In its original form, initiative was an email periodical which had about a 200 word count base text, complemented with a graphic to show connections, flows or other dynamics, including labels and other supplementary text. Those graphics were not compatible with later technology, so only the original base text has been preserved for the present archiving purpose. The material was current to the year and month of issue (Vol#,No#) but is not a legal opinion.
Vol.1. Vol.2. Vol.3. Vol.4. Vol.5. Vol.6. Vol.7.
Volume 5
Last year Client purchased the 30 yr-old business of her mentor; he offered to stay on to assist his successor.
Unfortunately, the arrangement is not working out as planned and Client is seeking a way to diplomatically break ties with her mentor – professionally and financially.
This may be an ideal situation for a retiring allowance.
From the Client-employer standpoint, as long as the amount of the allowance can be justified in the context of the employment relationship, the amount is tax-deductible.
On the receiving end, some or all of the amount may qualify for mentor to make a bonus RRSP contribution, as follows:
Base maximum is $2,000 for each pre-1996 service year
For each pre-1989 service year during which the employer did not contribute to an RPP or DPSP, an additional $1,500
Direct deposit to the RRSP by the employer will bypass the need for withholding tax
Unused sick credits may qualify, though that is unlikely in this situation
Transfer to recipient’s RRSP or RPP must occur within 60 days after the end of the year of receipt
Client-couple have had a ‘traditional’ family home with husband working full-time and wife mostly ‘stay-at-home’. Husband is retiring next year and the couple is looking for ways to reduce their household tax bill.
One simple option may be for the couple to share their Canada Pension Plan retirement benefits. Both pensions must be shared and therefore this is only effective where there is a disparity in the entitlements.
Some keys to this type of legally-sanctioned income splitting:
It is available to both common-law partners and legally married spouses
If only one spouse-partner is entitled to a pension, sharing can still occur if the other spouse-partner is at least age 60
The sharing scheme can integrate with provincial pension plans if the province permits it
The shareable portion is calculated is a ratio of cohabitation period to CPP contributory period.
Sharing commences once an application is approved — Past receipts cannot be retroactively taxed to a spouse-partner
Sharing may terminate upon written request (reinstateable on further mutual written request) or upon certain life events such as death, separation, divorce, and change in contributor status
While a private corporation enjoys tax advantages that allow it to earn and grow business income, that same corporation is an imperfect vehicle for the storage of that wealth, and can often penalize the shareholder/owners.
Client’s small business corporation has indeed generated excess cash, and he has now engaged Advisor to suggest investment alternatives for the company.
A significant concern is the imposition of the 26.67% refundable tax on non-active income (essentially investment income) that must be deposited with CRA.
The CRA deposit is tracked in the corporation’s refundable dividend tax on hand (“RDTOH”) account. To retrieve the RDTOH, the corporation must declare and pay taxable dividends to its shareholders: $1 returned for each $3 paid.
A key benefit that tax-exempt life insurance can offer to a small business corporation is insulation against RDTOH leakage. Money invested in an exempt policy not only escapes annual taxation, but also bypasses the associated mandatory deposit to CRA’s refundable tax account — meaning that more of that excess cash remains invested.
Client understands that insurance premiums may be less costly if the insurance is owned and paid corporately rather than using net after-tax funds to pay at the personal level.
Still, he is concerned that this may result in a tax hit when the proceeds are paid, and he has asked Advisor to clarify.
Indeed, certain tax-free corporate receipts such as life insurance may be flowed through tax-free to shareholders via the corporation’s capital dividend account (“CDA”).
A private corporation receives life insurance proceeds as a tax-free receipt to the corporation.
Its CDA credit is equal to the gross insurance proceeds less the corporation’s adjusted cost basis (“ACB”) of the policy.
Where the originating policy is not owned by the corporation itself, the ACB reduction will not apply, meaning that the CDA credit will be equal to the gross insurance proceeds.
