The Now Newspaper “Best of Your Neighborhood Award 2013″: http://issuu.com/surrey-now/docs/srysthu20140130
The Now Newspaper “Best of Your Neighborhood Award 2013″: http://issuu.com/surrey-now/docs/srysthu20140130
I’ve heard of divorce battles going on for quite a while. The story of Frances and Philip Ragusa, however, takes the cake. Their battle lasted for 34 years, starting in 1977, until Frances was 75, and Philip 77. Frances was making a claim for child support of $14,394, which Philip hadn’t paid. The amount, with interest, grew to be about $100,000.
If you’re going through a marriage breakdown, the best advice is to wrap things up sooner, rather than later. And take the time to understand the tax implications of splitting up. Here are the top tax issues to consider when you part ways:
The meaning of being ‘married’
For tax purposes, the definition of “married” matters a lot. Even common-law partners can be considered married if they’ve been living together in a conjugal relationship for at least 12 months, or they have a child. When does marriage end? In a legal marriage, you’ll usually separate for a time and then your relationship ends officially when you obtain a divorce. For tax purposes, your status as “married” is considered to have ended on the day you started living separately, provided you’ve been living separately and apart for 90 days or longer.
Dividing up assets
When you separate, you may be required to divide up assets. Generally, you’ll be able to transfer assets between the two of you without a tax hit. Capital property (most assets) can transfer at adjusted cost base (ACB) so that the recipient spouse inherits the current ACB of the property, and there’s no tax to pay on the transfer. Registered Retirement Savings Plan (RRSP) assets can transfer directly to the other spouse’s RRSP without a tax hit. It’s the same with assets in a Tax-Free Savings Account (TFSA). In the case of a TFSA, the transferor doesn’t receive a reinstatement of contribution room.
Sharing pension assets
Canada Pension Plan credits earned by both spouses during marriage can be combined and split without any immediate tax. Other pension plan assets can often be split without tax, but speak to a lawyer in your province, since family law and pension law are provincial matters.
Tax on support payments
Spousal-support payments are generally deductible to the payer, and taxable to the recipient. Lump-sum payments that reflect arrears support for prior years are generally taxed when received, but the recipient can request to be taxed as though they were received in those prior years if this works out better and if the amount that applies to previous years is $3,000 or more (not including interest). Child-support payments are generally tax-free to the recipient and not deductible by the payer (an exception applies with some pre-May, 1997, support orders or agreements).
Deductibility of legal fees
Legal fees are generally deductible if they relate to collecting late support payments, establishing a right to support, increasing your support, or to make child support payments tax-free. If you’re the payer of support, legal fees are generally not deductible. Nor are fees related to child custody or visitation issues. If your deductible legal fees happen to exceed your income in a year, a non-capital loss is created which can then be carried forward, or back, to other tax years.
Personal tax credits and deductions
Each spouse may be entitled to the eligible dependant amount. Only one spouse can claim the amount for a particular dependant, so if you have more than one child, it often makes sense to each to claim the credit in respect of different children, otherwise you’ll need to agree on who will claim the credit.
As for child-care expenses, you can claim expenses incurred by you for the period your child resided with you. Finally, in the case of tuition, textbook and education credits, a student can transfer these credits to either parent, but not a portion to both, which will require agreement between you and your spouse.
Universal Child Care Benefit
If one parent has custody of children, then the UCCB will be paid to that parent. With shared custody, you can apply to split the payment equally between the two of you. The UCCB is taxable, and if you’re single at the end of the year, you have the option of reporting the income yourself, or in the hands of your dependant.
Article: Globe & Mail
My kids love to read.
“Dad, what’s the most creative work of fiction you’ve ever read?” my son, Win, asked.
“Son,” I replied, “I’d have to say your uncle’s tax return would be at the top of the list.”
Unfortunately, Uncle Charles is no longer with us, but he did suggest in his last days that tax planning would have been a good idea. So, let’s go with that advice.
I’ve been talking about the four pillars of tax-smart investing: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income.
Today, I want to finish off by focusing on pillar number four: Offsets to income.
What I’m talking about is creating deductions or credits to offset income earned, or tax that might otherwise be owing, on your investment portfolio. The most common types of offsets include capital losses, charitable donation tax credits, interest deductions, foreign tax credits, losses from limited partnerships, business expenses in some cases, and other deductions, such as flow-through share deductions.
