Do Not Hold Dividend Paying U.S. Stocks in Your TFSA

We are still in the early days of TFSAs and all sorts of confusion about the rules that apply to TFSAs seem to abound not only among tax payers but also among financial advisors.

Recently, 70,000 out of the 4.7 million Canadians who have set up TFSA accounts since the beginning of 2009, received letters from CRA saying that they have made excess contributions to their TFSA accounts and therefore have to pay penalties on the excess contributions that in some cases amounted to hundreds of dollars (Source: “Ottawa acts on TFSA confusion”, Globe and Mail, June 25th, 2010).

Fortunately the government soon realized that most of the tax payers who were being penalized had made innocent mistakes in their interpretation of the TFSA withdrawal rules and therefore decided to show leniency and maximum flexibility in dealing with the offenders.

Closing the Loophole on Interest on Overpaid Taxes

If you have been looking for short-term liquid savings options for the cash in your corporate account lately you would know that the current interest rates are at historically low levels. The government has been paying interest on outstanding corporate taxpayer balances each quarter at a rate equal to the average yield on three-month government of Canada treasury bills sold in the first month of the preceding quarter, rounded up to the nearest percentage point, plus 2%. This had resulted in some corporations overpaying their taxes in order to take advantage of these favourable rates of return.

Extension of Mineral Exploration tax-credit for flow-through share investors

The mineral exploration tax credit is available to investors in flow-through shares. This credit is equal to 15 per cent of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors. Budget 2010 proposed to extend eligibility for the mineral exploration tax credit for one year, to flow-through share agreements entered into on or before March 31, 2011.

Under the current “look-back” rule, funds raised in one calendar year with the benefit of the credit can be spent on eligible exploration up to the end of the following calendar year. For example, funds raised with the credit during the first three months of 2011 can support eligible exploration until the end of 2012.

Closing the Loophole on Interest on Overpaid Taxes

If you have been looking for short-term liquid savings options for the cash in your corporate account lately you would know that the current interest rates are at historically low levels. The government has been paying interest on outstanding corporate taxpayer balances each quarter at a rate equal to the average yield on three-month government of Canada treasury bills sold in the first month of the preceding quarter, rounded up to the nearest percentage point, plus 2%. This had resulted in some corporations overpaying their taxes in order to take advantage of these favourable rates of return.

The 2010 Federal Budget proposed that effective July 1, 2010, the interest for overpayment of taxes payable by the government to corporations be reduced by 2%, to the average yield on three-month government of Canada treasury bills sold in the first month of the preceding quarter, rounded up to the nearest percentage point.

Changes to the Medical Expense Tax Credit

If you were considering cosmetic surgery, teeth whitening, hair transplants or Botox injections and hoping that the expenses would be eligible for the Medical Expense Tax Credit, you may be too late.

In 2010, the Medical Expense Tax Credit reduces the federal tax of a claimant by 15 per cent of eligible non-reimbursed medical expenses in excess of the lesser of $2024 and three percent of net income. You would be able to claim an amount under the credit if you have a disability or an existing medical condition. Since the rules were not clear as to exactly what could and could not be claimed, some tax payers had taken legal action to try and claim expenses paid for personally elected cosmetic procedures.

The Budget attempted to clarify the intent of the rules by stating that expenses incurred for purely cosmetic procedures (including related services and other expenses such as travel) are ineligible to be claimed under the Medical Expense Tax Credit. This includes both surgical and non-surgical procedures that are undertaken to enhance appearance such as Botox injections, liposuction, hair replacement and teeth whitening. This also means that these expenses will no longer be considered eligible expenses in health spending accounts.

However, cosmetic procedures required for medical or reconstructive purposes, such as surgery performed as a result of a personal injury or disfiguring disease will still qualify.

Changes to the Rules for Ontario Locked-In Accounts

On June 19, 2009, numerous important changes were made to the rules governing locked-in accounts. Locked-in accounts include Locked-In Retirement Accounts (LIRAs), Old Life Income Funds (Old LIFs), New Life Income Funds (New LIFs) and Locked-In Retirement Income Funds (LRIFS). The following points summarize the key changes to the rules, indicate when these changes come into effect, and provide answers to some of the questions that are likely to arise as a result of these changes.

What are the key changes to the rules?

• From January 1, 2011 to April 30, 2012, owners of Old LIFs and LRIFs will have a one-time opportunity to withdraw in cash or transfer to an RRSP or RRIF up to 50% of the total market value of the assets of the fund.
• From January 1, 2010 to December 31, 2010, owners of New LIFs will have a one-time opportunity to withdraw in cash or transfer to an RRSP or RRIF an additional 25% of the total market value of the assets of the fund that were transferred into their New LIF account on or before December 31, 2009.
• After December 31, 2009, anyone who purchases a New LIF will have a one-time opportunity to withdraw in cash or transfer to an RRSP or RRIF up to 50% of the total market value of the assets of the fund.
• As of January 1, 2011, all of the rules that govern locked-in retirement accounts (LIRAs) are consolidated into Schedule 3 under the Regulation.

What changes come into effect on January 1, 2011?

