Category Personal Finance/ Estate Planning

Raising a Family? Take Every Available Tax Break

There’s no doubt that raising a child is expensive. Although there is obviously no fixed price tag, some studies show that the cost of raising a child to the age of 18 is approximately more than $200,000, or nearly 13,000 for each child each year, or about $1,100 a month. And that is before you send them off to university.

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A Little Comic Relief

James Weber, a Calgary inventor, received notice from Canada Revenue Agency that he owed $110,000 in income tax.

Being inventive by nature, the man noticed that the bill showed a dollar sign with only one line through it — the symbol denoting the Colombian peso. So he thought he’d just pay those taxes in pesos, which amounted to the equivalent of about $75.

The tax agency didn’t buy the argument and seized the man’s motorbike, helmet, jacket and pants.

The taxpayer then filed 50 documents in Federal Court to back up his claim, including banking and other dictionaries, and the British North America Act.

While agreeing that Mr. Weber’s “type-face analysis of our currency shows a certain inventiveness” the court did not accept the argument. It noted that one of the dictionaries the taxpayer submitted as evidence showed the Canadian dollar sign also to be a one-bar dollar sign.(Weber v. Canada (Minister of National Revenue) Docket: ITA-6261-99)

Compounding the expenses are taxes. According to the Fraser Institute Canadian Consumer Tax Index, which has measured the tax bills of Canadian families since 1976, all taxes paid on the federal, provincial and municipal levels account for more of a family’s budget than shelter, food and clothing combined.

That makes it even more important to claim every tax break you can. Here’s a rundown of the tax relief Canada Revenue Agency (CRA) offers:

Childcare expenses: If you, your spouse, or common-law partner, pay for childcare so you can earn employment income, carry on a business, attend an eligible program at a designated educational institution for at least three consecutive weeks, or carry on research or similar work for which a grant has been received.

Some examples of eligible child care expenses include;

  • Day-care centres and day nursery schools;
  • Child care services provided by some individuals;
  • Day camps and day sports schools;
  • Educational institutions such as private schools (the portion of tuition costs relating to child care services), and
  • Boarding schools, and overnight sports schools and camps.

Generally, expenses have to be deducted from the lower-income earner, although there are exceptions.

Amount for Eligible Dependant:
 Most taxpayers are familiar with the spousal credit, but there is a similar credit for single, separated and divorced people who support a child, elderly parent or grandparent. Two or more supporting relatives cannot split this tax credit. Children must be under 18 at some time during the tax year, unless they are mentally or physically impaired.

Age Amount: This tax credit is available if you are aged 65 or older at the end of the taxation year. The credit is calculated using the lowest tax rate and each province calculates the credit in the same manner except Quebec. In that province you use family income in the calculation and combine the credits for you and your spouse or common-law partner.

Pension Income Amount:
 You can claim the lesser of $2,000 and the actual pension amount received. Don’t forget that this amount is available to both spouses if you are splitting pension income. You do not have to be older than 65 years of age to claim this amount.

Disability Amount: You can claim a tax credit if you are disabled and have a certificate signed by your doctor or medical practitioner stating that the disability is severe and prolonged and markedly restricts your daily living activities. Individuals younger than 18 years of age may claim a supplemental credit. 

Caregiver Credit: You may claim this credit if you provide in-home care for a related individual who is older than 17, is dependant because of mental or physical infirmity, or is your parent or grandparent AND over the age of 65. The infirm person doesn’t have to qualify for the disability tax credit. However, this credit isn’t available if you have taken the amount for eligible dependant for that person.

Adoption Expenses Credit: You may claim certain eligible expenses for each child you adopt in the year the adoption is finalized.

Public Transit Pass Credit: You may claim amounts spent on public transit passes for yourself, your spouse and any children under the age of 19 at year end.

Child Fitness and Arts Credit: You may claim a tax credit on each child on the fees you pay to register the child in a prescribed program of eligible activities. At the beginning of the year in which the expenses are paid the child must be under 16 years of age (or under 18 if eligible for the disability credit). Both credits will be eliminated for taxation years after 2016. 

Canada Employment Amount: If you are employed, you can the lesser of a credit indexed for inflation each year and the total employment income on your tax return.

Interest on Student Loans: You may claim interest paid on student loans in the year or the preceding five years for post secondary education. The loans must have been received under the Canada Student Loans Act, the Canada Student Financial Assistance Act, or a similar provincial of territorial government law.

Tuition and Education: If you do not need all your tuition and education tax breaks for the year, you can transfer all or part of the amount to your spouse or common-law partner, parents and grandparents, including those of the your spouse or partner.

Medical: You might be able to claim expenses for a dependent. The list of deductibles is long, so make sure you understand what you can and cannot claim. If medical treatment is not available locally, you might be able to claim the cost of travelling to get the treatment somewhere else. You don’t have to file your claims on a calendar-year basis. You can sort out your receipts on a month-by-month basis and choose the period that results in the highest yield.