A common strategy used to distance the corporation from the policy is to have an associated corporation own the policy, though one must be careful that this is not the sole purpose of the latter corporation, else CRA deem this an avoidance transaction using GAAR.
Client’s elderly mother prepared a Will some years ago, leaving the residual estate property – presently about $600,000 – to be shared equally between Client and her brother. Just this last year, mother gave brother $200,000 for the down payment on the purchase of a house.
Client has inquired with Advisor whether this may affect the Will distribution.
While there is no definitive answer, the likelihood is that the down payment falls within the rule against double portions, or “hotchpot”.
Under this equitable rule, it is presumed that when a child receives a substantial payment (relative to the size of the estate), it is an advance of a Will inheritance. The rationale is that a parent is presumed to wish to treat children equally, though this presumption is rebuttable based on the facts of the case.
If the issue threatens to cause some family angst (now or after mom dies), Client may wish to suggest that mother speak to her lawyer about incorporating a ‘hotchpot clause’ in a revised Will. That way mother will be able to explicitly state how any such gifts are to be treated.
Client has a $2.5M stock portfolio, a substantial portion of which is leveraged through bank loans.
She has a mentally disabled adult son who will be her sole heir. His inheritance is to be held in trust as directed in her Will, with her nephew as trustee managing son’s affairs.
Client’s problem is that, for the probate tax calculation, the only allowable deduction against gross assets is indebtedness against real estate. In her case the debt is against personal property, and therefore the portfolio will give rise to $35,000+ probate tax.
One option for Client is to create a corporation to house some of the portfolio and related debt. In that way, probate tax would be levied on the net value of her shares (ie., corporation value equals portfolio minus debt), rather than the gross value of the portfolio alone.
Of course, there are costs involved in establishing and maintaining a corporation, not to mention the legal and tax issues of holding an incorporated portfolio.
Still, it is worth Client’s time to meet with her investment advisor, accountant and lawyer to come up with a solution that fits her unique requirements.
Client-couple are retired in their late-60’s, with reasonable pension and other assets to sustain their lifestyle.
They have a GIC portfolio for play money to buy gifts for their grandchildren, and intend to pass on that portfolio to those grandchildren after the second of them dies.
They have approached Advisor with a challenge to achieve two apparently conflicting goals:
Produce higher returns without increasing risk, &
Guarantee the principal for the grandchildren’s inheritance
While Advisor will want to be certain through a financial planning review that indeed the targeted money is surplus to these Clients, this appears to be an ideal situation to employ an insured annuity strategy:
Re-allocate a portion of an interest-earning portfolio into a ‘prescribed annuity’.
The annuity pays a higher annual dollar-figure relative to a comparable interest-based investment, and is taxed more favourable in comparison to interest income.
Part of the excess income is used to fund a life insurance policy to replenish to the estate the funds committed to the annuity
The anticipated net income yields a higher return, with guaranteed annual income and guaranteed inheritance value
The strategy is flexible enough that it can be done individually, or on a joint-last death basis.
Client is the shareholder of a small business corporation that has become a cash cow in his winding-down years.
Client is aware of the high tax rate on passive (investment) income, and the related RDTOH (see Vol.5, No.3), and has asked Advisor to devise a strategy for more effective management and withdrawal of that corporate cash.
In consultation with Client’s legal, tax and accounting counsel, Advisor may wish to suggest the use of a corporate insured annuity strategy.
For a qualified corporation – The non-prescribed annuity income will be sufficient on an after-tax basis to pay insurance premiums that will replace the capital committed to the annuity, and still enable larger annual dividends
For a shareholder – The greater corporate income in turn means that larger dividends will be distributable annually, without increasing investment risk
For a shareholder’s beneficiaries (particularly the spouse) – Rather than having to pay full tax on a wind-up distribution, the corporation receives life insurance proceeds tax-free, and may in turn distribute some or all of those proceeds tax-free
An elderly grandmother wishes to provide that an inheritance to a young grandchild be used for post-secondary education. She has asked Advisor how she can be sure that the money is not instead frittered away.
