Archive for April, 2012

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File a Tax Return — Even If You Can’t Pay

The tax-filing deadline is midnight April 30 — unless you are self-employed, in which case the deadline is midnight June 15.  But even if you qualify for the June 15 deadline, you still have to pay the Canada Revenue Agency (CRA) any amount owing on your 2011 taxes by April 30.

So, filing by April 30 is the best and only way to avoid expensive late-filing penalties and interest on this year’s taxes. The CRA charges a penalty of 5% of the unpaid balance plus 1% for each full month the amount remains unpaid to a maximum of 12 months. The penalty is higher if you repeatedly file late.

Nor does it pay to use the CRA to bankroll accumulating unpaid taxes: it charges interest on the amount owing based on the “prescribed rate” of interest, set quarterly by the CRA, plus 4%. This interest compounds daily — it can add up quickly.

So, if you have savings, cashing out to pay overdue taxes could pay off. But seek the advice of your tax and financial advisory team before you take action. From a tax planning point of view, you will want to tap into tax-paid savings such as a guaranteed investment certificates or Tax-Free Savings Accounts before withdrawing money from your RRSP or RRIF — that will only result in a tax liability next year.

What happens if you can’t pay? If your balance is not paid within 30 days of the receipt of your Notice of Assessment or Reassessment, you will receive a letter or a phone call from the CRA. This is your opportunity to arrange a payment schedule with the CRA. If the CRA is satisfied you have exhausted all other means of paying — cashing in savings, borrowing or arranging lines of credit — it will work with you. Speak to a payment agent or ask your tax advisor do so for you.

Promptly clearing up your bill with the CRA is to your advantage.  Indeed, interest will be charged on the outstanding balance but you’ll avoid receiving what the CRA calls the “final letter.”  This will advise you that if you don’t make arrangements that are satisfactory to the CRA within 90 days of the Notice of Assessment, the CRA can take legal action, such as garnishing your income or directing a sheriff to seize and sell assets.

Also, don’t expect a refund from any other statute administered by the CRA, such as your GST/HST account if you are self-employed. The CRA will use those amounts to pay off your income tax bill.

It’s Your Money.  Your Life.  Filing an income tax return on time and paying balances promptly will save you time, money and the stress of dealing with legal action. So, do make the time to see your tax advisor this week.

Evelyn Jacks is president of Knowledge Bureau and author of Essential Tax Facts 2012 and co-author of Financial Recovery in a Fragile World with Al Emid and Robert Ironside.  Follow her on twitter @evelynjacks


Tax + Inflation = Investor Loss

Tax time is a good time to evaluate the tax-efficiency of your investment strategy. This is especially true if the market volatility of recent years has spooked you into replacing the equities in your portfolio with “safer” investments that guarantee your principal and interest.

In the Knowledge Bureau Report of April 4, I promised you a look at the eroding effects of both taxes and inflation on your investment returns. The picture is not pretty.

Recall that reporting interest on your income tax return follows two basic tax rules:

• You report interest in the tax year in which it is actually received or receivable.

• You report interest accrued from compounding investments on the debt’s anniversary date, even though you haven’t received the cash.

What effect do those rules, and the annual inflation rate, have on your real returns?  Consider the following chart, which analyzes the real return on a $1,000 Canada Savings Bond.  In this scenario, we are assuming a 1.8% interest rate, 3% annual inflation and a 10-year hold period.  The taxpayer is in the 31% tax bracket.  Amounts shown are in current-year dollars (i.e. adjusted for inflation from year 0).

After 10 years, your return after taxes and inflation is actually a loss of 14.41% in real dollar terms.  Was this a safe investment?  At the outset, you may have said “Yes” because the principle is guaranteed. Unfortunately, your principle has lost purchasing power because it could not compete with the eroding factors of annual taxes and inflation.

It’s Your Money.  Your Life.  Both time and money are precious. Always consider the real rate of return — after taxes, after inflation and after taking into account the costs associated with the investment — that you must earn to create purchasing power when you need it.  And be sure to discuss the role of interest in your overall portfolio with your advisors.

Evelyn Jacks is president of Knowledge Bureau and author of Essential Tax Facts 2012 and co-author of Financial Recovery in a Fragile World with Al Emid and Robert Ironside.  Follow her on twitter @evelynjacks


Reporting Interest Income

It really is time to do that income tax return, with the April 30 deadline for individual filers fast approaching. And reporting interest income deserves particular attention this year, if you are among the worried investors who exchanged stocks for the “safe” havens of interest-bearing debt obligations such as guaranteed investment certificates (GICs) and Canada Savings Bonds.

Indeed, the guaranteed return of principal and income resulting from the government using your money is attractive. But it is not all it appears to be: these interest-bearing investments are neither tax-efficient nor inflation-proof. If you take taxes and inflation into account, over time, you will actually lose both principal and purchasing power.

