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The Canadian Guide to Will and Estate Planning

Douglas Gray and John Budd have published the third edition of their book

The Canadian Guide to Will and Estate Planning

. They do a good job of explaining in simple language the bewildering array of ways to protect your estate from taxes when you die.

The range of topics covered includes building your estate, wills, trusts, probate, taxes, U.S. taxes, cottages, family businesses, charity, insurance, advisors, retirement care, and funerals. It’s almost enough to make me renounce all my worldly possessions – almost.

I won’t try to summarize this book and further – even at 400 pages, most topics are covered quickly. The main value of this book to me was to become aware of possible estate planning strategies. Actually acting on this information likely requires further investigation or professional help.

For the rest of this review, I’ll point out some parts of the book I found interesting, surprising, or I disagreed with.

CDIC Coverage

“You are protected up to a maximum of $100,000 for each separate deposit.” This may be technically true if you define “separate deposit” correctly, but this definition will not line up with what most people understand the words to mean. Similar deposits get lumped together. It’s best to read the details at the CDIC web site.

Financial Advice

“Unless you consider yourself an expert in the markets, and in forecasting the economy and interest rates, you should have a professional manage your investment portfolio.” Unfortunately, the professionals can’t do any of these things either. The real game is to invest in a way that allows for the possibility of a wide range of outcomes.

Disinheriting Family

Apparently it is quite difficult to disinherit a child or spouse. If you feel strongly about doing this, you’d better get some good advice, because the authors explain that various laws give spouses and children rights that can supersede your wishes.

Wills and Marriage

“A will is automatically revoked by law if the testator enters into a legal marriage after the will has been made.” There are some exceptions to this, but in general you need to look at your will whenever you get married.

Caution on Trusts

“Trusts are complex, and costly to set and maintain year-to-year.” Trusts can save on taxes and solve certain problems, but they are generally only worthwhile for large sums of money.

Final Income Tax Returns

The executor must file a final tax return for the deceased and must file another tax return for the estate to cover the time after death.

RRSP Tax Surprise

If you leave your RRSP to one child and the balance of your estate to another, the entire RRSP will go to the first child, and the balance of the estate will pay the income taxes on the RRSP withdrawal. This can skew the size of each share in a way you didn’t expect.

Electing Out of the Spousal Rollover

Ordinarily, you can leave property to a spouse without triggering capital gains taxes, and the spouse simply takes the property at your adjusted cost base. However, if you have a large capital loss from previous years, you may wish to elect out of the rollover to use up the capital loss and save the living spouse future capital gains taxes.

Principal Residence Exemption

See my previous post for a discussion of reducing taxes by taking advantage of the flexible principal residence designation.

Insurance Agents

“One might think that insurance agents’ … recommendations on the need for, and the volume of, life insurance that is required in a situation are ‘product and sales driven’” to create commissions. “In the writers’ experience, this is not the case.” I’m sure there are many honest insurance agents, but fewer than half of the ones I’ve dealt with had integrity.

Executor Duties

The authors provide a comprehensive list of executor duties in the appendices. This list is long and may make me a little less likely to agree to be executor for too many more family members. On the other hand, maybe it gets easier after you’ve been through it a couple of times.

Life Insurance

According to a chart in the appendices, to have $5000 available to spend each month, you would need investible assets of $2.2 million and require life insurance to close the gap between your current assets and $2.2 million.

Conclusion

Overall, I found this to be a useful book that manages to take dry subjects that are often described with impenetrable jargon and makes them comprehensible.

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Making the Most of the Principal Residence Exemption

Canadians don’t have to pay capital gains taxes on their principal residences. However, the definition of “principal residence” is quite flexible making it possible for families who own a second property, such as a cottage, to save substantial amounts on their taxes.

Douglas Gray and John Budd, in their book The Canadian Guide to Will and Estate Planning, explain that your principal residence isn’t necessarily your “main place of residence.” If you own a vacation property, “as long as you, your spouse or at least one of your children occupy the vacation property for some period or periods of time during the year, that is enough to bring you within the principal residence definition.”

“The fact that you show your home address on your income tax return does not mean that you are designating your house as your principal residence.” Further, “it is not generally necessary for you to decide which property is to be designated as the principal residence for capital gains tax purposes until the year that either property is sold or disposed of.”

Calculating your taxes owing on a property sale begins in the usual way by taking the proceeds of disposition and subtracting your adjusted cost base to get the capital gains amount. Then you get to reduce this capital gains amount by the “exemption fraction,” which is based on the number of years it was your principal residence. The exemption fraction is

1 + number of years after 1971 the property is designated as your principal residence

divided by

number of years after 1971 you owned the property.

Partial years count as full years in this fraction. The purpose of the “1+” in the numerator is presumably to deal with the fact that a family with just one property may move in the middle of the year, but only be allowed to designate one of their homes as their principal residence for that year.

An Example

Sue and Bob bought their home in 1994 and a cottage in 2004. They sold both in 2013 for a $200,000 gain on the house and a $150,000 gain on the cottage. They owned the house for 20 years and the cottage for 10 years.

If they designate the house as their principal residence for the entire 20 years, they will have to pay capital gains taxes on the cottage gain of $150,000. But, look at what happens if they designate the cottage as their principal residence for 9 years and the house for 11 years:

Cottage exemption fraction = (1 + 9)/10 = 100%.

House exemption fraction = (1 + 11)/20 = 60%.

