Claiming Personal Expenses

Sometimes when the piles of receipts begin to pile up and you’ve accumulated bags and shoe boxes of receipts you begin to think... if I throw in some personal expenses the government is never going to find them in this mess. This is not always the case, sometimes the government does find out what you’ve done when you are audited and they start sifting through your receipts. Then they rightfully make changes to your personal or corporation tax returns and the next thing you know you owe huge amounts of money in additional taxes and penalties and interest along with it!

The CRA compares businesses to prior years and other businesses in similar industries. They have a very good idea of what the ‘normal’ range of expenses are for your business. If you are well above this range, you can expect an audit to result eventually.

When you are audited, the auditor is going to want to see your documentation to support the expenses you’ve claimed. When they see pizza deliveries, lingerie purchases and children’s toys, they are not likely to allow you to keep these items as deductible expenses. It will also give them reason to look more in depth at your other expenses.

Filing false statements or omissions in both corporations and for individuals will result in penalties that are the greater of $100 or 50% of the amount of the understated tax.

If you have not yet been contacted by Canada Revenue Agency and you would like to correct your misfiled returns, there is a way to correct the returns under the Voluntary Disclosure Program that will waive the penalties associated with the omissions or overstatements. A Chartered Accountant will be able to help you through this process. Speak to one today before Revenue Canada contacts you. www.markfeldstein.net

Loans Deemed as Income

Lending and receiving loans can be essential to many businesses; but it must be done correctly to avoid severe allegations and consequences.

A loan agreement should be written up between the parties and detail everything from the dates, amount, interest rate, and the repayment arrangement. Both parties should sign and date this agreement and keep copies of it for future reference. The danger of not documenting the loan is that the CRA will see the money deposited into your bank account and deem it as income. And unless you have proof that it is a loan, you will be charged with undisclosed income and face penalties and interest and potentially criminal charges for tax evasion.

Another important lesson to be aware of is HOW you repay the loan. A recent example I encountered was a man who received a loan from a customer and then ‘repaid’ the loan with merchandise. Without a loan agreement in place, this transaction looked like any other sale transaction and not at all like a loan that was repaid with goods instead of cash.

The impact of the Canada Revenue Agency discovering these business practices can be detrimental on a business. If the loan is for over $10,000 the government will already be aware of the deposit into your bank account as the banks notify the CRA when deposits exceeding $10,000 are made.

Then when you cannot support that this money is a loan, the penalty for gross negligence is 50% of the understatement of tax! There is also the potential to spend up to five years in jail.

Be preventative and get your agreements done in writing and signed to make sure nothing like this can happens to you.

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Cash Transactions in an Audit

Sometimes cash is an unavoidable part of business. Customers choose to pay with it, vendors will only accept it. But how do you protect yourself in an audit when your sales or purchases occurred in cash? Create a paper trail. As detailed and as much as possible.

If you are a buy-and-sell type store it may not be enough to a government auditor that you documented the date and the item. How can the auditor trust that you did not skip recording some of these purchases and sales?

Issue receipts to every customer that pays you cash or that you pay cash to. If a receipt is not a possibility, at a minimum, write down all the details relating to the transaction and have the other person sign the paper and provide their contact information.

For example, if you picked up a large antique desk at a yard sale for use in your office, you likely paid in cash. An auditor will only see a cash withdrawal from your business bank account, assume it to be a personal withdrawal and deny the expense that may very well be a deductible capital asset. By having written confirmation from the seller acknowledging what, when, who and how much, it demonstrates to the auditor that the cash was legitimately used for a business purpose.

The best way to avoid the lack of evidence associated with cash is to use cheques, or other documented sources of payment. The cancelled cheques can be returned to you and will show to whom each cheque was made. Detail on each cheque the purpose of it so that the auditor can tie in your cheques to your reported expenses.

Another beneficial strategy is to obtain a ruling from the CRA asking them to confirm what evidence would be sufficient for your specific business.

If you must receive cash for your revenue, deposit it. If you do not deposit the amount and it goes directly into your pocket, the auditor will consider that both unreported income and shareholder appropriation. It is cleaner for the books to deposit it and not to use your cash sales as petty cash. By depositing all your cash sales it is far easier and more accurate to determine your actual sales.

As well, instead of withdrawal cash and using the cash for your business expenses, find out if the vendor will let you pay on interact so that the transaction will show up on your bank statement. Or try to find a vendor to do business with that will accept a method of payment that is not cash.

If cash is avoidable, it is always preferred to pick an alternative method of payment or receipt. Keep cash to a minimum and keep your audit that much smoother.

Voluntary GST/HST Registration

A Harmonized Sales Tax (GST/HST) account only needs to be registered when a business reaches $30,000 in sales either in one quarter or over four consecutive quarters. If you are below this threshold, you do not need to register, but if you have voluntarily registered for GST/HST and your sales are below $30,000 you still need to file your returns.

Many individuals make the mistake of not collecting GST/HST and filing returns once they are below $30,000 again. Others stop using their self-employed business and therefore have not collected any GST/HST, but still are required to file nil returns for the period that the GST/HST account was in existence.