Try the following ideas to reduce your tax using offsets:
1. Argue that it’s a business
If you’re actively trading in securities, you may be able to argue that your profit should be taxed as business income rather than capital gains. Now, only half of your capital gains are taxable, so don’t be quick to make this argument. Having said this, if you do report your profits as business income, you’ll be entitled to deduct many types of expenses against your income, including many things you may be paying for anyway, such as a portion of mortgage interest, property taxes, and similar expenses. See my article dated April 22, 2010, for more.
2. Donate securities to charity
Since 2006 it has been possible to eliminate the tax on capital gains on specific securities by donating those securities to charity. Normally, the capital gains inclusion rate is 50 per cent (meaning that one-half of your gains are taxable), but the inclusion rate is set to zero if the securities are donated to charity. In addition to zero tax on the capital gains, you’ll be entitled to a donation tax credit for the value of the securities donated.
3. Harvest capital losses wisely
As we near year-end, many Canadians will choose to sell some of the losers in their portfolio to realize the capital losses, which can then be offset against capital gains that might have been realized this year, or in the three prior years (2013, 2012 or 2011). This can make good sense if you have capital gains this year or in the past to offset, or if you simply don’t like the investment any more.
4. Track your cost properly
If you’re investing in mutual funds, be sure to add the amount of any taxable distributions each year to your adjusted cost base (ACB) of the investment. If you fail to do this you’ll end up paying tax twice on the same growth in value.
5. Claim foreign tax credits
Don’t forget to claim a foreign tax credit for foreign taxes paid on income you’re reporting on your Canadian tax return. You may also want to avoid dividend-paying foreign shares in your Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP) or other registered account since you won’t be able to claim a foreign tax credit for foreign taxes withheld on income inside those plans.
6. Avoid the superficial loss rules
If you sell an investment at a loss and you, or someone affiliated with you (your spouse or a corporation you control, for example), acquires or reacquires that same security in the period that is 30 days prior to your sale, or 30 days after your sale (a 61-day window), your capital loss will be denied. The loss isn’t gone forever; it will be added to your ACB of the reacquired securities, so that you’ll eventually realize the tax savings from that loss when you ultimately sell those securities.
7. Choose your funds wisely
If you invest in mutual funds that have unused capital losses, future capital gains in that fund could be partially sheltered using those losses, which can result in higher after-tax returns for you.
8. Deduct interest costs
It can make sense to borrow to invest if you do this prudently. Interest on money borrowed to earn income can generally be deducted, offsetting some of your investment income, and providing tax savings.
Article: Globe & Mail
I’ve been talking recently about the four pillars of tax-smart investing: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income. Today, I want to chat about the third pillar: The location of income.
When I told my wife Carolyn about the topic this week, she said “the location of income should be very simple: in my bank account.” Then I told her that the location of income has less to do with where the money ends up, and more to do with who pays the tax on the income, if anyone. She wasn’t as excited by that concept.
Location. Location. Location. Perhaps you thought this matters only in real estate. Not so. The location of your investments has a big impact on how much tax you’ll pay. Common “locations” include: Your personal hands, your spouse’s hands, the hands of your children or other family, inside a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF), inside a tax-free savings account (TFSA), or inside a corporation, family trust, or partnership.
Speaking of location, people often ask whether holding assets in another jurisdiction can save tax. As a general rule, this won’t help you because you’ll face tax on your worldwide income if you’re a resident in Canada, and our tax law and recent court decisions are tough on taxpayers who try to use offshore trusts or corporations to avoid tax.
Consider the following ideas to optimally locate your investments to save tax:
1. Use registered plans when earning interest
To the extent you own interest-bearing investments, hold them inside a registered plan (RRSP, RRIF or TFSA) so that the interest, which is otherwise highly taxed, is sheltered from the taxman. This is not to say that equities, which you’re holding for capital growth, should not be held in a registered plan, but not if it means you then have to hold interest-bearing investments outside the plan.
2. Consider a corporation to hold investments
By holding some or all of your non-registered investments inside a corporation you won’t face tax personally on the investment income. This could reduce a clawback of government benefits such as Old Age Security, minimize U.S. estate tax on U.S. securities, and minimize probate fees. In some provinces, in some years, the tax you’ll face on investment income inside the corporation could be less than what you’d pay personally if you’re in the highest tax bracket.
