April 6, 2015

Canadian Taxes A to Z (2015): H is for Harmonized Sales Tax (HST)

Today, H is for Harmonized Sales Tax (HST). Eight down, 18 to go!

Yeah, I know it was only yesterday that we talked about GST. And that HST is a lot like GST, except that H is worth four points in Scrabble, while G is only worth two points. But given the grief that my clients suffer over GST/HST problems, I figured it was worth another post.

For those not in the know, in 1996 Nova Scotia, New Brunswick and Newfoundland & Labrador cut a deal with the feds to blend (and reduce) the provincial sales tax with the federal GST. Provincial sales taxes in Canada were cascading or turnover taxes. Meaning that you got hit with the tax every time ownership of the same items (or their earlier components) changed in the supply chain. The taxes artificially encourage vertical integration of business, rather than sensible organization of business according to sound economics, in order to avoid getting hit with the tax multiple times in the manufacturing process.

Sound economic studies, not voodoo math political smoke and mirrors, show that HST encourages business investment, whereas PST slows economic growth. Most of the western industrialized world has now moved to HST-type taxes (often called VAT - Value Added Tax).

As a tax lawyer, I'm all for a lower tax burden. From both a business and consumer perspective, HST does equal a lower tax burden when combined with its effect on greater economic growth - leading to more money in everyone's pockets at the end of the day.

Most studies show HST to be tax revenue neutral, and some suggest that everyone will pay less tax under an HST system. Certainly life is easier for business - especially small business - in collecting and remitting only one sales tax, and being able to claim input tax credits on business purchases.

In 2010 HST was implemented in both Ontario and British Columbia, but in 2011 a referendum in British Columbia voted 55% in favour of abolishing the HST and reverting back to the GST/PST system, effective in 2013. This resulted in BC having to pay back $1.6 billion in implementation funding to the federal government.

Don't mistake me for some government cheerleader. There are lots of wacky things about our tax system, and unfortunately taxpayers do sometimes need to fight for their rights (either by themselves or through hiring folks like me). But the theory of the HST is good economic and business policy. Full stop. The problems lie in its interpretation and application.

Read More About How a Tax Lawyer Could Help You

Sunday, April 5, 2015

The Nice Folks at Hall Albright Garrison, Accountants in Alabama, Feature Canadian Taxes A to Z (2015) in their weekly blog tax roundup

Canadian Taxes A to Z (2015): G is for Goods and Service Tax (GST)

Today in the continuing Canadian Taxes A to Z saga, I present to you the letter G, representing Goods and Services Tax. Better known to its friends and foes alike as GST. Also sometimes going by the name Harmonized Sales Tax (HST) in provinces where it has merged with provincial sales taxes.

Since its introduction in 1991, the GST has become almost as much of a target for critics as the dating way back to 1917 income tax itself. Although GST replaced a higher (13%) hidden manufacturers sales tax with a 7% tax, and promised rebate credits to low and middle income Canadians, sticking an obvious consumption tax on top of pre-existing provincial sales taxes proved to be deeply unpopular among Canadians. I've got an undergrad background in economics, and the math remains far beyond me as to just how revenue neutral the GST really was, notwithstanding government claims at the time.

I can tell you that during the early years of its implementation, when I was responsible in Toronto for prosecuting offences under Part IX of the Excise Tax Act (the rather poorly named place where GST rules reside), we had folks do things like submit an input tax credit application for a rebate on the GST supposedly paid on the purchase of a 737 jetliner, notwithstanding the taxpayer was living in his mother's basement with no real business, and the government simply mailed him a gigantic cheque! Which he quickly spent.

Yes, he did go to jail. And no, you can't get away with this any more - the system and oversight of GST/HST rebates has been improved. But arguably the rules surrounding GST/HST remain more uncertain than those covering income tax.

Part of the uncertainly is that we have less than 25 years of GST history under our belts. Another part of the problem is that the relatively well developed principles of income tax law aren't all that relevant in the GST world.

I'm a tax lawyer, and I can tell you that I get stumped by far more GST questions than income tax questions. I'll eventually figure out the answer to the GST questions - that's my job - but they usually require more research and discussions with the CRA than would be required for even esoteric income tax questions.

