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Canada: Amending Your Tax Return – Careful, Now

Sometimes in the rush to file an annual tax return mistakes or accidental omissions occur. On the other hand, businesses or individuals may receive a Notice of Reassessment, which requires additional work before your previous year’s tax return is finished. Depending on which of these two groups you’re in, there are different ways to proceed. If you receive an unfavourable Notice of Assessment, then review it to see why it has been changed. The first place to look is at the Explanation of Changes because it may be a simple clerical error. Then, review the Summary section. Once you understand the reason, then you can proceed.

Key Takeaways:

If you need to amend a return, the CRA prefers that you write to the Tax Centre where you filed your return. Either use form T1-ADJ with an explanation and any additional material, or make the changes to your return through CRA’s electronic service.
If you received a Notice of Assessment, then there is a time limit to object of 90 days from its mailing date or within one year of the due date of the T1 return.
It’s often best to contact the CRA first, since depending on the reason, it may be cleared up on the spot. Filing a Notice of Objection is then the next step.

“If you receive an unfavourable Notice of Assessment, the first thing you must do is find out why CanRev has disallowed a claim or otherwise increased your taxes. If there’s a difference between your figures and CanRev’s, it’s quite possible that no one has even looked at your return beyond a keypunching clerk. You have a legal right to appeal your case. More importantly, if you do this properly, you stand a very good chance of winning.”

How your tax bracket decides whether a TFSA or RRSP contribution is best

A person’s tax bracket before and after retirement can help you decide whether you would benefit more from putting your money into an RRSP or TFSA account. By using this as a basis for your financial planning, it will become more obvious how to limit the taxes you pay. For instance, RRSP accounts are better investments for those who make more now, but require and plan to live on less after retiring.

Key Takeaways:

The large majority of Canadians are in either the first (up to $47,630) or second bracket (i.e., most Canadians make less than $95,000 a year).
From an after-tax perspective, most people would likely be indifferent between an RRSP and a TFSA, because most people are in the same tax bracket when working and when retired.
Those who would benefit from the ‘tax bracket arbitrage’ by using an RRSP are those who earn less in retirement while maintaining a similar standard of living due to having put their children through school, paid off the mortgage and so forth.

“While many people have no strong opinion when choosing between RRSPs and TFSAs, there is a clear advantage to RRSPs for those people who have more than modest incomes that are likely to be a fair bit lower in retirement. For most people earning over $47,000 a year, therefore, RRSPs are likely to be the better option.”

How to make the right pension decision when longevity is so variable

With the average life expectancy ranging from the mid to late eighties, yet, in reality, could be much more or less, Canadians planning to retire have to make decisions about where their retirement income will come from. You need to figure out where you stand to lose money on your household balance sheet should you or your spouse lives longer than expected. You need to know how much cash flow you will have and plan your budget. Having a financial plan in place for any situation will take away the stress and uncertainty.

Key Takeaways:

The average Canadian woman lives 21.9 years in retirement, and the Canadian average man lives 18.9 years in retirement.
To help reduce the risk associated with using the average life expectancy in financial planning the 25% probability of survival is used, not the 50% probability provided by average life expectancy – as “forecasting a longer life expectancy offers protection from future improvements in mortality and accounts for the greatest financial risk to an individual: longevity risk.”
When you shift your focus from projections and probabilities to risks, dependencies, and contingencies, then the goal of financial planning is sometimes not be to maximize the funds paid out of a pension, but rather to reduce the risk on your household balance sheet.

“The real value of financial planning [is] it helps reduce uncertainty—not by making highly exact predictions, but by identifying financial vulnerabilities and dependencies, and ways to effectively address them.”

CRA draft newsletter on annuity purchases from pension plans

A draft newsletter released by The Registered Plans Directorate of the CRA provides guidance on the tax implications of purchasing annuities by both plan administrators and individuals from registered pension plans. Currently, Section 147.4 of the Income Tax Act allows an annuity to be purchased from a pension plan with the condition that the annuinty terms are not “materially different” from the pension plan. If different, then 147.4 doesn’t apply resulting in the individual being seen to receive the full purchase price as a taxable payment. The draft newsletter outlines how their definition of “materially different” will be changing.

Key Takeaways:

Prior to the Draft Newsletter, the CRA has taken a conservative view of the term “materially different”, effectively requiring annuity terms to be substantively identical to the pension plan terms.
Now, the CRA will accept fixed-rate indexation in lieu of CPI indexation.The fixed rate can either be the mid-range of the Bank of Canada’s inflation control range at the date of purchase
The newsletter maintains that where the commuted value of pension plan benefits is more than enough to provide the promised benefits under an annuity, the excess must be paid in cash to the member.

“The main change in the Draft Newsletter is the new guidance respecting the forms of inflation indexing that will not be considered materially different by the CRA from CPI-based indexing. These will be welcome to plan administrators of pension plans who wish to purchase annuities with respect to benefits with CPI-based indexing.”

How to calculate capital gains and losses on rental property

Homeowners may not realize it at the time, but renting out a home they used to live in will change its tax status when you go to sell it later. By making a primary residence a rental property, capital gains taxes will come into effect and be based on the increase in property value when you go to sell it. There are ways to continue to assess the property as a primary residence provided certain conditions are met. If you don’t qualify, then you’ll need to calculate the capital gain or loss using the fair market value when the home was converted from a principal residence to a rental property. This means any acquisition costs such as legal fees and land transfer tax, which would normally be added to the adjusted cost base or tax cost for capital gains purposes wouldn’t apply.