Another common scenario is when a self-employed business owner stopped operating a business and kept the GST/HST account active and years later receives a new source of self-employed income that may be well below the GST/HST threshold. However, since the GST/HST account is still active he or she is presumed to have collected the tax anyways!

Here is an example:

THE SCENARIO

Joe has a plumbing business with $50,000 sales a year. He is registered for GST/HST and files an annual return each year.

Joe then joins a plumbing company and works for them as an employee for a number of years and ceases any independent sales. Therefore his only income is employment income.

Joe then gets into teaching guitar on the side and makes $10,000 as a self-employed business. GST/HST does not even cross his mind.

THE DISCUSSION

What Joe should have done is deregister the GST/HST account once he stopped being self-employed. Alternatively, he could have kept the account and filed nil returns each year if he thought he may go into business again.

Joe was not required to collect GST/HST on his guitar lessons because his sales were low. But because he has an active GST/HST account, he was supposed to be collecting 13% GST/HST from his customers. Now when Joe does his personal tax return, his accountant will take the GST/HST off the top as if he properly collected it.

If you have ever opened up a GST/HST account, make sure you are up to date with your filings. If you know you have reported your personal income and GST incorrectly, contact a Chartered Accountant to help resolve your tax matters.

Stealing From Your Own Business

Many people fail to realize that a corporation is a separate entity, essentially a separate person from the individual who owns the company. And while it is the owner who makes the business decisions, manages the cash flow, etc, the money in the company cannot be freely taken out of the business without any repercussions.

There are several ways to take money out of the business, but each one needs to be planned in order to avoid the government accusing you of stealing money from your own business.

There is an account that is often referred to as “Shareholder Loan” or “Shareholder Advance” that tracks the money put into and taken out of the business by the shareholder. It is essentially a loan that the shareholder has with the business. When the company owes the owner money, there is no issue. However, when the shareholder owes the company money, it CAN turn into an issue because you have essentially taken out money without paying tax on it.

If the Canada Revenue Agency discovers that you have taken out this money from your company, they will hit you with severe penalties. Usually they will deny the deduction from the company and add the benefit to the shareholder’s personal return, resulting in double taxation.

One way to properly take money out of the business as the owner it to pay yourself a salary. This means setting up a payroll account, paying the proper source deductions and issuing a T4 slip for employment income. An advantage to this method is that taking a salary from your business helps build your RRSP room. A salary is also included as a business expense on the income statement, which helps to reduce the bottom line and therefore the tax paid by the corporation.

Another method is to issue a dividend. This method will reduce the retained earnings in the business. When you get a dividend, it means that instead of a T4 slip, you will issue a T5 slip to declare the dividend income on your personal tax return.

Another mistake shareholder’s often make is to move out investments held in the company to be held personally. Again, this is viewed as a shareholder taking an asset (the investments) from the company and enjoying a personal benefit as now the individual shareholder holds the investments that were previously company property.

If you want to move the investments to a personal account, that is fine as long as it is done properly and with all the tax implications of it considered.

Federal Budget 2011 Overview

The budget highlights below are not comprehensive and only refer broadly to some of the changes that have been made in the budget. For a complete review of the 2011 budget, please direct yourself to the official government website.

BUSINESS

· Charities

o Monetary penalties and suspension of receipting privileges for charities who issue improper donation receipts.

· Hiring Credit

o A one-time temporary hiring credit is available to employers with total employment insurance premiums of $10,000 or less. This credit of up to $1,000 has been introduced on the excess of 2011 employment insurance premiums over those paid in 2010.

· Changes in Accelerated CCA

o Clean Energy Generating Equipment

§ Class 43.2 has been expanded to include clean energy generation equipment that has been acquired on or after March 22, 2011. Depreciation will be at 50% on a declining basis.

o Manufacturing and Processing Equipment

§ Class 29 manufacturing and processing equipment acquired between March 18, 2007 and before 2014, are able to be depreciated at a 50% CCA rate on a straight-line basis, subject to the half year rule. Subsequent to 2013, the rate will be decreased to 20%.

· Stub Period- Corporate Deferrals With Use of Partnerships

o New rules to limit deferral opportunities for corporations with involvement in partnerships. Income earned in a fiscal year by the corporation for its participation in a partnership will need to be claimed on a calendar year basis. Therefore income will need to be accrued for the income from the partnership for the portion of the year that falls within the corporate tax year.

INDIVIDUAL

· Changes To Tax Credits

o Family Caregiver Tax Credit

§ New non-refundable tax credit at 15% of $2,000. This credit is available to caregivers of infirm dependent relatives.

o Medical Expense Tax Credit

§ Currently there is a cap of $10,000 on medical expenses that caregivers can claim for dependent relatives. The budget proposes to remove this limit to years beginning in 2011.

o Child Tax Credit

§ Changes to the current legislation to repeal the limit of one claimant per household. This will allow for multiple families sharing a home to each claim this credit.

o Tuition Tax Credit

§ Changes to the credit that will allow for fees paid to an education institution, provincial ministry, professional association or similar institution to be recognized.

