Change in the Taxation of Personal Services Businesses
John Wright, CA, CMC
Draft legislation was released at the end of October that, if passed, would result in major changes in how personal services businesses are taxed. The tax rate on income earned in these companies would increase by 13% for fiscal years beginning after 2011. The shareholders of personal service businesses are sometimes described as "incorporated employees". If they were not incorporated the shareholder would usually be considered an employee of another organization. Usually the personal services business has a long-term contract with one organization. Personal services businesses are already ineligible for the small business deduction. The draft legislation will also deny them the general rate reduction. On top of that these businesses will continue to be limited in terms of what types of expenses are deductible for tax purposes. They are restricted to those an employee would normally be allowed to deduct. As a result of the proposed changes personal services businesses will generally not be effective from a tax deferral or income splitting perspective after 2011. But contractors are required to be incorporated in order to work with some organizations. Care should be taken to include clauses that are beneficial to the contractor from a taxation point of view. For all of these reasons we recommend that taxpayers who are earning income through incorporated personal services businesses consult with their tax advisors.
Contributions to “Children’s” Tax Free Savings Accounts
We have something else to share with you regarding TFSA's that has to do with parents funding their children's accounts. Some parents are contributing to the TFSA's of their children (who must be 18 or older to have a TFSA). The Canada Revenue Agency has made it clear that the funds must come from the person who holds the TFSA. If you would like to fund your "child's" TFSA contribution, be sure to gift him or her the funds so that they can be transferred from his or her own bank account to the TFSA. We know that this seems like an unnecessary extra step but it is important to follow the rules so that you can be certain that the TFSA will continue to be considered valid by CRA . If it is no longer considered valid then all of the income earned in the account will be considered taxable.
Last year we posted a blog on Tax Free Savings Accounts, or TFSAs, to explain how they worked and why you should have one.
This year we would like to update you on two items related to TFSAs.
One item relates to naming a beneficiary or a successor account holder for your TFSA. Many financial institutions did not have a form ready for the first wave of TFSAs. You should ask your financial institution if they have a signed form on file for you. If they don't then you should obtain a form and complete it so that the TFSA can be transferred to your spouse or adult child without any tax ramifications. If you do not name a successor account holder or beneficiary then the TFSA will lose its tax-exempt status when you die.
The other item relates to the 72,000 letters CRA sent to taxpayers who over-contributed to their TFSAs in 2009. CRA is prepared to show leniency for 2009 because it was the first year for TFSAs and many people who over-contributed did not do it intentionally. For example, they may have over-contributed because they did not realize that withdrawals do not increase TFSA room until the next tax year. So they might have withdrawn $3,000 in 2009 and then replaced the $3,000 later that year instead of waiting until 2010.
If you received a letter about an over-contribution you need to respond to the letter with an explanation; otherwise you will be subject to a penalty plus interest charges of 1% for each month of your over-contribution. If you have already received a TFSA Notice of Assessment that includes an over-contribution, please be sure to contact us about filing a Notice of Objection so that we can request that the penalties and interest be reversed. There is a time limit for filing Notices of Objection so it is important that you inform us about your TFSA Assessment sooner rather than later.
This blog entry is about a tax-saving & deferral vehicle that is sometimes overlooked in will planning called testamentary trusts. The topic of today’s discussion is the type of trust that is created after death according to the deceased’s will.
Testamentary trusts are taxed differently than other trusts. All trusts are taxed as individuals, not as corporations, with some exceptions. For example, many refundable tax credits are not available to trusts. Fortunately the dividend tax credit and the donation tax credit are available to trusts.
What’s especially good about testamentary trusts compared to other trusts is that they are taxed at the graduated tax rates. Other trusts are all taxed at the highest tax rate.
So if you establish multiple testamentary trusts then your estate can benefit from the lower tax rates with each trust. Depending on the income the trust earns, tax savings of up to $17,500 per year per trust is possible. You can create a trust for each beneficiary. It might be possible to create trusts for combinations of beneficiaries as well. So if you have two heirs the maximum number of trusts might be two or three: one for each beneficiary; and possibly one trust for both beneficiaries.
Another way that testamentary trusts are different from other trusts is that they can have any year-end, not just December 31st. By having a year-end early in the calendar, tax can be deferred for the better part of a year.
Another tax benefit is that testamentary trusts do not need to make installment payments.
There are many reasons for creating testamentary trusts in addition to the potential tax savings. You might want to preserve capital for your children from an earlier marriage. Or you might want to use trusts if someone is incapable of handling their financial affairs for any number of reasons such as age, illness or addiction. Setting up a trust for charity is another option. Or you might want your capital to be distributed to your heirs gradually.
All of these are good reasons for considering the use of testamentary trusts in estate planning.
What qualifies for the principal residence tax exemption and how the exemption works
The principal residence tax exemption is an issue that we are frequently asked questions about. Often we’re asked about what qualifies and how the exemption works.
Generally any habitation qualifies. It can be a house, a cottage, a mobile home or even a houseboat. Plus about an acre and a quarter of land. More land might qualify depending on the circumstances.
This is how the exemption works:
If you own only one residence and you’ve ordinarily lived in it at least part of every year since you bought it, a capital gain will be exempt from taxation.
Another common situation is when two residences are owned by a couple, say a condo and a cottage. When they sell the cottage they will need to estimate the capital gain on the other residence as well so that they designate the residence with the higher appreciation in value as their principal residence. If the gain will be higher on the cottage and it was ordinarily inhabited on a regular basis every year then they can deem the cottage as their principal residence and be exempt from paying taxes on its capital gain.
But if they had previously sold a house, say before they bought the condo, and the house had been claimed as the principal residence, then only the increase in value of the cottage since the housewas sold would be exempt.
If a residence was owned prior to 1982 the situation is more complicated because before 1982 both spouses could designate a residence as a principal residence; in effect a couple could have two principal residences at any point in time.
Here are a few more situations where you should obtain some professional advice:
If there will be a change in use, such as converting an income-producing property to a principal residence;
If a couple is separating or divorcing; and
If you are purchasing a residence such a vacation home and you have children over the age of 18 you may wish to explore some tax planning opportunities.
We hope you’ve found this discussion about principal residences useful.
You’ve probably been seeing a number of ads and articles about Tax Free Savings Accounts. That’s a good thing because most Canadians should have one.
This blog entry outlines why Tax Free Savings Accounts are beneficial and how they work.
The main reason for putting savings in a TFSA is that they are an easy way to earn tax-free investment income. Once you open a TFSA you can deposit up to $5,000 each year. Any interest, dividend or capital gains you earn can be withdrawn at any time and you won’t have to pay tax on this investment income. That’s why they are called Tax Free Savings Accounts.
When you deposit money to a TFSA you won’t deduct your deposit from your income on your tax return like you do with a RRSP contribution. But when you withdraw money, whether it is the money you deposited or the income it earned, you won’t need to report it on your tax return as taxable income. Also, after you withdraw money you can re-deposit it in the next calendar year (plus the $5,000 for that year).
Some other things you might like to know about TFSA’s:
You don’t need $5,000 to start a TFSA.
You can start it any time after January 1st 2009 if you are 18 years old or older.
You can contribute to your spouse’s TFSA without any tax ramifications to you.
If you deposit less than $5,000 in one year then you can add the amount you didn’t deposit to your $5,000 limit for the next year.
You can use your TFSA to save for whatever you want: a car, a house, a renovation; or a once-in-a-lifetime vacation.
In my opinion, if you're saving any money for any reason at all you should seriously consider opening a TFSA.
