CH 4 - TAXATION FOR INDIVIDUALS Flashcards
How or what does CRA consider to determine if a person is an employee or self-employed tax payer ?
To determine the difference, CRA considers the
relationship between the individual and the income source (form), plus various other factors (substance).
What are the several factors that CRA considers to assess the substance of the client’s self employment relationship ?
- What level of control does the income source have over the worker’s activities?
- Are tools and equipment provided by the income source?
- Does the worker have the autonomy to hire or use assistants?
- What degree of financial risk does the worker undertake?
What degree of responsibility for investment and management does the worker undertake? - Are there any other relevant factors?
- What is the level of integration of the worker in the business?
What is CRA’s definition of business activity ?
CRA generally defines a business as an activity conducted for profit, or reasonable expectation of profit,
to distinguish it from a hobby.
*[However, there is no specific criteria regarding size or frequency of business transactions, which may be for minimal amounts or earned sporadically.]
What does CRA look for determine if your client’s business has a reasonable expectation of profit ?
CRA considers various factors, including
gross income and profit and loss reported in recent years. The time to reach profitability should be relevant to the
business activity, which should also be comparable to similar businesses.
[CRA also looks at the amount of time
clients spend on the business activity, their qualification and eligibility in the profession, and their efforts and plans
to earn a profit.]
Are non-residents required to report any net business income earned outside of Canada ?
No, Nonresidents, are only required to report on their Canadian tax return any net business income earned within
Canada.
What does CRA require when it comes to accounting methods ?
CRA requires that all businesses use the accrual method of accounting to report income and expenses. However,
farming and fishing businesses are exempt; they can use the cash basis of accounting, if preferred.
What is the accrual method of accounting ?
The accrual method of accounting requires the taxpayer to record income and expenses in the period it is incurred,
not necessarily paid.
Must clients also use the accrual method to record inventory ?
Yes, Clients must also use the accrual method to record inventory and to determine the value of expenses for items that
are sold. CRA allows business inventory to be recorded at the cost or market value, whichever is lower.
What type of business can use the cash basis accounting method ?
clients who operate a farming or fishing business can use the cash basis of accounting, if preferred.
[Therefore, they record income when they receive it and deduct expenses in the period in which they are paid. However, capital assets (e.g., major fishing or farming equipment) are only deductible through the capital cost allowance (CCA) system. Farming and fishing businesses that use the cash basis of accounting may have fluctuating net business income (or losses), based on the varying cash flows in and out of the business].
What are the many different forms of Farming income activities ?
- Soil tilling
- Livestock raising or showing
- Racehorse maintenance
- Poultry raising
- Dairy farming
- Fur farming
- Tree farming
- Fruit growing
- Beekeeping
*Cultivating crops in water or hydroponics - Christmas tree growing
- Operating a wild-game reserve
- Operating a chicken hatchery
- Operating a feedlot
What are the other circumstances that CRA may also allow farming income to be earned ?
- Raising fish
- Market gardening
- Operating a nursery or greenhouse
- Operating a maple sugar bush, including the activity of maple sap transformation into maple products (only if
this activity is considered incidental to the basic activities of a maple sugar bush, such as the extraction and the
collection of maple sap, which are farming activities)
Does CRA allow raising animals to eventually be sold as pets to be considered farming income ?
No, CRA will not allow farming income earned from raising or breeding animals, fish, insects, or any other
living thing to be sold as pets.
What many different fishing activities that earn income be considered income by CRA ?
*Salt water fishing (boat owners with crewshares)
* Salt water fishing (boat owners without crewshares)
* Salt water fishing (sharesmen)
* Freshwater fishing (boat owners with crewshares)
* Freshwater fishing (boat owners without crewshares)
* Freshwater fishing (sharesmen)
* Animal aquaculture
* Sale of fish, shellfish, crustaceans, or other marine products
CRA may also allow fishing income earned from the following sources ?
- Grants
- Credits
- Rebates
- Subsidies
- Compensation for loss of fishing income or property and other income
[income earned by an employee of a fishing business is not considered self-employed fishing income].
What is the portion of farming loss that cannot be deducted ?
(Formula).
$2,500 + [50% (actual farming loss – $2,500)
or
$17,500
What must your client consider to determine if an exepense is deductible ?
*Income earning and reasonable
* Capital
* Exempt income
* Reserve
* Personal expense
list the typical business expenses of items that may not be fully (or even partially) deductible for tax purposes ?