In 2014, it’s the case that capital gains and interest earned in a corporation offer no benefit over earning the amounts personally, but certain dividends earned in a corporation, rather than personally, may leave you better off in some provinces.
3. Place assets in trust
Putting assets in trust can provide you with continued control over the assets while passing the tax bill on any investment income to the beneficiaries of the trust – if you structure it properly. You do have to be concerned about the attribution rules in our tax law, but if you lend money to the trust and charge interest at the prescribed rate on the loan, or are careful about which beneficiaries are entitled to the income (adult children only, for example) you may be able to reduce the overall tax of the family.
4. Transfer assets to family
I’m talking here about splitting income by moving assets to the hands of family who will pay tax at lower rates than you. If you do this properly you’ll avoid the attribution rules in our tax law and you’ll save tax. You might also gain a measure of asset protection and reduce taxes and probate fees on death when moving assets out of your name.
5. Avoid superficial losses and average costs
If you own a security and sell it at a loss, your loss could be denied if you reacquire that security in the 61-day window that starts 30 days prior to, and ends 30 days after, your sale. By repurchasing the security in the name of a child you can avoid this superficial loss. Also, when you buy a security at different points in time, your adjusted cost base (ACB) on each purchase is averaged to arrive at a weighted average ACB per share. Any future gain or loss will be based on this average ACB.
If you want to avoid averaging your cost amounts, perhaps to keep flexibility in the ACB that will be used when selling the security, consider making subsequent purchases in the name of your corporation, a family member, or your family trust.
Article: Globe & Mail
I miss my grandfather. He shared with me so many words of wisdom over the years.
He used say “Tim, before you criticize someone, you should walk a mile in their shoes. That way, when you criticize them, you’ll be a mile away and you’ll have their shoes.” That advice has come in handy over the years.
He also used to tell me that “a penny saved in taxes is like a penny more in after-tax income earned.” He would be proud that I’m not paying more in tax on my investments that I should.
Last week, I introduced the four pillars of tax-smart investing. These are to: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income. Today, I want to talk about the second pillar: Controlling the type of income you earn on your portfolio. Here are six ideas to consider:
1. Understand your marginal tax rate
Your marginal tax rate is the amount of tax you’ll pay on one additional dollar of income. That rate will vary, depending on the type of income. Interest income is the most highly taxed. Then there are capital gains and eligible dividends. When it comes to these, capital gains are generally taxed at more favourable rates if you have a higher level of income (typically over about $80,000; but it varies by province), and eligible dividends are generally taxed at lower rates when your income is lower. If you structure your portfolio to earn capital gains or dividends, you’ll face less tax overall than if you earn interest. Keep in mind, the level of risk you take on will also be different and should be factored into your decision about the type of investments to hold. For a good summary of marginal tax rates, I like to visit this facts and figures page.
2. Returns of capital are tax-efficient
Some investments are designed to return your original capital to you over time. You won’t face tax on a return of capital, and so this type of cash flow is very tax-efficient. Keep in mind that this is really a deferral of tax since you’ll pay tax later, when you ultimately sell the investment, but the money is better in your pocket for the time being than the taxman’s. If you happen to own private company shares, you can extract your “paid-up capital” (a cousin to your adjusted cost base) tax-free from your company, which can be better than dividends.
3. Manage clawbacks of OAS benefits
If you receive Old Age Security (OAS) benefits and your income in 2014 is over $71,592, then you’ll have to repay part of your benefits. You’ll repay 15 cents for every dollar of income over $71,592 this year. If you earn eligible dividends, those dividends will be grossed-up for tax purposes, so that you’ll report $1.38 of taxable dividends federally for every $1 of actual cash dividends, and this will make a potential OAS clawback problem even worse. Again, don’t let the tax tail wag the investment dog: If dividend-paying stocks are right from a risk perspective, they may be best for you. But understand the tax implications.
4. Share buybacks can be better than dividends
If a company has excess cash and chooses to buy back shares, you’ll face tax on a capital gain rather than dividends, which could be better for you than dividends if you’re in a higher tax bracket, and provided you don’t need the income.