Now the cottage gain is entirely tax-free and they only have to pay capital gains taxes on 40% of the $200,000 house gain, or $80,000. This is a reduction in capital gains of $70,000 compared to declaring the house as their principal residence for the entire 20 years. Assuming Sue and Bob pay 23% capital gains taxes, they save $16,100.

For families with vacation properties, it definitely pays to understand these rules when it comes time to sell homes and cottages.

I am not a tax expert. I relied on the information in Gray and Budd’s book to construct this example. Seek professional tax advice, particularly when dealing with large sums of money.

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Confessions of a Tax Accountant -2013- Week 4

This is my last confession for this income tax season. I am now deep in the tax trenches and really looking forward to May 1st. A final reminder, please file your income tax return on time to avoid the 5% late-filing penalty.

This week I discuss the following:

Do as I Say, Not as I Do

It is funny how we often ignore the advice we provide to others. I have been thinking about this the last couple weeks as I have been inundated with personal tax returns and the related emails, phone calls, couriers etc. My failure to heed my own advice can be traced back to my November, 2012 blog post on

The Income Tax Cost of Working Overtime.

In that post I stated that you have no reason to decline new clients or new work based on not wanting to enter a higher tax bracket. However, I went on to say that there are times when work should be turned down.

Those times may include the following:

  1. 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.
  2. You are working so hard that your family life or health is suffering. In this case the extra dollars may cost you something more important than money.

As I thought about this blog post, I realized I have not listened to my own advice. The nature of tax return preparation has changed in the last 5 years. The late issuance of T3’s and T5013’s have condensed income tax season into a hellish 3-4 week period, instead of a 6-8 week period. As I contemplated this change, it hit me that I am now compromising my own health and/or taking years of my life. So I am making a public vow that I will be making significant changes to my work environment next year.

Disappearing Dividend Income

It is “cool” to be a dividend investor. Whether you are a do it yourself (“DIY”) investor or you are like many of my clients who have investment advisors or private investment firms handling their investments, maximizing dividend income seems to be the “in” thing. The issue is that many of these dividends seem to disappear without a trace and I am often called in to assist in locating the ever elusive dividend.

Inspector Goodfield is called upon when the current year’s dividend income on a 2012 return is less than last year’s dividend income. I am asked, “Where could these dividends have gone?” Well, there are typically three reasons a dividend can go “poof”.

  1. The first reason is one or two of the companies in your investment portfolio have cut their dividend payouts.
  2. The second is you are missing a T5 or T3 slip.
  3. The most common reason for a decrease in dividends is …… take a guess?…. Yes, it is not reporting the sale of the dividend yielding stock. Now I am not saying this is an overt attempt at tax evasion, it is just that many people sell stocks early in the year and forget they sold them or just do not properly track their capital gains and losses.

So if you filed your return with lower dividend income than last year or have not yet filed, you should always confirm that any decrease in dividend income reported year over year is the result of a dividend cut or missing T-slip and if not, review your sale transactions for the year.

Investment Advisor Chasm

In last years

Confession of a Tax Accountant Week 6

I wrote about the varying quality of assistance investment advisors provide in respect of capital gain/loss reporting and the fact that some advisors feel it is the accountant’s responsibility to track the adjusted cost base (“ACB”) of all their clients’ holdings, a contention almost all accountants dispute. Two weeks ago I discussed an offshoot of this topic, the poor reporting of flow through shares. This week I once again pick on investment advisors and their financial institutions for poor capital gain/loss reporting.

In the last couple weeks I have experienced some terrible capital gain/loss reporting by client’s advisors and/or their institutions. I have had up to 75 trades missed, non-reporting on accounts closed during the year, situations where I had to inform the advisor of all the clients accounts for which I expected capital gain/loss reports and huge adjusted cost base variances where advisors moved firms during the year (In these cases I expect the greatest of care and diligence since the cost base of investments often get lost or not carried forward properly on the transition to a new firm).

Being the BBC and not having the greatest patience even at the best of times, I have been less than subtle when expressing my displeasure in respect of this misreporting. However, to my surprise, my client’s have been unfazed, they just say “aren’t all investment advisors pretty much the same?” I confidently answer no.

For example, an advisor who works for several of my clients reconciles each clients expected interest, dividend, capital gain income and their expected interest expense and management fees. Others are constantly asking if there is anything they can do to help. So the answer is definitely no, all investment advisors are not the same.

Obviously an advisor can be administratively strong but very weak from an investment advice perspective or visa versa. But I would suggest that they very often go hand in hand and if your advisor is not providing the proper level of service either administratively or investment advice wise, you should put them notice or consider finding an advisor who will make you a priority.

U.S. Donations

With our close proximity to the United States, many Canadians make donations to U.S. charitable organizations. While I always applaud charity, you may want to consider that for income tax purposes, U.S donations (except for certain Universities and specific exceptions) are not included together with your Canadian donations, but are treated separately and are subject to separate rules. Like Canadian donations, U.S. donations are subject to an overall limitation of 75% of your net income, however, that limitation is based on U.S. source income.

In plain English, if you made a $200 donation to a U.S. organization, you must have $266 in U.S. source income to claim the $200 ($266 x.75). If you have no U.S. source income the donation is wasted, although it can be carried forward for five years.

Thus, before you donate to a U.S. cause, you may want to consider whether you are willing to forgo the income tax credit you would receive on a donation to a similar Canadian organization. If not, consider making the donation to the Canadian organization.

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