*Interest or penalties paid to CRA
* Use of recreational facilities
* Club membership fees
* Political and charitable contributions.
* Allowance for automobile. 58cents on the first 5km, & 52 cents on each km after.
* Meals and entertainment
* Business vehicle -max of $800 per mth for leased vehicle, $300/mth of interest cost for financed vehicle.
* Work space in the home
Expenses normally allowed for deducations ?
*CCA
* Incorporation costs
* Interest on capital assets
* Landscaping
* Reserve for bad debts
* Convention expense
What is the CCA system?
This is the treatment of capital costs, namely depreciation of a pool of assets?
What is UCC ?
Undepreciated Cost of Capital. this is the balance of the capital cost left in each pool for further depreciation at any given time.
What is a terminal loss?
Arises at the end of the year when there is a positive balance remaining in the CCA pool, and when
there are no assets left in the CCA class.
[Essentially, a terminal loss occurs when the taxpayer has not claimed enough CCA. The asset is worth less upon sale
than is left in the pool; therefore, the client gets to expense the remainder, since no other assets are left in the class.]
What is recapture of CCA ?
A recapture of CCA arises at the end of the year, when upon the disposition of an asset from the pool, the entire
pool goes into a negative balance.
[Recapture often occurs when a client disposes of a capital asset at a capital gain. However, the nature of assets
that are subject to CCA is that they are depreciable assets that are “consumed” in the business earning process.
Therefore, for assets such as buildings, your clients must also check if there is a capital gain upon disposal. In some
cases, disposition of a building can trigger both a capital gain and a recapture. Only 50% of the capital gain is
subject to tax, but the full amount of recapture is included in business income.]
What are the CCA deductions for a personal residence ?
When your clients use a portion of their principle residence to earn self-employed income, they may claim expenses related to that portion to reduce taxable income. CCA for that portion may also be included in the deductions. However, this portion becomes an expense to earn taxable revenue and may not be included in the calculation of the principle residence exemption upon the disposal of the principle residence.
Can a sole proprietor of a business pay a salary to a spouse or other family member ?
A sole proprietor of a business or a partner in a partnership can pay a salary to a spouse (or other family member) in
exchange for services. The salary is treated as a deductible business expense and is included in the calculation of net
business income of the sole proprietor or partner.
Why might a sole proprietor use income splitting ?
[transferring/Income Splitting through a Sole Prop.]
To reduce their net business income -with it being a deduction, but still have the income provided to the family member.
[The salary paid has to reasonable for the services provided].
If the business expense for splitting income is denied. Does the family member still have to pay tax on what they receive ?
Yes, they still do. They also are allowed to contribute to CPP and that salary is earned income that generates contribution room.
How can one income split if the client owns a corporation ?
[transferring/Income Splitting with a Corp.]
By issuing shares to the family members.
Shareholders & Managers of a corp can also transfer income by paying wages, salary or directors fees, or by issuing a dividend.
What two key issues must be considered to pay a salary to a family member ?
1) The spouse must actually work for the business. Ideally, a job description should outline the nature and scope of
the family member’s employment tasks and responsibilities.
2)The salary or wages must reflect the fair market value that would be paid to anyone else performing a similar
job.
What is the main benefit of using paying a dividend to a family member for income splitting ?
They payment amount can be varied year to year.
At what rate is Tax on Split income (TOSI) for dividends paid to a family member charged ?
The highest Marginal Tax Rate.
Who is income splitting allowed with through a corp ?
- The spouse of a business owner who is age 65 or older
- Adults who are age 25 or older and hold a 10% voting share in a non-professional corporation that earns less
than 90% of its income from services - Adults who are age 18 or older and have averaged 20 hours per week of work in the business during any of the
five previous years
Why is it important to have both spouses listed as a shareholder for a qualified small business corp ?
Because that way both will be eligible for the lifetimes capital gains exemption.
LCGE -which can allow them to claim up to $900,000 in Capital gains upon disposition or transfer of the business.
[They can consider an estate freeze if it has appreciated beyond this point].
Income splitting is allowed only with the following parties ?
- The spouse of a business owner who is age 65 or older
- Adults who are age 25 or older and hold a 10% voting share in a non-professional corporation that earns less
than 90% of its income from services - Adults who are age 18 or older and have averaged 20 hours per week of work in the business during any of the
five previous years
What are TOSI rules trying to prevent ?
Income Sprinkling
[an attempt to lower your tax burden]
What is a partnership capital account ?