Consider the tax filing rules. Interest reporting follows two basic tax rules:

• You must report the interest in the taxation year in which it is received or receivable.

• Compounding allows you to earn interest on interest during the term of the contract. On your income tax return, you must report all interest income that accrues in the year ending on the debt’s anniversary date. So, you pay taxes on income you haven’t received as you’ve effectively reinvested the pre-tax interest at the same rate as the principal pays.

The issue date of the debt instrument is important because reporting stems from that date rather than the date of ownership. For example, because of the annual reporting rules, which apply to investments acquired after 1989, an issue date of Nov. 1, 2011, does not require interest reporting until the following year, that is 2012. In other words, the accrual of interest for the two-month period of Nov. 1 to Dec. 31 is not reported in the 2011 tax year.

Things get even more tricky when investment contracts have unique features, such as:

• they do not bear interest and are sold at a discount to their maturity value;

• the interest rate of the instrument is adjusted for inflation over time;

• the rate of interest may increase as the term progresses;

• interest payments may vary with the debtor’s cash flows or profits;

• if the instrument is transferred before the end of the term, a reconciliation of interest earnings must take place.

It’s Your Money.  Your Life.  Interest received or accrued each year must be reported as investment income on Schedule 4 – Statement of Investment Income and Line 121 of the tax return.  Remember: you must report interest income earned even if you did not receive a T slip.  Get help from your tax advisor in the trickier situations.

Next time — Evaluating CSB returns: Taking inflation into account

Evelyn Jacks is president of Knowledge Bureau and author of Essential Tax Facts 2012 and co-author of Financial Recovery in a Fragile World.  Follow her on twitter @evelynjacks


Family Tax-Efficient Investment Strategies

If the federal budget brought home one lesson about our post-crisis reality it is the importance of being financially self-reliant. If you were born on or after Feb. 1, 1962, you will not qualify for Old Age Security (OAS) benefits until you are 67. That means you need to create another $13,000 in retirement savings to replace those benefits.

Yet, economists forecast negligible net returns after inflation and taxes over the next five years — and that’s going to make filling the gap more challenging.  Fortunately, your tax return is one vehicle that can propel your efforts forward.

That begs the question: are you taking tax rules into account when you are planning your family investment strategies?  Tax-efficient investment-income planning uses available tax rules to shift income among family members to equalize the amount reported by each family member, thereby reducing taxes for the unit as a whole.  That helps your family create more “redundant income,” allowing you to save more money for the future.  Done well, an effective tax strategy will also temper future tax erosion on the accumulated capital pools dispersed among family members’ hands.

The first goal is to create taxable income in the hands of each family member, thereby using the progressive nature of the tax system — that is, all the tax credits and deductions you are entitled to as a family unit — to average down the tax burden for the family as a whole.

Be sure to discuss the following elements of a successful and tax-efficient family investment plan with your tax and investment advisors:

• Recover errors and omissions. First and foremost, always use the Taxpayer Relief Provisions to recover taxes owing to each family member as a result of errors or omissions on previously filed returns. This includes filing omitted returns, which is critical if you are to maximize RRSP contribution room as well as carry forward investment provisions such as capital losses which can reduce future taxes payable.  Errors and omissions that end in recovered tax refunds also provide new capital for investment purposes.  However, be audit-proof, as opening prior returns invites a check-up by the taxman.

Maximize access to family tax-free zones. Begin with the Basic Personal Amount by taking advantage of family income-splitting opportunities.  Also, by transferring important tax credits from one family member to another — such as tuition, education and textbook amounts — those tax-free zones are increased, reducing taxes for everyone. Again, leverage those tax savings by investing refunds in the right tax-exempt or tax-deferred investment vehicle.

• Put capital in the right hands.  Know how to transfer assets among family members.  Inter-family investment loans, for example, can shift money to the lower-income family member from a higher income-earner during lifetime and at death.  To do so legally, however, you’ll need to transfer income and capital within the confines of the Attribution Rules, which can allocate investment income back to you on certain assets transferred to family members. You can avoid the Attribution Rules by putting money into tax-exempt assets for family members, such as Tax-Free Savings Accounts or a principal residence.

• Use tax-deductible debt. Understand what debt is tax deductible and how to shift capital losses from one spouse to another.  In addition to interest expenses, other deductible carrying charges include safety deposit box fees, investment counsel fees as well as accounting fees for investment-income calculations.

It’s Your Money.  Your Life. Tax-efficient investing increases income, which leads to the more effective accumulation, growth, preservation and transition of family wealth.  Tax-filing time is a great time to educate yourself and family members: ask your tax and investment advisors the questions for which you need answers. They can help you set up your 2012 tax year to benefit from tax-efficient investing.

Evelyn Jacks, president of Knowledge Bureau, is author of Essential Tax Facts 2012 and co-author of Financial Recovery in a Fragile World. To purchase your books, visit www.knowledgebureau.com/asp.

Follow on Evelyn on Twitter @evelynjacks