Consult with your accountant to help ensure you take all the credits available to you and the proper amounts.

Lighten the Tax Load on Your Heirs

Your Registered Retirement Savings Plan (RRSP) poses the potential threat of a large tax liability, as well as probate fees, when you die. This can place a burden on your spouse or other heirs unless you carefully map out a plan to either minimize or defer taxes.

Here are some considerations:

If your RRSP isn’t paying retirement income when you die, Canada Revenue

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Leaving a Mature RRSP

If your RRSP has matured (in other words, it is paying retirement income), you are considered to have received the full fair market value of all remaining payments as income.
That amount, along with any payments already made during the year, must be included on your final tax return after you die.
However, the beneficiary won’t have to pay tax on an RRSP payment if it can reasonably be regarded as included in your income.
If you name your spouse, common-law partner, financial dependent child or grandchild as sole beneficiary, the CRA allows the RRSP to be rolled over to them. The beneficiary simply becomes the successor annuitant and receives all future payments.
But if you also name another beneficiary, the portion of the fair market value that doesn’t go to the qualified beneficiary must be included in the final return as taxable income.
What if you don’t name an RRSP beneficiary in the contract? Your will plays a central role.
The plan’s assets go to the estate. Your spouse, common-law partner, or financially dependent child or grandchild, along with the legal representative, can jointly choose in writing to be the successor annuitant. This is only the case, however, if your will states that one if these people is the heir or is entitled to the RRSP annuities.
The CRA will then assume that the successor annuitant received the RRSP property and it will have to be included in income for the year it was received.
Any post-death decreases in the value of an RRSP or Registered Retirement Income Fund can be carried back and deducted against the year of death inclusion. 

Agency (CRA) considers that you received the entire fair market value of its assets on the date of your death. Thus, the value becomes taxable income on your final return.

What happens next depends entirely on how well you planned and who you named as the beneficiary in your RRSP contract. If you haven’t specified a beneficiary, your heirs may receive very little of the money. The after-tax funds become part of your estate, probate fees are assessed, and what’s left is distributed according to the terms of your will.

If you named a beneficiary, the person will receive all of the value of your RRSP. Probate fees are not assessed, but the income taxes are paid by the estate. This can result in an imbalance of the inheritance — with the heirs of the estate receiving very little after the taxes are paid, and the RRSP beneficiary receiving most of the value of the estate. (If the estate is unable to pay the taxes due on the RRSP at the date of death, the RRSP beneficiary is jointly liable for the taxes owed on the RRSP value.)

The good news is the Income Tax Act contains strategies that allow you either to defer or to minimize those taxes:

Tax Deferral: You can roll over your RRSP tax-free to a spouse or common law partner, or to a financially dependent child or grandchild. To the CRA, this rollover is the same as if that beneficiary had been the annuitant all along. So taxes aren’t due until that person actually withdraws money from the plan or from an annuity set up with the RRSP funds.

This strategy requires two basic steps:

1. In the RRSP contract, you must name the qualified individual as the sole beneficiary.
2. Before December 31 of the year of death, the beneficiary must arrange for the RRSP issuer to transfer the plan’s assets to an eligible RRSP, a Registered Retirement Income Fund (RRIF), or an annuity.
Warning: This tax-free rollover isn’t available if you named a beneficiary other than your spouse, common law partner, dependent child or grandchild, or you named more than one beneficiary.

Tax Minimization: Alternatively, your qualifying beneficiaries can qualify for special treatment by rolling the RRSP amount over into their own RRSPs — your income essentially becomes their income.

Amounts actually received by a qualifying beneficiary can be removed from your income and added to the beneficiary’s income. Then, the beneficiary can deduct the amount contributed to the RRSP, resulting in no taxes being paid. This allows the beneficiary to minimize the total taxes paid.

The beneficiary can transfer any amount of refunded premiums to an RRSP, RRIF or annuity, and claim a deduction to offset some or all of the refunded premiums included in income. This is not the same as a regular RRSP deduction because the beneficiary does not need RRSP contribution room, and the deduction does not use up any contribution room.

If you own an RRSP and are concerned about the taxes your heirs will pay after you die, consult with a professional to ensure you make the proper arrangements. And while you’re at it, make sure your named beneficiaries reflect any changes in your life circumstances to avoid any unwanted results.

Consider a Freeze as You Plan the Future

Estate freezes are considered by many to be the cornerstone of estate and succession planning for Canadian family businesses.

Crystallizing Capital Gains

When considering an estate freeze, you will want to consider crystallizing capital gains in order to take advantage of the lifetime $750,000 capital gains exemption.