5. Sell shares on the right side of the ex-dividend date
You have some control over whether you’ll face tax on capital gains or dividends by choosing the time of your sale. If you sell a security before the ex-dividend date you’ll realize capital gains only, which could be best if you’re in a higher tax bracket. If you sell on or after the ex-dividend date you’ll receive dividends, which could be best in a lower tax bracket.
6. Consider a back-to-back prescribed annuity
Here’s how: Consider taking some of your capital invested in interest-bearing investments and buy a prescribed annuity. A portion of each annuity payment will be taxable interest, but a portion will be a tax-free return of capital. You’ll face less tax and put more in your pocket. Then, take some of the additional cash flow from the annuity to purchase a life insurance policy (back-to-back with the annuity) that will pay out on your death, replacing all or some of the capital invested in the annuity.
Next time, I’ll continue this discussion on the pillars of tax-smart investing.
Article: Globe & Mail
Did you know that, in China, it’s possible to buy insurance for some pretty crazy things? You can, for example, buy insurance that will pay out if your child displays “mischievous and destructive” habits, or your favourite team is defeated in the World Cup (both of which happened to me in the past few months; I could have been wealthy if I had been living in China).
I’d love to see a policy that pays out if the taxman decides to increase taxes on investment income. Although, given the likelihood of this happening, I suppose no insurer would touch it with a 10-foot pole. So, what’s an investor to do to reduce the impact of taxes on a portfolio?
Now, I’m not suggesting that you put taxes ahead of the merits of an investment itself, but if you can take steps to minimize the tax on your portfolio, you can add significantly to your net worth over time. A study headed up a few years ago by Professor Moshe Milevsky from the Schulich School of Business showed that returns equal to 1.35 per cent annually were lost to income taxes over the 10-year period and the 340 mutual funds he examined. If you could save that 1.35 per cent annually, you could increase the value of your portfolio by almost one third over 20 years.
By the way, the responsibility for tax-efficiency should fall on the shoulders of two individuals: You (the investor), and your money manager (if you don’t manage your money yourself). Each of you needs to consider what we’re about to discuss.
At the end of the day, there are four pillars of tax-smart investing: (1) control the timing of income, (2) control the type of income, (3) control the location of income, and (4) control the offsets to income (deductions, credits and losses that may be used to reduce your taxes on investment income). Today, let’s consider the first of these.
Timing of income
All other things being equal, you’ll be better off paying a tax bill far in the future than paying it today. The value, of course, lies in your ability to use those dollars to generate returns between today and the time you have to pay the taxman. A $100 tax bill today that is deferred for 10 years will cost you just $61 in today’s dollars, if we assume a 5 per cent return annually.
Here are some ideas to consider as you look to control the timing of your income and the resulting taxes:
Defer the liquidation of investments.
You can control the timing of any taxable capital gains by simply deferring the sale of investments that have appreciated in value. Again, don’t ignore the merits of the investment here; if it’s no longer a good investment, deferring the sale may not make sense.
Keep portfolio turnover low.
Turnover is the number of times in a single year that the investments in your portfolio are sold and the proceeds reinvested. You’d be surprised at how high turnover can be in some mutual funds (well over 100 per cent). The lower the turnover, the lower the taxes annually, assuming a growing portfolio.
Watch the style of money management.
Understand the approach of your money manager. A value-oriented approach will generally result in lower taxes annually than a growth or momentum style approach. A passive approach is generally more tax-efficient than an active approach. You might still prefer a less tax-efficient approach if you believe the returns will justify it, but look for returns that are 1 to 2 per cent higher than with a more tax-efficient approach, to justify the investment.
Evaluate the timing of distributions.
If you’re invested in funds, a sale of securities inside the fund can create a distribution of taxable capital gains without providing an increase in the value of your investment. If you buy into an established fund that has a large accrued gain, beware that you may be buying into a near-term large taxable distribution.
Remember the hurdle rate.
If you choose to sell an investment, and pay some tax as a result, you’ll need to earn even more on the next investment to make up for the capital lost to income taxes. Call this the “hurdle rate.” As a guideline, look for 2 to 3 per cent higher returns on the next investment than what you could have achieved with the current investment, to compensate for the taxes lost on the sale.
Next time, I’ll continue this discussion with a focus on more pillars of tax-smart investing.