The main things you need to know about the GST are:

1. you should always apply for personal credits, and let the CRA tell you no, rather than assuming you won't qualify;

2. even if your self-employment income is under $30,000 annually (the threshold where registration becomes mandatory), you should still consider registering for GST, as you'll be able to recover GST you pay for business supplies;

3. if you are GST registered, make sure you do your required filings (even if you have no business sales, you still need to file or deregister);

4. if you do collect GST from clients, keep careful track of all the GST you pay out (or use the simple method if permitted) to minimize the GST you need to remit to the CRA;

5. if you are obligated to remit GST, don't instead divert the funds to prop up your failing business; the CRA will find you, and GST audits are very easy from the CRA perspective compared to income tax audits, because there's very little room for grey areas.

Read More About How a Tax Lawyer Could Help You

Saturday, April 4, 2015

Canadian Taxes A to Z (2015): F is for Fraud

Today's instalment of Taxes A to Z brings us to the letter F. F is for Fraud. Six letters down, 20 to go!

You occasionally hear the words "tax" and "fraud" used together, but more common is "tax evasion." Fraud is a very broad term, encompassing any deception intended to result in financial or other gain. It's probably the best umbrella term covering everything and anything intentionally intended to cheat the tax system. 

The reason you don't see the F word all the time in the tax context is because it's already used in the Criminal Code (CC) for the big C criminal offence of fraud. According to s. 380 of the Code, fraud over $5000 dollars can net you 14 years in prison! That's a lot of heavy time by criminal offence standards. By comparison, tax evasion under s. 239 of the Income Tax Act (ITA) can only net you 5 years imprisonment at most. 

What most people don't know is that tax fraud can be prosecuted under s. 380 of the Code, instead of s. 239 of the Income Tax Act, exposing accused to almost three times the penal jeopardy! I spent the first few years of my legal career as a Federal Crown with the Revenue Prosecutions Unit of the Department of Justice, and worked on hybridized cases where sometimes we'd proceed jointly under the CC and ITA if investors were also defrauded, lots of money was at stake, or we needed to make a mutual legal assistance request work in a foreign state like Switzerland who would share information with us if the allegations were criminal fraud, but not tax evasion. 

Fortunately for those worried about getting a little too creative in preparing their taxes, both fraud (under the CC) and tax evasion (under the ITA) are mens rea offences, meaning to convict a court needs to find the accused actually intended to defraud or evade, and wasn't just careless with his taxes. This can get a bit nuanced, since intent can be implied from all the circumstances, but mere tax avoidance isn't a crime - even if the CRA later rules that what you believed to be legitimate avoidance isn't permissible. 

Read More About How a Tax Lawyer Could Help You

Friday, April 3, 2015

Canadian Taxes A to Z (2015): E is for Employment Income

Today, E for for Employment Income. Five letters down, 21 to go!

For most Canadians, the concept of what is, and is not, employment income may be the most fundamental tax concept of all. 

When I was an employed lawyer I couldn't deduct much against my employment income, because my employer was supposed to be paying for all my expenses. Once I became self-employed, I could claim all sorts of deductions like home office use or computer purchase. Even if you only earn a small amount of self-employment income, you can usually apply any losses you incur in self-employment against employment earnings to reduce you overall net income. 

The tax position of those earning employment income versus those who are self-employed, and the necessity of keeping detailed records of income and expenses,  is dramatically different. Employees are permitted to deduct very few expenses related to their employment (things like instruments for musicians or mileage if not-reimbursed by employer), whereas the self-employed are permitted to deduct almost all expenses of their business. Many perceive this to be unfair, but like a lot of things under the Income Tax Act the best that can be said is that's just the way it is. You need to be in a position of knowledge strength to take full advantage of all the deductions available to you, be you employee or self-employed. 

Most employees don't need an accountant to do their taxes for them (though it's never a bad idea), whereas most of the self-employed definitely need an accountant. Look for an accounting firm with a designation. Accountants in Canada are increasingly switching to a common CPA designation (from CA/CMA/CGA). Non-designated people might still do a good job on your taxes, but you'll need to be more selective as they might not carry insurance or be subject to professional regulation. 

Everyone, employee or self-employed, can benefit from good tax preparation software. For years now I've been using http://www.taxfreeway.ca/, which I love. It's cheap, they offer great support (I've emailed them esoteric questions 24 hours before tax deadline and receives an answer within the hour), and Mac and iPad versions are available (in addition to Windows). 