While she will simply pay the costs herself if she is living at the time, she can use her Will to settle a testamentary trust to assure her wishes will be fulfilled in her absence.
As long as the terms of the trust are not illegal or immoral — and we are talking about education here — then she has great latitude in how the trust will be managed:
Distribution could be delayed until one or more dates after the age of majority
Prior to those dates, the trustee can be empowered to encroach on capital if it would be in the child’s best interests
The trustee could pay costs directly to the institution, just to make sure it doesn’t get diverted into a less education-related purpose — like a sports car — on the way to the registrar
Grandmother could even use a reward system to accelerate the inheritance based on achievement
If the grandchild does not enter or continue in school, Grandmother could have an alternate beneficiary altogether. More likely, the distribution will simply be delayed until one or more later dates — and this alone may be an incentive for grandchild to enter & complete school.
Client-couple, both professionals, equally contribute to a jointly-owned $500,000 investment portfolio.
While the joint ownership structure assists in avoiding probate and simplifies estate transfer at a first death, they are aware that the portfolio is exposed to either of their potential creditors.
They have asked Advisor if there is a way to achieve a variety of goals — probate avoidance, creditor protection, and tax-effective spousal transfer & estate succession.
Here is a simple alternative Advisor may wish to suggest:
Sever the joint ownership and maintain two distinct portfolios
Hold the new portfolios in segregated funds
Name one another respectively as beneficiaries, thus
Avoiding probate and estate creditors on first death
Obtaining lifetime creditor protection pursuant to the Insurance Act
Enabling capital cost rollover on a first death
If the couple has children, they may wish to modify this structure so that the children are contingent beneficiaries, thus extending creditor protection and probate avoidance on past the second death. If the children are minors, insurance trusts may be used within the structure to maintain the mentioned benefits, while extending control and tax-effectiveness of the estate well into the future.
The central tax feature of RRSPs/RRIFs (and their locked-in variations) is that they provide tax-sheltering during the life of the plan holder, with any withdrawals being taxed annually as regular income.
At death,
There is a deemed disposition of the entire plan
The plan value is added to the deceased’s income that year
The estate and the plan beneficiary are jointly liable for the tax
Apart from the obvious emotional loss, this deemed disposition at death visits upon a family a tax hit at an otherwise very financially vulnerable time:
A principal financial provider has been lost
A key tax-sheltered savings/income source has been disposed
The forced lump sum receipt often causes the deceased to be taxed at a higher marginal rate, resulting in a lower realization of the plan’s spendable value compared to a controlled disposition
Fortunately, the income and associated tax bill can be recognized in other hands and/or deferred where certain family members are named as beneficiary of the plan:
A spouse
A minor child or grandchild
A disabled dependent child or grandchild
The next three issues of initiative will look at the options that may be available in each of these circumstances, and where it might be preferable not to exercise such options.
When a “qualified beneficiary” is named to receive registered funds (either directly, or possibly via the deceased’s estate), some or all of the income recognition (and related tax imposition) can be in the hands of a lower-tax beneficiary rather than in a high-tax terminal return.
A “qualified beneficiary” is a:
Spouse, being either a legally married person or a common law partner. A common law partner is a person with whom the annuitant lives in a conjugal relationship, and such person:
Has been so living for at least 12 continuous months
Is the parent of the annuitant’s child by birth or adoption, or
Has custody and control of the annuitant’s child, and the child is wholly dependent on that person for support
Financially dependent child or grandchild, being a person whose income is less than the basic personal amount for income tax filing purposes ($8,012 for 2004)*
Physically or mentally infirm child or grandchild, who is financially dependent, being a person whose income is less than the prescribed annually indexed amount ($14,035 in 2004). It may also be possible to establish financial dependence in a fact-specific appeal to CRA where income exceeds these amounts
The Canada Revenue Agency specifically intends that this scheme be used to enable people in such situations to pay the least amount of tax the law allows.
Next month’s initiative will look at how the qualified beneficiary may further defer tax on the received funds.