Article: Globe & Mail
I was speaking to my good friend James last weekend about his son, who decided to make a trip to Las Vegas for his 19th birthday. As it turns out, his son is pretty good at Blackjack, and came back with double his money.
“Tim, I don’t know whether to laugh and celebrate, or cry,” James told me. “I’m glad my son didn’t lose all his money, and proud of the fact that he’s so good at Blackjack, but I’m not impressed that he took the entire savings in his in-trust account that we set up for him years ago.”
I think this is cause for a look at in-trust accounts.
You’ll know an in-trust account when you see one, by the name on the account. Most often, the account will be in the name of the adult “in-trust for” the child; for example: “John Doe in-trust for Bobby Doe.” Many parents or grandparents will set up an account like this for a child because there’s a desire to split income with the child. And for the most part, this can save tax. More on this in a minute.
Setting up an in-trust account can provide a vehicle for saving for an education, or for other purposes, and if the growth in the account over the course of time faces little or no tax, that growth can be much higher than if the parents were to keep the money invested in their own names.
There are some challenges with in-trust accounts. Three key issues, in fact. First, once your child has reached the age of majority there’s no guarantee you can keep your child from taking the money in the account and running. There’s a historic case called Saunders v. Vautier, which established that a trust can generally be wound up if the beneficiaries are of sound mind, have reached age of majority and want to wind up the trust.
As a practical matter, most parents assume their kids won’t recognize their right to wind up the trust, and that a little moral suasion would likely prevent junior from blowing the money on a trip to Las Vegas even if he did recognize his rights. Ultimately, most parents would likely respect the rights of their children if the kids did choose to wind up the trust. Just be aware that this is a possibility.
Next, you won’t be able to arbitrarily allocate the assets in the in-trust account to different children. If you’ve set up separate in-trust accounts for each child, you can’t steal from one to give to the other. Even if you’ve named more than one child as beneficiaries on a particular in-trust account, you can’t simply change the percentages allocated to each child. A formally established trust, with a written trust agreement, can provide greater flexibility here, but at a greater cost.
Finally, if you place assets into an in-trust account and name your spouse as the trustee (to avoid the attribution rules in our tax law – more on that below), what happens if your marriage breaks down? Your spouse will control the account. And if your spouse were to die, who would control the account after that? Perhaps his or her second spouse, or someone else named as executor over his or her estate. This may not be your intention.
As mentioned, an in-trust account can be used for income splitting. But you’ll need to avoid the attribution rules in our tax law, which can cause all of the interest, dividends, rents or royalties to be taxed in the hands of the person who transferred the assets to the account. You can avoid this attribution by avoiding those types of income and focusing on capital growth. Capital gains will not be attributed back and can be taxed in the hands of your children named as beneficiaries on the account. Also, income earned on Canada Child Tax Benefits, Universal Child Care Benefits and second-generation income (that is, income on income), won’t be attributed back to you.
Make sure that there’s a true transfer of the assets to the child, the transfer is irrevocable, and you’ve specifically named the beneficiaries on the account. If you’re the one who has transferred assets to the in-trust account, make sure a different adult (perhaps your spouse) is named as the trustee (that is, your spouse’s name should be on the account, in-trust for the child). If you don’t follow these guidelines, CRA could take the view that a trust doesn’t truly exist, and that you should pay all the tax on the income earned in the account.
Article: Globe & Mail
My son, Win, is a budding entrepreneur. He’s already asked me for money to help him start his latest venture: A cheese-sculpting business.
“Win, who in the world needs a very large sculpture made of cheese?” I asked. Evidently, thousands – according to Sarah Kaufmann, who started a thriving business with the tag line “So much cheese… so little time.” My son showed me her website. Very impressive.
“Win, I’m not going to fund your business, because you’ve never sculpted anything.”
“That’s okay, Dad,” he replied, “I’ve already started raising money online through crowdfunding. I’ve got $56 so far.”
“Well, son, good luck with that. And by the way, we should talk about the tax implications of crowdfunding.” Here’s a summary of our chat.
Crowdfunding seems to be taking the world by storm. It’s the idea of matching up people who want to raise capital for a particular purpose with those who are willing to provide it, using the Internet and social media to connect them. Most of the amounts contributed are small, but when you add the contributions of potentially thousands of people, it can be an effective way to raise quite a bit of money.