A partnership capital account is a distinct account showing the equity in the partnership that each specific partner
owns.
[This account typically exists as an item shown in a business’s financial and accounting records, rather than
as an actual bank account.]
Do partnerships pay income or file an income tax return ?
No, they don’t. Instead each partner files an income tax return to report their share of the partnership’s net income or loss.
[Each partner is entitled
to a share of the profits or losses of the business, and the business profits are usually divided among the partners
based on the partnership agreement]
What transactions are typically recorded in a partnership capital account ?
- Initial contributions by partners to the partnership
- Subsequent contributions by partners to the partnership
- Profits and losses generated by the business and assigned to partners, depending on the percentage of
ownership or partnership agreement - Distributions, earnings, and payments made to the partners
The ACB of a partnership account is increased or decreased by the following factors ?
- Contributions of capital or original cost of unit (or both)
- Plus, share of income from all previous periods
- Minus, partner drawings
- Minus, share of losses from all previous year
What are the deductible expenses in the calculations of Net Rental Income?
*Mortgage interest
* Property taxes
* Condo fees
* Advertising
* Insurance
* Management and administration fees
* Office expenses
* Prepaid expenses
* Professional fees (includes legal and accounting fees)
* Property taxes
* Repairs and maintenance
* Salaries, wages, and benefits of employees who help with the rental property
* Travel
* Utilities
* Interest and bank charges
* Motor vehicle expenses for travel related to the rental property
* Other rental expenses
What is a current expense?
A current expense tends to occurs regularly and does not have a lasting benefit—usually, less than one year.
[painting the rental property]
What is a capital expenditure ?
A capital expenditure has a lasting benefit to the property and usually lasts longer than one year. A capital
expenditure tends to improve the property beyond its original condition.
What are the general rules around claiming CCA for a rental property ?
You can not depreciate the land. Land is not a depreciable asset
When it comes to taxation for the deceased, what is a clearance certificate?
A clearance certificate certifies that all amounts for which the client is liable, or can reasonably be expected to
become liable, have been paid.
[Therefore, by failing to obtain a clearance certificate, the legal representative can be
held personally liable for unpaid amounts, whether assessed before or after the actual distribution of property.]
What does obtaining a clearance certificate achieve ?
- It confirms that the estate of the deceased client has paid all taxes, interest, and penalties owing.
- It allows the legal representative to distribute the assets without any personal responsibility from any amount
owed by the corporation. - It allows CRA to identify the legal representative of someone who has died or a trust or corporation that has
wound up or dissolved.
What are the exceptions for when a clearance certificate is not needed ?
One exception is when the estate or trust continues to exist and pays income to the beneficiaries. In another instance, the corporation’s assets may be rolled over into another corporation, which means that there is no tax liability.
Alternatively, the estate or corporate account has enough funds to pay the amounts owing to CRA.
What is a “Valid release from the Beneficaires” ?
- Valid release from beneficiaries—An estate administrator may send accounts to a beneficiary for approval. This
involves sending a package to the beneficiary that generally includes, a cover letter identifying the enclosed
statements, account statements, and a release (or other approval) form for the beneficiary to sign stating that
the accounts and the estate administrator’s compensation meet all approvals. The signed release form frees the estate administrator from liability.
What is the application to the court for passing accounts?
In the passing of accounts, the estate administrator obtains
approval from the court for all accounts. Although this is not a requirement for all estates, the administrator can
reduce liability by choosing to make the application.
Which accounts typically would be involved in the passing of accounts ?
The estate includes minor beneficiaries.
The estate includes mentally incapable beneficiaries.
The estate includes contingent beneficiaries or some beneficiaries have not been determined.
A beneficiary of the estate challenges the actions of the estate administrator.
A beneficiary of the estate challenges the handling of accounts by the estate administrator.
A beneficiary obtains a court order to force the passing of accounts.
How are the assets of a deceased person treated at death tax wise, i.e. deemed disposition ?
- Personal use assets—Personal assets such as cars, furniture, or personal effects often decline in value over time,
but capital loss cannot be claimed on personal use assets. - House—The principal residence of the deceased client may be a house or other real property that the client
normally inhabited (e.g., a cottage). One property should be designated as the client’s principal residence based
on capital gain and year of ownership. - Cottage or other real property—This property may be defined as the principal residence, depending on use and
length of ownership. - Non-registered brokerage account—The account’s capital gain or loss should be recorded based on its fair market
value on the date of death and on the ACB. - Bank account—The client’s bank accounts have no serious tax implications.