• Owners of Old LIFs or LRIFs can apply to withdraw or transfer 50% of the assets in their account.
• Owners of New LIFs will no longer be able to withdraw or transfer an additional 25% of the assets that were transferred into their account on or before December 31, 2009.
• The rules for determining the maximum annual income payment from an Old LIF or an LRIF will become standardized with the rules under a New LIF: the greater of the investment earnings of the fund in the previous year, or the amount that would be paid using the LIF formula in the regulations.
• Owners of Old LIFs and LRIFs will no longer be able to transfer assets from those accounts to a locked-in retirement account (LIRA).
• The new Schedule 3 which sets out the LIRA rules comes into effect.
What changes come into effect May 1, 2012?
• Owners of Old LIFs or LRIFs will no longer be able to withdraw or transfer 50% of the assets in their account.

New Employment Insurance Special Benefits for Self-Employed People

April 1st 2010 is the deadline for self-employed people to register for special Employment Insurance (EI) benefits that became available as of January 31, 2010. If you are self-employed and you register before April 1st, you can access the benefits as early as July 11, 2011. If you wait until after April 1st 2010, you will have to wait 12 months before you can apply for the benefits.

While self-employed people in Quebec are already eligible to apply for maternity and parental benefits under the Quebec Parental Insurance Plan, the special benefits that have recently become available to self-employed individuals across Canada include the following:
1- Maternity benefits
2- Parental benefits
3- Sickness benefits
4- Compassionate care benefits

You can register online using My Service Canada Account. You can visit http://www.servicecanada.gc.ca/eng/sc/ei/self_employed_workers.shtml for more information or call the EI Telephone Information Service at 1-800-206-7218.

End Pension Discrimination for Business Owners with an RCA

If you are an executive working for a large Canadian company, most likely you have a generous pension plan that funds your retirement based on a formula that allows you to have an income equivalent to 70% of your final average earnings.

If you are a Canadian business owner who has made maximum contributions to your RRSP each year and are counting on this nestegg to provide you with a comfortable retirement income you will most likely be shocked to find out that the level of income you can expect is going to be nowhere close to the level of income that a Canadian executive with a pension plan can expect, even if both of you have been making the exact same amount of money during your working years.

This pension gap is so significant that it can amount to the pension income being received by the executive of the public company (with a pension plan and supplemental agreement) with 35 years of service at age 65, being three times that of the income received from RRSP savings by a 65 year old business owner who has contributed the maximum to his/her RRSP over 35 years of service and has had exactly the same income as the executive during his/her working years.

Fortunately there is a solution for this serious problem. According to Roy W. Craik, President of Retirement Compensation Funding Inc. in Toronto, “…in 1998, Revenue Canada realized that those in private business were facing serious pension discrimination over those in the public sector. A provision in the Income Tax Act being used by Public Corporations to fill the “pension gap” was extended to Private Business if the guidelines for public corporations were followed. The provision (defined under Subsection 248 (1) of the Income Tax Act) was referred to as a Retirement Compensation Arrangement (RCA) which could be wrapped around whatever form of pension the person in private business had…. The RCA (Retirement Compensation Arrangement) is Revenue Canada’s tool for equalizing a business owner’s pension to provide the remainder of the 70% allowed for funding a full pension. The RCA will eliminate the pension discrimination that high earning executives face with Registered Pensions Plans, and is wrapped around the owners RRSP or IPP.”

A unique feature of an RCA is that 50% of each deposit to the RCA has to be contributed to a Refundable Tax Account (RTA). While the RTA earns to interest while it is being held by CRA, it can provide downside protection from market volatility as it will be refunded as funds are withdrawn at retirement.

Contributions made by the corporation to the RCA are tax deductible to the corporation, and are exempt from payroll taxes. The business owner is not taxed until distribution begins from the RCA at retirement. The RCA is a trust and assets are held in a Trust and may be protected from creditors with a third party Trustee. The RCA can also be helpful in succession planning and be part of an exit strategy for the business owner on the sale of business.

If you are a business owner or executive with earnings over $500,000 or are accumulating excessive amounts of cash and investments in your corporation, a key executive with an underfunded corporate pension plan or an executive with stock option plans and your income as reported on your T4 slip is in excess of $125,000 then you should seriously consider an RCA and discuss it with your financial advisor.

Save Tax by Purchasing Flow-through Limited Partnership Units

Although flow-through limited partnerships are not suitable for all investors, they can be used to defer tax payable in the year of a capital gain. Because flow through shares provide deductions against taxable income (typically within the first two years of purchase), the deductions can be used to offset taxable income resulting from a capital gain.

Note that the flow-through limited partnership units will have an adjusted cost base (ACB) of $0, meaning that capital gains tax will be payable when you ultimately sell your units. Flow-through limited partnership units normally reduce the ACB of the units. In some cases, alternative minimum tax (AMT) may apply – particularly where there is excessive use of flow-through limited partnerships.

QUICK RRSP FACTS

The RRSP season is upon us once again and it is time to take stock of your income in 2009, your RRSP contribution room and the optimal amount that you need to contribute to your RRSP before the March 1st, 2010 deadline, in order to minimize your 2009 taxes.

Maximum RRSP Contribution for 2009

The maximum allowable RRSP contribution for 2009, is the lower of $21,000 or 18% of your 2008 earned income, minus your pension adjustment which reflects your company pension plan contributions. Your pension adjustment is reported in box 52 of your T4 slip.

For RRSP purposes, earned income includes your salary or wages, bonuses, alimony received and rental income. It does not however, include dividends or investment income.

You can find out the exact amount of the maximum contribution you are allowed to make for the 2009 taxation year at the bottom of the first page of your notice of assessment that you received from Canada Revenue Agency after filing your 2008 tax return.

Deadline for RRSP Contributions

For your RRSP contributions to be eligible for deduction against your 2009 income, you need to make your contribution by March 1st 2010.