I’ve seen crowdfunding provide money for charitable causes, personal causes, music or other artistic productions, research, and to start businesses. Take Pebble Smartwatch, for example, which raised $10.27-million (U.S.) from 68,929 backers, or Oculus Rift, a virtual reality headset for gamers, that raised $2.44-million from 9,522 backers.
There are four popular crowdfunding models that you’ll typically find online:
-the lending model (backers offer interest-bearing loans to those looking for funding);
-the equity-based model (where investors take some ownership in the companies they choose to fund);
-the reward-based model (where backers give money to projects and get rewards in return, often in the form of a final product being produced, a discount or advance order of the product, or some other promotional reward);
-the donation model (where backers simply give altruistically to a project without anything in return – there are typically no donation receipts issued either).
The most common of these models has been the reward-based model. The equity-based model, however, is expected to have the greatest growth in the future.
In Canada, equity-based crowdfunding wasn’t legal in the past, but that’s changed. Today, as long as accredited investors make up the “crowd,” it’s possible to raise funds this way. Securities regulation is a provincial matter, and Saskatchewan was the first province to allow equity-based crowdfunding by way of a specific exemption. As an aside: If you’re looking to raise funds using an equity-based model you should consult with a local securities lawyer to understand the rules in your province. Check out the National Crowdfunding Association of Canada’s website for great information.
All of this raises the question: How will the Canada Revenue Agency (CRA) view the funds raised through crowdfunding?
The tax rules
The fact is, the taxman is still contemplating the taxation of crowdfunding. It’s a new concept and the CRA hasn’t said much about it yet, although the first guidance came last fall in the form of technical interpretations (letters to taxpayers who had asked for the taxman’s views). The CRA said that each arrangement must be looked at on its own merits, but that crowdfunding receipts could be treated as a loan, capital contribution, a gift, income, or a combination of these four – depending on the arrangement.
In the end, I expect that the tax treatment will very likely depend on what the backer, or funder, gets in return, which could be nothing (a donation model), a reward of some kind, a presale or advance access to a product, equity, or debt.
In the case of reward-based models, amounts received will generally be included in the income of the recipient as income from carrying on a business (if you’re in fact carrying on a business). The good news is that the recipient, in this case, will be able to deduct expenses incurred in connection with the crowdfunding campaign.
In equity-based models, the funds raised shouldn’t be taxable since they are paid as capital in the company, and in the case of lending models, the funds should not be taxable because they are loans to be repaid; the interest paid on the loans should be deductible.
A donation model is less clear; I expect amounts will be taxable as with a reward-based model if a business is carried on.
Article: Globe & Mail
I’m not sure if the story is true or not – but it makes for an interesting discussion. I’m talking about the gentleman who wanted to borrow $200.
“What collateral can you provide for the loan?” the banker asked.
“I own a Rolls-Royce and I’ll leave the car with you until I repay the loan. Here are the keys.”
The bank extended the loan of $200 and the man returned six months later, paid back the $200 plus $10 in interest.
“Sir, why would a wealthy gentleman like you borrow $200 from the bank?” the banker asked.
The gentleman looked at the banker and replied: “Where else can I store my car for six months for $10 while I’m travelling?”
The real question, of course, is this: Can the gentleman deduct the $10 interest charge he paid to the bank?
When it comes to saving tax dollars, the ability to deduct interest can make a significant difference if you’re paying more than just a little – which is the case with many Canadians. Today, I want to share some do’s and don’ts when it comes to deducting interest.
Paragraph 20(1)(c) of our tax law is the key provision that will allow a deduction for interest costs in certain situations. Specifically, the taxman will look at the purpose of your borrowing. To be deductible, the interest must relate to loans that were taken out for the purpose of earning income from a business or property. It’s important that you have a reasonable expectation of earning income at the time the loan proceeds are invested.
Now, it might be the case that you’ve used the borrowed money to invest and your primary objective is capital growth, not earning income. This is okay with the taxman as long as a secondary objective is to earn income.
It’s not necessary that the income you earn be more than the interest costs you’re paying in order to deduct those interest costs (I should mention that in Quebec, you won’t be able to deduct interest in excess of your investment income in a given year; excess interest can be carried back up to three years or forward indefinitely to be deducted in the future when income – including taxable capital gains – is earned. This is strictly a provincial rule and doesn’t apply to your federal tax filings or outside of Quebec).