- RRSPs—For RRSPs and registered retirement income funds, the entire fair market value of the account is taxable,
as if all account assets are withdrawn. For example, if the balance in the registered account is $300,000, the
entire amount of $300,000 is added to the deceased client’s taxable income. - Tax-free savings account—The client’s tax-free savings account has no serious tax implications.
- Shares of a Canadian controlled private corporation (CCPC)—If the deceased client owned shares in a CCPC, there
is a deemed disposition at fair market value immediately before death. Capital gains on the shares must be
recorded and the lifetime capital gains exemption (if any is remaining) should be claimed.
In what situations might the executor choose to elect out of a spousal rollover?
- The deceased client leaves CCPC shares to the spouse but has not used the lifetime capital gains exemption. By
electing out of the spousal rollover, the executor triggers a capital gain and uses the exemption. - The deceased client dies early in the year, so there is little income. By electing out of the spousal rollover, the
executor can bump up the ACB for the recipient spouse and pay taxes in the lower tax bracket on the capital
gain. - A net capital loss of carryovers remains. Although the carryovers can be used against other income, the
deceased client’s income (e.g., at retirement) may be low. - The deceased client had a significant amount of medical expenses in the year of death. Electing out of the
spousal rollover ensures that there is enough income to use them all. - Electing out of spousal rollover on a registered retirement income fund can prevent a large balance passing to
the hands of client’s spouse, which can be an issue if both spouses were elderly.
When determing if a Trust is taxable based on residency status, what are the key factors that a factual residence is based on ?
The location where the trust’s real business is carried on—This is where the actual business, management, and
control of the trust take place.
* The trustee, executor, liquidator, administrator, heir, or other legal representative—This factor determines where
control of the trust takes place.
* More than one trustee involved in the central management of the trust—Factual residency is determined by the
location of more substantial management and control.
* Substantial portion of central management and control resting with someone other than the trustee—The actions
of these other persons must be considered to determine control of the trust.
What are the tax filing requirements for a Trust ?
The deadline for a trust to file a T3 return, and all related slips and summaries, is 90 days after the trust’s tax year
end. Trusts are required to make quarterly instalment tax payments. Any additional balance owing is due upon filing
(i.e., 90 days after the trust’s yearend).
What are the penalties for filing late ?
A late filing fee is applied based on 5% of the net taxes owing on the date that the T3 tax return was due. Another
1% of net taxes owing is added for each full month that the T3 return is late.
CRA charges compounding interest only when all of the following three conditions apply:
* An instalment reminder has been sent to the taxpayer showing the required instalment payments.
* CRA has determined that instalment payments were required.
* The client did not make any instalment payments, or the instalment payments were late.
If interest is charged, it is calculated using the highest prescribed interest rate, and it is compounded daily.
What is a graduated real estate trust ?
When a testamentary trust is first established, it may qualify as a graduated real estate (GRE) trust, if it meets the
following conditions:
* The estate has designated itself in the T3 return as a GRE.
* No other estate of the client has been designated as a GRE.
* During the 36-month period after the client’s death, the estate includes the client’s social insurance number in
its tax return for income in each taxation year after 2015.
Before the introduction of the GRE, which took effect in 2016, testamentary trusts provided a long-term
opportunity for income splitting for estates. After the introduction of the GRE, this opportunity became limited to a
shorter term of only 36 months.
what tax benefits is a QDT eligible for ?
The disability tax credit.
What is the benefit of a QDT ?
The benefit of a QDT is that the taxable income within the trust may be taxed at only graduated
tax rates.
DEATH OF AN INCOME BENEFICIARY OF A TESTAMENTARY TRUST
If a deceased client was an income beneficiary of a GRE with a taxation year other than the calendar year, the
executor can file a separate personal tax return to report the deceased client’s income from the trust. The period
must be from the end of the trust’s last completed fiscal period to the date of the taxpayer’s death. This tax deferral
also permits the double use of certain personal tax credits.
The executor may choose to elect out of the spousal rollover and allow the assets to transfer at fair market value.
This option may be beneficial in the following instances ?
- The client may have unused capital loss to carry forward.
- The client may have unused capital gains exemption limit (e.g., exemption on the disposition of shares of small
business corporation, or property from a farming or fishing business). - The client died early in the year and had little income in the year of death. By electing out of the spousal
rollover, taxable capital gains may be realized and subject to tax at the lowest or second-lowest tax bracket.
