“Why do you do tax return work?”

Krista Kerr, chief executive of Kerr Financial in Toronto, has been asked that question on more than one occasion.

Her response: tax time allows us to talk with clients and review the strategies we proposed the previous year.

Myron Knodel, director of tax and estate planning at Investors Group in Winnipeg, says tax returns are sometimes the only place clients formally list income sources. And that information is essential to tax efficiency.

Reviewing taxes allows an advisor to understand a client’s overall situation, adds Kerr. For example, a client with foreign investment income from U.S. securities could have U.S. estate tax exposure. Or, capital losses this year could be realized and carried back up to three years if the prior years had taxable gains.

Kerr suggests advisors who aren’t doing returns in-house should speak with clients’ accountants.

The highlight reel

Principal residence exemption reporting

As announced in October 2016, “In order to claim [the principal residence] exemption, you must report the disposition,” says Knodel.

Any principal residence designation must also be reported. Under proposed changes, CRA will be able to accept a late designation in certain circumstances, but a penalty may apply.

The same legislation also proposes that for tax years that end after October 2, 2016, CRA may reassess you at any time if you fail to report the sale or other disposition of real estate, despite the normal statute of limitations period for reassessments being three years. “It’s prudent that taxpayers now report those dispositions even though they may not give rise to income tax,” says Silvia Jacinto, a tax partner at Crowe Soberman in Toronto.

Trusts holding principal residence properties are also subject to new rules. Previously, a family trust, for example, could own a principal residence and, as long as one or more trust beneficiaries lived in the property, any gain on the sale of the property would be sheltered by the principal residence exemption (PRE).

But now, “any dispositions after December 31, 2016, will not be eligible for the principal residence exemption inside the trust,” says Jacinto. “Some planning will be required to distribute that property to one or more of those beneficiaries that live in it, so that the distribution happens on a tax-free basis. When the property is ultimately sold, it is those individuals who will claim the principal residence exemption on their personal tax returns.”

Alternatively, clients may have non-tax reasons to keep a property held in a trust and deal with the tax on disposition—for creditor proofing, for example, or to retain control.

Family trusts and other non-eligible trusts remain eligible for the PRE with respect to gains accrued until December 31, 2016, so long as certain conditions apply.

Forms for clients

Clients should anticipate the following forms from the investment custodian:

  • T3 (Statement of Trust Income Allocations and Designations, which shows mutual fund distributions)
  • T5 (Statement of Investment Income, which shows dividends, capital gains and interest income)
  • T5013 (Statement of Partnership Income)
  • T5008 (Return of Securities Transactions, which lists all securities sold in the year, providing security name, date of sale, quantity sold, price per share, total proceeds and commission paid.)
  • RRSP slips

But it’s left to the advisor to provide a proper gain/loss summary, says Krista Kerr, president and CEO of Kerr Financial, because the custodian sends only a trading summary and doesn’t calculate adjusted cost base—that’s technically the client’s responsibility. Provide the summary in Canadian dollars for easier tax filing.

CRA says to calculate the capital gain or loss on the sale of capital property made in a foreign currency by:

  • converting the proceeds to Canadian
    dollars using the exchange rate at the time of the sale;
  • converting the adjusted cost base to Canadian dollars using the exchange rate at the time the property was acquired; and
  • converting the outlays and expenses to Canadian dollars using the exchange rate at the time they were incurred.

The Bank of Canada website provides historical exchange rates. Also helpful are:

  • knowing how the cost base of a given investment is calculated so you can explain it to clients or accountants;
  • identifying approved foreign spin-offs, so clients can elect to exclude taxable foreign dividends from income; and
  • clearly showing fees on nonregistered accounts, which are generally deductible, so clients can more easily claim them.

Canada child benefit

The universal child care benefit (UCCB) and the family tax cut—along with the Canada child tax benefit and the national child benefit supplement—were repealed and replaced in 2016 with the Canada child benefit (CCB). Unlike the UCCB, the new benefit is tax-free, and falls as taxpayers earn more income.

Eligible clients must apply, says Jacinto, and high-income earners won’t receive the CCB, which is based on family income. To get the CCB, the primary caregiver must file a return every year, even if she has no income, as must her spouse or common-law partner. For heterosexual couples, a male primary caregiver must attach a note from the female parent, stating he is the primary caregiver.

New tax brackets

As of the 2016 tax year, clients with income greater than $200,000 are in a new federal tax bracket (33%, up from 29%), while rates decreased for middle-income earners (to 20.5%, down from 22% for income between $45,282 and $90,563).

The new brackets also provide incentive to more efficiently allocate income among family members. Options include:

  • Using a spousal loan. The higher-income spouse lends money to the lower-income spouse at CRA’s prescribed interest rate of 1%, and the lower-income spouse invests that money, with returns taxed at the lower bracket. The borrower must make annual interest payments no later than 30 days after year-end (January 30); otherwise, the arrangement is no longer valid. Similarly, the loan could be made to a family trust for the benefit of children.
  • Gift money to a child under the age of 18. That money can be used to buy a security and generate capital gains income that’s taxable in the minor’s hands. But be mindful of the attribution rules when choosing a security, says Jacinto, because any other income generated on gifted money to a minor child is taxed in the parent’s hands.
  • Issue family corporation shares to a child 18 or older. Another option is available to professionals with an incorporated business. A child who is turning 18 in the calendar year (or older) can own dividend-paying shares issued by the corporation, earning tax-free income if she remains within CRA’s basic personal amount. “Those dividends would be taxed in their hands—at probably no tax because they have no other sources of income,” Jacinto says. She says clients must check whether their professional associations allow the arrangement.

Kerr has witnessed the consequences of investment managers and accountants failing to communicate. For example, when she reviewed the tax situation of a client living in a nursing home, she found unclaimed medical credits as well as unrealized capital gains.

With better communication, the client could have realized tax-free gains each year by offsetting them with the medical credits (which would have been lost because the client didn’t have enough income). And, if there were still remaining credits, the client could use them up by selling shares and buying them back to bump up the cost base of the securities. Doing so would reduce future capital gains tax (when she sold the stock) or future estate tax on the deemed disposition at death. Says Kerr: “It’s not bad to have gains if you know the rest of the tax situation.”

Cross-border filing deadlines and warnings

FormPrevious filing deadlineNew filing deadline for 2016 taxation year
FBARJune 30April 15
Partnership returnsApril 15March 15

This year, because of the change in the filing deadline, the IRS gave everyone an automatic extension to October 15, says Marc Gedeon, director of cross-border taxes at Cardinal Point Wealth Management in Toronto and Los Angeles.

Things advisors may have to do for cross-border clients

  • If clients receive both a T5 and a Form 1099 for an investment account, work with financial institutions to determine how income is sourced between Canada and the U.S. For Canadian filing, foreign income is reported on form T1135 (and the T1 form). For U.S. filing, foreign income is reported on Form 8938 (and Form 1040).
  • Gather Passive Foreign Investment Company (PFIC) annual information statements for U.S. citizen clients who hold PFICs, which include Canadian mutual funds in non-
    registered accounts. (Canadian mutual funds haven’t received an exemption from U.S. tax rules for PFICs, as previously hoped.) Although fund companies issue and certify clients’ statements for tax reporting, advisors usually contact company reps to obtain them, says Gedeon.