There are a few other points worth noting here. First, interest is generally not deductible when you’re earning exempt income with the loan proceeds. So, if you borrow to contribute to your registered retirement savings plan, or tax-free savings account, for example, you won’t be able to deduct the interest. Similarly, borrowing to acquire a life insurance policy typically results in no deduction for the interest (although there are exceptions in the case of life insurance).
Next, the direct use of your borrowed money matters. The taxman will want to trace the use of your borrowed money to an identifiable income-producing use before a deduction will be allowed.
And it’s the current use of the borrowed funds that really matters. So, if you borrow to invest and then sell those investments, you can continue to deduct the interest if you reinvest the proceeds from the sale of the investments. Similarly, if you make a bad investment and it declines in value, you may be able to continue deducting your interest costs (for example, if you borrow to make a $10,000 investment, watch it decline to $7,000, then sell the investment and use the $7,000 to pay down the debt, the remaining debt will give rise to deductible interest).
Finally, be sure to keep your deductible borrowings separate from your non-deductible. Suppose, for example, that you owe $100,000 on a line of credit, and $40,000 of this was used for a deductible purpose, while the other $60,000 was not. You’ll able to deduct 40 per cent of your interest costs in this case. Now suppose you pay down that line of credit by $60,000, so that $40,000 remains owing. You’d likely want to argue that the $40,000 still outstanding represents the money borrowed for deductible purposes, so that you can deduct the full interest on the remaining $40,000. Sorry, but the taxman won’t allow this.
Any repayment on the line of credit will reduce both the non-deductible and deductible portions of the line of credit, so that you’ll still be able to deduct just 40 per cent of the interest on the remaining debt.
You can avoid this problem by having separate borrowings for deductible and non-deductible purposes.
Article: Globe & Mail
If you have kids or grandkids at the postsecondary level, you should both be aware of planning ideas and opportunities that can result in money in your pocket, or theirs. I want to share 10 ideas today:
1. Claim tuition and education credits.
A student is generally entitled to a tax credit for tuition paid, plus an education credit based on $400 a month of full-time ($120 for part-time) attendance in school.
If she doesn’t need the credits to reduce her taxes to nil, she can transfer up to $5,000 of these costs to a parent, grandparent or supporting spouse, or carry them forward for use in a later year.
2. Claim textbook and ancillary costs.
In addition to tuition and education credits, a student can claim a credit for books, student fees, parking and equipment. The credit is based on $65 a month for full-time ($20 a month for part-time) attendance in postsecondary school.
3. Claim an exemption for scholarships, fellowships and bursaries.
A student eligible for the full-time education credit and who receives postsecondary scholarships, fellowships or bursaries is generally exempt on those amounts required to support the student in the program. Go to cra-arc.gc.ca and look up instructions for Line 130 of your tax return for more details.
4. Claim student loan interest.
If the student receives a qualifying loan under the Canada Student Loans Act or similar provincial legislation, he should be entitled to a tax credit for interest on the loan. He should receive an official slip to support the claim.
5. Claim moving expenses.
A student can claim moving expenses if the move to school, or home again, is at least 40 kilometres.
He’ll have to earn income (which can include taxable research grants or other awards) in the new location to claim the expenses. Holding down a part-time job while at school can create the income needed to deduct the costs of moving to school.
6. Claim public transit costs.
A student may be able to claim a tax credit for the costs of public transit to get to and from school. The cost of monthly (or longer) transit passes for travel within Canada can be claimed.
These passes must permit unlimited travel on local buses, streetcars, subways, commuter trains or buses, and local ferries. Passes of shorter duration can be claimed if certain conditions are met.
7. Claim child-care costs.
A student (or her spouse) may be entitled to claim a deduction for child-care costs where at least one spouse attends school full- or part-time.
8. Don’t consolidate student debt.
Many students graduate with various types of debt (credit cards, student loans, car loans, etc.) and often roll them into one single loan payment at a more attractive interest rate. Generally, it’s a bad idea to consolidate student loans that qualify for the student loan interest credit. You’ll lose the credit by consolidating.
