Myth #1 – Income Splitting With Joint Accounts
One of the most common questions I receive is: “If I make my investment account joint with my spouse can we split the income 50/50?” Not necessarily.
The Canadian Income Tax Act requires that each spouse account for every dollar they brought into the marriage and every subsequent dollar earned. While, you can give cash or investments to your spouse the transfer will occur at your original cost base and all interest, dividends and capital gains (or losses) will continue to be taxed in your hands.
In order to properly income split with your spouse, you must sell the investments to your spouse at its fair market value and your spouse must be able to show they paid for the investment with their own funds. You realize any capital gains or losses on the transfer but all subsequent income and capital gains and losses will be taxed in your spouses’ hands.
You can also lend your spouse the funds to purchase the investments from you. The loan must be documented and have an interest rate of at least the CRA’s prescribed rate. You spouse must pay you the interest annually on the loan fro their own funds and the interest must be paid no later than 30 days after the end of the tax year to avoid attribution.
Myth #2 – Holding Investments In A Corporation
“If I hold my investments inside a corporation, I will pay less income tax.”
Private corporations with “active business income” may be taxed at lower levels than an individual. However, when investments are held inside a corporation, the combination of lower personal tax rates and the way investment income is taxed inside a small corporation means that it may not make sense to hold investments in the corporation.
In many cases, from a tax point of view, holding investments inside a corporation may actually cost you more in tax compared to holding them personally. This does not necessarily mean that investments should never be held inside a corporation: There may be other reasons to hold investments in a corporation including for U.S. estate tax planning reasons or for credit protection.
Myth #3 – If I don’t report my capital gains the CRA will never know.
The Canadian income tax system is based on self-disclosure. While it may appear the CRA may never know until you tell them, the fact is they can find out through a variety of means. And when the CRA does find out, you may be subject at best to penalties and interest or at worst face a prison term for tax evasion.
In all likelihood, failure to report capital gains will be found out in an audit. The CRA decides who will be audited based on a risk profile. If a taxpayer only ever has T4 income, it is less likely they will be audited as compared to a taxpayer with with employment expenses, self-employment income, or those with investment income.
Myth #4 – Whomever’s SIN is on the tax slip is responsible for the income tax.
No necessarily. A person who purchases an investment is always the one who pays the tax on the income and gains generated from that investment. Like the situation in Myth #1, the Income Tax Act requires taxpayers to account for every dollar earned and invested. Putting your spouse, child’s name on an account to have the tax slips issued in their name does not mean you can income split.
You can however, gift money to an adult child or unrelated third party and the tax slips may be issued in their name without consequences other than you will be considered to have sold any investments at fair market value and pay tax on any gains.
Myth #5 – If I don’t keep any records the CRA can’t tax me.
Not true. The Income tax Act specifies that every resident of Canada shall pay tax on their income but does not clearly define income. If you have not kept records for tax purposes and the CRA is unable to determine your income or where it came from, they will turn to another technique called the “net worth method” to assess your income for tax purposes.
The net worth method simply means that the CRA will look at your assets and lifestyle and estimate the income level you need to have to achieve that lifestyle and tax you according to that estimate. Obviously, this method is not accurate and may be subject to challenge in court. The courts have ruled the method can be used as a last resort and normally only allow challenges as to the reasonableness of the assessment.
Tips To Keep Avoid Tax Complications
Income Taxes can be complex and there are grey areas that can surface. It is always advisable to obtain the opinion of a professional accountant if you are unsure of how a particular situation applies. A few tips to make your tax filing easier as are follows:
- Develop a filing system and stick to it.
- File your taxes on time. Failure to do so can cost you penalties and interest.
- If you have made a mistake, contact the CRA and file an amendment.
- Keep records of all of your income and expenses. This is particularly true for business owners and the self-employed.
- If you use your car for business, keep a mileage log. This is one of the most common areas the CRA will look at.
- Keep all copies of trade confirmations, summaries and other information from your investment dealer.
- If you attempt advanced tax planning techniques without help, ensure you document exactly what you did and the steps you followed. Chances are that it will save you a headache down the road if the CRA asks for the information.
- If the CRA reassesses you, you can object to their assessment. Appealing an assessment is your right and you in many cases you may not need a lawyer.
Again, if you have any concerns about whether you can or can’t do something, you can ask the CRA their opinion as well as ask for the opinion of a tax professional.