Let’s say you opted for an internal freeze, that Maple Leaf Co.’s shares qualify for the capital gains exemption and that you haven’t used any of that exemption.

Even with an internal freeze, you have the option of filing a holding company election that allows you to shed your common stock for an amount greater than its nominal ACB. In that scenario, you might elect that the shares be disposed of for $750,000, resulting in a capital gain of that amount, which you would report on your income tax return. That gain would be offset by the exemption.

Your preference shares would have an ACB of $750,000. On a future sale of the shares, or on your death, your capital gain would be $1.25 million ($2 million FMV minus $750,000). Without the crystallization and the capital gains exemption your capital gain would be $2 million.

Fundamentally, a freeze captures all or part of the value of appreciating assets at their current value and future growth accrues to your children who will take eventually take over the business.

The primary benefit is that the growth will not be taxed in your hands, either on an actual disposition or a deemed disposition on death. Among the other benefits are:

  • You can manage the tax liability on the gain accrued before the freeze by purchasing, say, life insurance in an amount to cover the known tax liability on the frozen assets;
  • The growth assets can be converted to the fixed amount in several ways that can offset any immediate tax consequences to you;
  • You retain control over the assets with sufficient voting rights, and
  • You may crystallize your capital gains exemption (see right-hand box).

Most commonly, estate freezes are accomplished either by creating a holding company or by reorganizing the capital structure of the existing company.

Holding Company Freezes

Under this method, which falls under Section 85 of the Income Tax Act, you trade your growth shares in exchange for fixed value preferred stock in a holding company. Those preferred shares have voting rights that allow you to retain control of the underlying assets. The designated children receive common shares in the holding company.

As an illustration of how this works, say you own Maple Leaf Co., holding 200 common shares with a total fair market value (FMV) of $2 million and a nominal ACB.

You incorporate Holdco and trade your Maple Leaf stock for 10,000 preferred shares in that new holding company. The new shares would:

  • Be redeemable at the FMV of the common shares of the family business;
  • Carry enough votes to allow you to control Holdco (you could also opt for non-voting preferred and then subscribe to a separate class of nominal value voting stock to retain control);
  • Be retractable so you or Holdco could require the redemption of some or all of the preferred shares, and
  • Have dividend privileges over the common stock and have preferential treatment if Holdco is ever wound up.

A holding company freeze is a tax-deferred transaction, so your accountant will file an election with Canada Revenue Agency (CRA). Under that election, you choose any purchase price ranging from the adjusted cost base (ACB) of Maple Leaf’s shares, which is nil, to their FMV at the time of the transaction. If you opt for the ACB, there will be no capital gain.

Meantime, your designated children would acquire new common shares, either through a stock subscription or as a gift. Those shares would have a nominal value but would reflect all future growth of Holdco, which would amount to half the future growth of Maple Leaf.

So, if over time Maple Leaf grows in value to $2.6 million, Holdco’s shares would be worth $1.3 million. Assuming the holding company had no other assets, $1 million of that value would be reflected in your preferred stock.

The remaining $300,000 would be reflected in your children’s common shares. So the capital gains that would normally be taxable to you becomes taxable to the children.

Internal Freezes

Here, you simply exchange common shares for new preferred shares under Section 86 of the Income Tax Act. New common stock is then issued to the children, either directly or through a trust.

You would have the same benefits as with a holding company freeze without having to incorporate a holding company and without having to file the election form. The stock rollover in an internal freeze is automatic.

To illustrate how the internal freeze works, given the same scenario as above, you exchange your $2 million in Maple Leaf common shares for $2 million in new preferred shares. Your children acquire new common shares with a nominal value that would later reflect future gains in Maple Leaf’s FMV.

Your stock rollover is automatic and you realize no capital gain, unless you opt to crystallize that gain.

Take Advantage of Family Trusts

Family trusts are not just for the rich and famous. If your family runs a small business, owns rental properties or holds investments, it, too, may benefit from these trusts.

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Other Family Trust Benefits

Setting up a trust while you are alive offers several advantages, including:

1. By making yourself a trustee, you can keep control of the trust assets (such as shares of your business).

2. By getting the assets out of your estate, you can reduce probate fees.

3. Because the assets will not be in your estate, they will not form part of the public record that anyone can examine in the court office.

To understand why family trusts have been used extensively in tax and succession planning, you should first have a clear grasp of how the Income Tax Act treats them. Family trusts are inter vivos trusts, perhaps more commonly known as living trusts. In other words, they are between living people and distinct from testamentary trusts, which are formed by wills and executed when an individual dies.

All income in family trusts is taxed at the highest personal tax rate — with no personal exemptions — if the money the trust earns isn’t distributed to its beneficiaries. When the money is distributed, however, the trust pays no tax.

