All advisors know tax strategies can mean the difference between so-so and stellar financial planning. But does the average advisor really understand every tax particular? Tax expert Jamie Golombek recently surprised a group of financial planners with a pop quiz to find out.
Here’s a sample question: A capital loss is carried back from 2008 to 2007. In 2007, the client reported a large capital gain so he lost all of his Old Age Security since his reported income was $103,191. So, yes or no: Will the loss carryback from 2008 to 2007 restore his $5,900 of OAS for 2007? The majority of attendees at the Canadian Institute of Financial Planners conference in Halifax earlier this month answered yes.
But the answer is actually no.
“The reason is that OAS clawback testing is not based on taxable income, which is where capital losses from other years are deducted,” said Golombek, managing director, tax and estate planning at CIBC Private Wealth Management. “It’s based on net income which does not change.”
Now, try this one: A client loses all her OAS in 2008 because she had a massive capital gain in 2008 and her income level was over $105,000. Unfortunately, the client will also lose her 2009 OAS based on 2008 income. But what if her 2008 income was a one-time occurrence? Is there anything you can do to stop the OAS clawback?
Not many attendees knew that the CRA has a special form — T1213 OAS: Request To Reduce OAS Recovery Tax At Source — for the year in question. Golombek noted he himself just discovered the form recently while working on a similar client case.
Pension income — specifically the new pension splitting rules — is another area where advisors need to brush up their knowledge. Most understand a client can transfer up to 50% of pension income to a lower-income spouse. This can include a regular monthly pension from a defined benefit and defined contribution plan at any age, and RRIF, LIF, LRIF and PRIF withdrawals, but in these cases, the client receiving the pension must be age 65 or older to be eligible for pension splitting.
Golombek presented this scenario: Eve received $120,000 of pension income in 2008. Adam died on September 1, 2008. How much can be reported on Adam’s final tax return? The majority of attendees guessed $60,000, or 50% of the pension income. Golombek noted the answer is actually $45,000.
“Technically speaking, [pension splitting] is prorated based on the number of months you were alive,” he explained. “Adam was alive for nine months — one day in September is enough to include the ninth month. Nine months divided by 12 is three-quarters and three-quarters of $60,000 is $45,000.”
More advisors had luck with this situation: Jack received $10,000 of pension income as a RRIF minimum in 2008. Under the special 2008 RRIF minimum re-contribution rule, he had until mid-April to re-contribute up to 25% and did so. How much could have been reported on his wife’s 2008 return? The correct answer is $3,750 since only the net taxable amount ($10,000 – $2,500 = $7,500) is eligible for the split.
TFSA conundrum
The new tax-free savings account has sparked a lot of excitement in the financial community and rightfully so, as it presents new planning opportunities for Canadians of different demographics.
Golombek sees the TFSAs as an excellent account for emergency funds since you can earn tax-free interest income, they are highly liquid and clients have the ability to re-contribute. And for clients who have tapped out their RESP contribution to maximize the Canada Education Savings Grant for their child’s education and want to contribute more, the TFSA is a possible alternative.
Golombek also said advisors cannot ignore the TFSA’s estate planning features, since it is tax-free upon death and avoids probate when clients name a beneficiary of their choosing.
That said, Golombek noted some particulars for advisors to figure out concerning TFSAs. Try this question: In March 2009, you contribute $4,000 to a TFSA. It increases in value to $5,000 and you withdraw the entire $5,000 in July. In October of this year, how much can you contribute? The answer is $1,000. “You have $5,000 coming out but still have $1,000 of room left for 2009,” Golombek said. “The $5,000 withdrawn can only be recontributed beginning in 2010.”
More planners had success with this example: In March, you contribute $4,000 to a TFSA. In July, it increases in value to $5,000 and the entire amount is withdrawn. In January 2010, how much can you contribute to the TFSA? Most correctly guessed $11,000, since “you have $1,000 of unused room left for 2009, $5,000 for 2010, plus the TFSA room gained back as a result of the 2009 $5,000 withdrawal,” said Golombek. “You’d be amazed at how many advisors across Canada get this wrong.”
(06/25/09)