INCOME TAX LIABILITIES AND ONE NON- INCOME TAX LIABILITY TO CONSIDER WHEN COMPLETING A FINANCIAL STATEMENT

Transcription

1 THE ANNOTATED FINANCIAL STATEMENT INCOME TAX LIABILITIES AND ONE NON- INCOME TAX LIABILITY TO CONSIDER WHEN COMPLETING A FINANCIAL STATEMENT Steve Z. Ranot, CPA, CA, CBV, IFA June 19, Bloor Street West, Suite 2603, Toronto, Ontario M4W 3E2 Tel: (416) Fax: (416) sranot@marmerpenner.com Website:

2 CURRENT INCOME TAX LIABILITIES 1) Arrears Tax 2) Tax for Year up to Valuation Date 3) Stub Period Income 4) Tax on Unreported Income - Little or no present value adjustment required 1

3 ARREARS TAX Can usually be determined by reviewing a Notice of Assessment or Reassessment Be careful not to include postvaluation date interest charges 2

4 TAX FOR THE YEAR TO THE VALUATION DATE Where income is earned evenly during the year, may be simplest to prorate the year end income tax obligation less income tax paid (withholdings plus installments) to the valuation date More complicated if income not earned evenly (e.g. a large capital gain during the year) or if there are large deductions or credits (e.g. large post-valuation date RRSP contribution or charitable donation) A spouse who makes a $20,000 RRSP contribution after V-Day can hide a $10,000 V-day tax liability 3

5 STUB PERIOD INCOME For unincorporated business income reported on a personal income tax return Can be very complicated with a non-calendar year-end because estimates have been made on tax returns For dates of marriage where a spouse had an unincorporated business with a non-calendar year end, there can be up to three years tax liabilities owed at one date (Consider a dentist with a January 31 year end who gets married on March 31, She has yet to file her 1993 return which reports her income for the year ended January 31, She has not yet filed her 1994 return for the year already ended on January 31, Plus, she has already earned two months of income from the year ended January 31, 1995) 4

6 TAX ON UNREPORTED INCOME Your client is self-employed and clearly lives beyond his means based on his reported income The other spouse threatens to report him to Canada Revenue Agency so you counsel him to make a voluntary disclosure The tax on the unreported income to V-Day only is a liability in calculating Net Family Property 5

7 CONTINGENT INCOME TAX LIABILITIES 1) Remaining Portion of 1995 Stub Period Reserve 2) RRSP, RPP, DPSP and RRIF Balances 3) Capital Gains and Recaptured Depreciation on Capital Property (including capital gains reserve) 4) Sale or Wind-up of an Incorporated Business 5) Foreign Taxes - May require a present value adjustment 6

8 REMAINING PORTION OF 1995 STUB PERIOD RESERVE For valuation dates before 2005 where the spouse was selfemployed in 1995 and had a non-calendar year end for an unincorporated business Commonly seen for professionals (e.g. lawyers, doctors, dentists, accountants) If spouse earned $100,000 in the 1995 stub period, 10% of this amount was required to be included in income from 1996 to 2003 and 15% in 2004 Accordingly, a tax rate must be estimated for the subsequent years As the tax is spread over up to ten years, a present value adjustment is required 7

9 REGISTERED RETIREMENT SAVINGS PLANS, REGISTERED RETIREMENT INCOME FUNDS, REGISTERED PENSION PLANS AND DEFERRED PROFIT SHARING PLANS Retirement Savings Plans a) RRSP s Taxed on withdrawal as regular income Must convert to RRIF or annuity before end of year annuitant turns 71 Deemed withdrawal on death unless transferred to spouse May also qualify to transfer tax-free to dependent child or grandchild b) RRIF s Continuation of RRSP after 71 Required annual withdrawals Taxed as regular income but allows annuitant to claim pension credit c) Employer Pension Plan Illiquid compared to RRSP Surviving spouse may have asset and related tax liability d) Deferred Profit Sharing Plan Illiquid compared to RRSP 8

10 REGISTERED RETIREMENT SAVINGS PLANS, REGISTERED RETIREMENT INCOME FUNDS, REGISTERED PENSION PLANS AND DEFERRED PROFIT SHARING PLANS (CONT D) All of these are taxed only on withdrawal and likely not until after retirement Appropriate to use an expected average future income tax rate on retirement A retiree earning $100,000 in investment income may pay income tax at an average rate of about 25% So after present valuing this tax, don t be surprised if the appropriate rate is about 10% to 15% 9

11 CAPITAL GAINS AND RECAPTURED DEPRECIATION ON CAPITAL PROPERTY Real Property a) Capital Gains on Increased Value b) Recaptured Depreciation can create tax liability even when property does not rise in value c) Principal Residence Exemption where multiple properties held, thought should be given to choice d) Must consider non-tax disposition costs such as expected real estate brokerage and legal fees 10

12 CAPITAL GAINS RESERVE Allows the tax on a capital gain to be spread over a period up to five years Requires that the vendor takes a debt back as all or partial payment of proceeds of disposition If a spouse has a mortgage receivable on a vendor take back mortgage following the sale of a property at a profit, there is likely an unpaid capital gains tax created by a reserve 11

13 SALE OF AN INCORPORATED BUSINESS a) Capital Gains Tax on Sale of Shares Availability of capital gains exemption Impact of Cumulative Net Investment Loss account Qualification now or in future as a Qualified Small Business Corporation* Election made in 1992 and 1994 to adjust cost base upward b) Capital Gains Inclusion Rate 0% pre % on post 1971 gains until % for 1998 and % from 1990 to February 27, 2000, 66.67% from February 28, to October 17, 2000 and 50% from October 18, 2000 to date c) Capital Gains Reserve Allows Further Deferral d) Contingent Tax Savings If a Capital Loss is Created e) Exemptions on some Stock Option Benefits, too! *Only for Canadian-controlled private corporation carrying on active business in Canada 12

14 WIND-UP OF AN INCORPORATED BUSINESS a) Corporate Tax on Internal Gains and Accrued Income Capital gains on business assets Regular income on inventory gains b) Some Taxes Are Refundable and Represent Additional Hidden Assets* c) Non-Taxable Portion of Capital Gains* Pre-1972 versus post * Only for Canadian-controlled private corporations 13

15 FOREIGN TAXES Property held in a foreign jurisdiction (e.g. condominium in Florida) is subject to foreign tax on gains Possibly offset by a foreign tax credit on Canadian taxes No foreign tax credit if property selected as Principal Residence for Canadian tax purposes 14

16 Case #1 GUARANTEES Wife s business owes $500,000 to the bank Bank requires wife to personally guarantee the loan Value of business determined $1 million after deducting the $500,000 bank debt Should any of the guarantee show as a personal liability? Case #2 VERSUS Husband s brother is a ne er-do-well Husband guaranteed brother s $100,000 loan on latest getrich-quick scheme which failed miserably Brother has no ability to repay bank loan 15