Then, the beneficiaries include the distributions on their income tax returns, pay their (presumably) lower tax rates and claim any credits and deductions that are available to them. The family trust reports the distribution to the Canada Revenue Agency (CRA) on a T3 information slip and a copy is sent to the beneficiary.

The paid-out income retains its character. For example, if the distribution is dividend income, then the beneficiary can claim available dividend tax credits. If the income is from a capital gain, the beneficiary reports it as such and only half is included in income.

This concept should be familiar to anyone who owns mutual funds outside a registered retirement savings or income plan. Mutual funds are actually trusts and, like family trusts, issue T3 slips to their holders.

It is in the distributions that the flexibility and power of family trusts becomes apparent. The income earned by assets in the trust can be split among the beneficiaries as desired, if the trust is properly set up. This means that all of the beneficiaries can utilize their personal exemptions and benefit from the graduated income tax rates available to individuals.

However, over the years, the Department of Finance has imposed restrictions on the use of family trusts to close loopholes and end abusive practices related to two major provisions of the Income Tax Act:

1. The Tax on Split Income (more commonly called the “Kiddie Tax”). This applies to income a trust pays out to a child under the age of 18, where the money comes from a private corporation owned or operated by a related person. Essentially, the owner of a business is prevented from splitting income with a related minor through a trust. This tax does not apply to mutual funds or dividends from publicly traded companies.

2. The Attribution Rules. There are two sets of attribution rules that may apply to family trusts. The first set covers attribution related to income from property. This includes rental income, investment income and interest, but not business income. When income from these sources is transferred or lent to spouses, minor children, nieces and nephews, it is attributed back to the person who transferred it.

The second set of attribution rules applies to capital gains after disposal of property transferred to a spouse — but not a minor child. In this case, any capital gain is attributed back to the transferring spouse who must report it.

If you think you may benefit from a family trust, talk to your tax accountant and lawyer.

Testamentary Trusts and Taxes

lores_testamentary_trust_kkTestamentary trusts, unlike inter vivos trusts, are formed by wills and executed when an individual dies.

A trust is a legal structure that allows you to separate the control and management of an asset from its ownership. Trusts involve relationships between three different parties:

  • The settler, who sets up the trust, contributes the first assets and sets the instructions on how to manage the trust and who will benefit from it;
  • The trustee, who controls and manages the assets; and
  • The beneficiaries, who benefit from the assets.

The transfer of the assets to the trust is known as the trust settlement.

Trusts can be either:

1. Discretionary, where the trustees decide who will receive the distribution from the trust, or
2. Non-discretionary, where the distribution is made according to the trust agreement.

Testamentary Trusts

A testamentary trust is a trust or estate that is generally created on the day a person dies. The terms of the trust are established either by the will of the deceased or by provincial or territorial court order.

Testamentary trusts do not include any trust created by anyone other than the deceased or a trust created after November 12, 1981, if any property was contributed to it other than by an individual as a consequence of the person’s death.

If the assets are not distributed to the beneficiaries according to the terms of the will, the testamentary trust may become an inter vivos trust.

Advantages

Income splitting: Despite the kiddie tax rule, you can still split interest income received from arm’s-length parties and certain other forms of income with a minor.

Taxes: Currently the income of a testamentary trust is taxed at marginal rates so it has significant advantages if the beneficiaries are already taxed at high marginal tax rates. Income splitting between the trust and beneficiaries allows the beneficiaries to reduce taxes significantly.

Beginning in 2016, flat top taxation is scheduled for estates in taxation years that end more than 36 months after death and all grandfathered inter vivos trusts and testamentary trusts created by will. There is an exception aimed at ensuring graduated-rate taxation that continues to apply to trusts with disabled beneficiaries. In addition there are several other exemptions, including the:

  • Elimination of the exemption from the calendar year as a taxation year requirement: The new rules provide that existing testamentary trusts and estates that have existed for longer than 36 months, and that have off-calendar year-ends will have a deemed year-end as of December 31, 2015.
  • Elimination of the exemption from tax installment requirement.
  • Charitable donations treatment: For 2016 and subsequent years there will be more flexibility to the tax treatment of charitable donations made in the context of death after 2015. Donations made by will, and those made by Registered Retirement Savings Plans, Registered Retirement Income Fund, Tax Free Savings Accounts or life insurance policies will no longer be deemed to be made by the individual immediately before the individual’s death.

Instead, these donations will be deemed to have been made by the individual’s estate at the time the property actually transferred to the qualified donee within 36 months after death. The trustees can choose the year in which the donation was made so it can be the year of death, an earlier taxation year or the individual’s last two taxation years. The current annual limit will continue to apply.

Only one testamentary trust (even if there are several mentioned in the will) and usually the estate itself is the only trust eligible for graduated rate estate treatment for the 36 months.

Setting up trusts can be complicated so be sure discuss your needs with your accountant.