9. Consider the Lifelong Learning Plan (LLP).
If you’re an RRSP owner, and a resident of Canada, you can generally withdraw funds from your RRSP on a tax-free basis for full-time education for you, or your spouse or common-law partner (but not the kids – sorry). You can withdraw up to $10,000 a year for up to four years, but to a maximum of $20,000 in total. After you’ve withdrawn $20,000, you have the option of repaying your RRSP and then making further withdrawals. Failure to repay the amounts in accordance with the CRA’s schedule can mean paying tax on the withdrawals.
10. File a tax return.
Although a student may not be required to file a tax return if she doesn’t have tax to pay, it makes good sense to file anyway if she has earned any income at all. The reason? She’ll create RRSP contribution room this way (for use later when she’s earning an income), and filing a tax return could entitle your child to a GST or HST credit worth about $268 in cash once she’s 19.
Article: Globe & Mail
Our youngest son decided that he wanted to earn some money. Like a true entrepreneur, he started his own business: He sold golf balls at a public beach near our cottage. “Dad, this business is amazing! I sold 55 golf balls, and I made $53. The kid next door still owes me two dollars.”
What he didn’t remember was that he owes me $80 for the two rounds of golf that allowed us to find the 55 golf balls. So I explained to him the concept of debt. At the end of the day, I told him that he doesn’t have to pay me back the $80 until he graduates from university – about 12 years from now. By that time, I’m sure I will have forgotten about the money. Time will tell whether he forgets, too.
The truth is, over one half of students will graduate from postsecondary school with debt – primarily from financing their education. A recent poll conducted by Leger for CIBC reveals that 51 per cent of postsecondary students today have borrowed, or will borrow, to help pay for school. No wonder. About three quarters of students won’t earn enough money in their part-time work to fully pay for school.
The last National Graduates Survey conducted by Statistics Canada was almost 10 years ago (2005). At that time, the graduating class of 2005 had an average debt load of $18,800 (which was up from $15,200 a decade earlier), and the proportion of borrowers who graduated with debt of $25,000 or more had increased to 27 per cent (up from 17 per cent 10 years earlier). According to the recent Leger poll, 40 per cent of students today expect to graduate with debt of at least $25,000. So the trend is clear: Students are borrowing more to cover the increasing costs of postsecondary education.
As an aside, student debt can really impact finances after graduation. A past Survey of Financial Security conducted by Statscan showed that student borrowers had a significantly lower probability of having savings and investments than non-borrowers, and that borrowers with postsecondary education were less likely to own their homes. Finally, postsecondary graduates with student loans had, on average, lower assets and correspondingly lower net worth than those who did not have student loans.
Don’t get me wrong – student debt can be worthwhile if it allows a student to create higher earning capacity. But the debt needs to be managed. Here’s some advice for students who want to borrow prudently for an education (some of these ideas come courtesy of Consolidated Credit Counseling Services of Canada):
Rule of 10s. Follow this rule when borrowing for education: For every $10,000 in student debt, you should be able to earn $10,000 over a base of $10,000 annually to be able to pay off that debt in 10 years. For example, if you graduate with $30,000 of debt, you should be able to earn $30,000 over a base of $10,000, for a total of $40,000 annually in order to pay off that debt over 10 years.
Soften the blow. Although you may not earn enough in the summer to fully pay for a year of education, those earnings can make a big difference. You should save as much as possible, and consider working part-time during the school year to help cover education costs. But balance your work hours; it’s tough to work more than 15 hours a week while in school and still excel academically.
Create a budget. You should use loan proceeds wisely. Identifying needs and wants will help, and vow to spend student loans only on needs. Don’t spend your loans on a trip to Mexico.
Live lean. Most students in their late teens and early 20s don’t have other mouths to feed, so take advantage of this time in life. Live frugally. If you can get by without a car, do it. You’ll live with monthly bills most of your life, so avoid them now if you can.
Apply for bursaries and scholarships. Getting free money beats borrowing any day. Start the search for bursaries and scholarships a year ahead of the time you’ll need the money.
Pay it back. After graduation, be sure to reduce your debt as quickly as possible. Start with any credit-card debt (since there is rarely relief for interest on credit-card debt), then follow that by paying down your student loans (you’re generally entitled to a tax credit for student-loan interest). Make more than the minimum payment monthly if you can.
Article: Globe and Mail