Key Takeaways:

Under subsection 45(2) of the Income Tax Act, it’s possible to treat a rental property (which was your residence) as your principal residence for up to four years provided you meet several conditions.
Selling costs, like legal fees and real estate commission, are deductible expenses, and will reduce the overall capital gain when selling a house.
If depreciation (capital cost allowance) were used as a tax deduction against net rental income in previous years, then these deductions are added to your income in the year or sale.

“When you convert a home that is your principal residence into a rental property, this is considered a change in use. You are deemed to dispose of the property at the fair market value at that time, and immediately reacquire it.”

Personal Investor: Is your house really an investment?

Some Canadians are looking to purchase a home not only a place to live, but as an investment for when they retire. But, is this an accurate perspective to take on a home? A house can be considered an investment in some ways, but not in other ways. It can be an investment as it appreciates in value, there are tax-free gains when sold (if it is your primary residence and the value has gone up), and it saves you from paying rent and could potentially be used to earn rental income. The equity in your home can also be used as collateral to get a low-interest line of credit. However, a house as an investment can be problematic as it can’t be quickly liquidated for cash and it can depreciate.

Key Takeaways:

According to the Canada Mortgage and Housing Corporation (CMHC), the average Canadian home has grown in value by over 5 percent annually over the past 30 years.
Assuming your property is your principal residence, any appreciation in value is tax free when it is sold.
Real estate investment trusts (REITs), mutual funds, and exchange-traded funds can provide diversified exposure to real estate – especially if you don’t already own a home.

“For most Canadians, a home is their largest single investment, and in many cases a keystone in their retirement plan. But is a house really an investment?”

Is Income Splitting Dead?

Despite the Department of Finance changing the “income splitting” rules in 2018, there are no shortages of income splitting plans. Some of them take advantage of various provisions of the Income Tax Act while others are a little more complicated. The average business owner can become permanently trapped in the tax on split income (TOSI) legislation. Splitting income with family members to avoid the attribution rules using prescribed rate loans has become common, and can still work with the new TOSI rules. The TOSI rules do not apply to salaries to family members.

Key Takeaways:

The new tax law makes it nearly impossible for the average business owner to navigate, which means a tax professional is highly recommended.
It is very important that you keep the income from the PR Loan as passive income which then can be reported.
Salaries paid to family members must prove that they are income producing and be sure to only make reasonable deductions.

“No matter what the Department of Finance dreams up to stop perceived mischief, income splitting plans will survive, especially if the affected parties feel targeted, attacked and their overall tax situation is not fair.”

Do you need to make income tax instalment payments?

If you owe more than $3,000 in taxes from the previous tax year, then you may be asked by the CRA to pay your next year’s taxes in installments. Employees typically do not need to worry about instalments because their employer will withhold tax throughout the year. However, individuals with more than one source of income may be required to pay installments. Since installments are based on the previous year’s income, a one-time event that causes a spike can trigger an installment notice. If you’re unsure, check with a certified accountant to help you through the process.

Key Takeaways:

Installments are required when your net tax owing income is greater than $3,000 for the previous tax year.
The letter the CRA sends in February 2019 is based on your 2017 income and outlines the required payments on, or before, March 15 and June 15. The August letter is based on your actual 2018 net tax owing and outlines the required payments on, or before, Sept. 15 and Dec. 15.
If installments are late or less than the requested amount, taxpayers may have to pay interest and penalty charges, which cannot be deducted on their tax return.

“Twice a year, Canada Revenue Agency sends out instalment reminder letters to those taxpayers who are required to make payments.”

Cutting down capital gains tax on real estate sales

Real estate investors often dread paying capital gains. Unlike the stock market, real estate is seen as a long-term investment with larger capital gains. For real estate, capital gains are taxed at your marginal tax rate. Other forms of income like employment, interest and foreign dividends are taxed at twice the tax rate and taxable annually, whereas capital gains for real estate are deferred until the sale of the property. There are exceptions for qualified small business corporation (QSBC) shares and farm properties, which are subject to certain conditions. Losses from other non-registered investments can be used against your capital gains to lower your tax burden. You can even avoid paying capital gains yourself by freezing it and passing it along to the next generation, but eventually it will be triggered, so, how you set up a transfer matter.

Key Takeaways:

In the year of its sale, all past depreciation, also known as capital cost allowance (CCA), gets “recaptured” and taxed in addition to capital gains tax.
One good way to mitigate tax on a real estate sale is to defer RRSP contributions or deductions in anticipation of a large income inclusion from the sale of real estate.
In Canada, there is a capital gains tax exemption for real estate used by a taxpayer to earn income from a business, but rental real estate does not qualify as a “business.”

“One of the biggest deterrents I’ve observed with real estate investors is the dreaded capital gains tax hit.”

Paying income taxes is bad enough. Canada’s brutally complicated system makes it worse

A detailed examination of Canada’s system is long overdue. The Canadian tax system is complex and has become more so over the years. The original document was 4,000 words, and is now 1.1 million words. The tax guide includes complex tax codes and is further complicated by an increased number of tax credits and exceptions. This makes tax preparation more expensive for individuals and more costly for the government. Many other countries have made laws to simplify their tax laws. Canada is long overdue for a similar simplification. Reduction of tax credits could be balanced by lowering the tax rates. That way, it’s easier for taxpayers and the government, without any loss in revenue or increase in taxes.

Key Takeaways:

Canadas Income Tax System has not changed for the better over the last 25 years.
The high number of personal tax credits adds complexity and the number of credits has increased by 26 percent between 1991 and 2015.
The Income Tax Act’s length, inaccessible language, and numerous exceptions increase the cost of compliance for taxpayers, which amounted to an average of $501 per household in 2012.

“While Canada has made no major revisions of its Income Tax Act since the 1960s, other countries have implemented measures to reduce the size and complexity of their tax codes over the past 25 years.”