Read More on How a Tax Lawyer Could Help You

Thursday, April 2, 2015

Canadian Taxes A to Z (2015): D is for Deemed Disposition

Today, D is for Deemed Disposition. Four letters down, 22 to go!

When can you be considered to have sold property, when you didn't actually sell it? Under the Income Tax Act, of course!

You might know that you're subject to capital gains tax (or can claim a capital loss) when you sell a piece of property, and that property has either gone up in value from its original purchase price, or dropped in value below its depreciated (capital cost allowance) value.

What not everyone realizes is that such gain or loss tax rules kick in for many circumstances when you don't actually sell the property. These are called deemed dispositions.

Such sales that aren't really sales can kick in during principally five situations:

1. You transfer securities from a non-registered investment account to a registered account like an RRSP, RDSP, TFSA or RRIF. Deemed proceeds will be market value of securities at time of transfer.

2. You make a gift of the property to someone else. Deemed proceeds are fair market value of property at time of transfer.

3. You change property's use from personal to business, or from business to personal. For example, you change a personal residence into a rental property.

4. You die. All of your capital property is deemed to have been disposed of at the time of your death.

5. You cease to be a resident of Canada. Note that many people may leave Canada for a few years but still be residents of Canada for tax purposes (either intentionally or unintentionally), because they don't sufficiently cut their ties to Canada.

The reason you need to be very wary about triggering deemed dispositions is that you could get hit with a huge tax bill that might have been deferred until the much later date of the time you actually sell the property.

Wednesday, April 1, 2015

Canadian Taxes from A to Z (2015): C is for Capital Cost Allowance

Today, C is for Capital Cost Allowance. Three letters down, 23 to go!

Capital Cost Allowance (aka CCA to its friends) is a perfect example of why the drafters of the Income Tax Act sow needless confusion by using three legal words to describe one accounting term: depreciation. Because that's exactly what CCA is, tax deductible depreciation which will reduce your net income due to you have purchased capital items for the purpose of earning income. 

It takes long enough for any of us to learn accountant-speak. Why should we then have to learn yet another language, tax law-speak? Because the government says so, full stop. 

You'll mostly have two kinds of expenses to claim on your tax return to reduce your self-employed income: operating and capital. Operating expenses you can usually claim at 100% in the tax year they're incurred. They constitute things like rent, utilities, pencils and salaries. 

By contrast, capital expenses need to be depreciated, because they're supposed to last you for longer than just the year you bought them in. Vehicles, computers and desks are all capital items.

Don't ask me why the government in its wisdom decided to change the name of depreciation to CCA for tax purposes. There was probably some meeting in some Ottawa boardroom at the Department of Finance (bereft of even coffee and muffins, because we in government were always told such things were an extravagance, notwithstanding other waste). A few plain language folks with common sense may have been fighting a rear guard action in defence of using the term "depreciation," but alas the Assistant Deputy Minister had his heart set on Capital Cost Allowance. He thought it sounded modern, and sexy, and unique. And so CCA was born. 

The most important thing to know about CCA is that it varies greatly by "class" of asset. For instance, you get 15% per year CCA on boats placed in Class 7, an improved 25% on aircraft residing in Class 9, and a princely 30% on automobiles. The theory is that planes last longer than cars, but shorter than boats. Not sure if that's true, but that's what the government's decided, so we're stuck with it. 

The second most important thing to know about CCA is that you only get to claim half of it in the year you acquire the capital item. This is known as the Half Year Rule. So that 25% deduction on your new Lear Jet becomes only 12.5% in its first year. Thus picking up capital items in December (where you can effectively claim for six months but only own for one month) is a far better idea than in January (where you're again stuck with a six month claim, even though you'll own for the entire year). 

Last in the CCA greatest hits list is that you need to beware of "recapture," where if you sell a capital item for a value greater than its remaining undepreciated value, you'll have to pay tax on the difference between the remaining undepreciated value and the sale price up to a maximum of the original acquisition price. This can be a particularly touchy issue for buildings. While they depreciate at a few percent per year, in reality their resale price may keep going up and up, meaning you'll pay tax later on all that depreciation you've claim - but deferring tax until later is still a good thing, even if you can't avoid it. 

Read More on How a Tax Lawyer Could Help You