§ Tuition abroad will now be eligible for programs that are three consecutive weeks, instead of the former 13 weeks.

§ Certain exam fees are now tax deductible such as purchase of examination materials, lab coats, calculators, etc.

o Children’s Arts Tax Credit

§ New non-refundable tax credit at 15% of $500 for children under 16 years of age at the start of the tax year. Eligible activities include arts, cultural, recreational and developmental activities. This credit is available for tax years beginning in 2011.

o Volunteer Firefighters Tax Credit

§ Volunteer firefighters are now able to claim a 15% non-refundable tax credit at a base rate of $3,000.

o RESP Transfers

§ Changes to RESPs will allow for subscribers of separate plans to allocate assets among siblings.

· Guaranteed Income Supplement (GIS)

o Seniors will receive increase GIS payments.

· Registered Disability Savings Plan (RDSP)

o Individuals with shortened life expectancies will be allowed to withdraw annual amounts without triggering the ten year repayment rule. This is to allow for these individuals to more easily access their funds.

· RESP Transfer

o Changes to RESPs will allow for subscribers of separate plans to allocate assets among siblings.

· Individual Pension Plan

o The budget proposes that minimum withdrawals be made from the IPP on an annual basis.

Easy Ways To Reduce Your Personal Income Tax Bill

There are many simply ways to reduce the time, and therefore cost, of preparing your personal tax returns without having to have any knowledge of tax.

Accountants frequently charge based on the amount of time it takes to complete a tax. If you organize your documents in a logical and efficient way, your accountant can process your documentation quicker and therefore spend less time on your return, which should translate into a lesser bill. Below are some common mistakes clients make that add to the cost of their return:

· Open your envelopes: If you do not open your mail from the government, small dividend cheques, etc, then someone will need to spend time to take each piece of mail from its envelope and read each item to determine if it is useful or not.

· Extra Information: Do not provide clutter to your accountant. Only provide documentation that is related to your tax return. If you are an employee and have a T4 slip, your accountant likely will not need a pile of your pay slips.

· Do Some Work Yourself: If you are self-employed, why not prepare an income statement. If you tally all your expenses and turn them into an income statement, an accountant can quickly enter your information and notice what expenses you may have missed.

· Totals: Many people summarize their self-employed expenses, medical expenses, etc on a spreadsheet and do not include a column for the total. This will cause someone to have to manually add up your entire column of numbers. By including a total column for each expense on your spreadsheet, it will certainly help to reduce your accountant’s time.

· Multiple Drop Offs of Documents: If you are at your accountant’s office two, three, even four times to drop off papers you forgot to include, expect a higher bill. Every time someone goes into your file to keep entering in information you forgot, the time will increase and so will your bill. Perhaps make a list of all the items you give to your accountant and refer to it each year before you drop everything off.

· Organize your papers: Separate your tax papers into piles by type of document. For example, keep all the donations together in an envelope (or better yet, add them yourself and give the total to your accountant). Keep medical in another separate area. Keep children fitness receipts in another.

· Stapling: A way to reduce time on your file is to avoid stapling all of your documents together. Accountants frequently make photocopies of your slips in order to keep a copy for you, themselves, as well as provide a copy to the government (if paper filing). If all your documents are separated into stapled piles, someone will need to remove the staples from all your pages in order to make photocopies. Simply use paper clips das a faster alternative.

· Multiple Family Members: If you are providing information to your accountant for several people in your family, ensure that your documents are separated by individual. It will be much faster for the processer to enter your returns and not have time spent sorting which papers belong to which family member.

· Use a Professional: It may be initially cheaper to use a tax preparing software or go to a booth in the mall to prepare your return. However, these methods do not often have the knowledge to maximize your refund or know how to help you avoid being a target for an audit. An accountant will know what credits or expenses you may be missing, how to determine which spouse claims which expenses and will be able to help you avoid (or help you through) a tax audit.

Employing these strategies will make completing your personal tax return easier for you, and your accountant!

Dentists and Taxes

When we think of dentists and we think of taxes, we usually consider the medical expenses incurred at the dentist to claim on our personal tax returns.

However, in 2010 the Canada Revenue Agency has made some changes to the medical expense tax credit. Procedures that are purely cosmetic are now ineligible to be claimed as medical expenses.

For instance, your decision to whiten your teeth will no longer provide a tax credit but your root canal extraction will. If the expense is for medical or reconstructive purposes, then the expense will still qualify.

Another change to the dental industry is the decision by the government in the 2010 Budget to have GST/HST be charged on the cosmetic procedures. So now not only will your cosmetic treatments not get you a tax credit, you will also be paying 13% GST/HST on top of the cost.

The rationale is that cosmetic procedures are not basic health care and therefore are subject to tax. For details on which specific procedures qualify, visit the CRA website at www.cra-arc.gc.ca.

Charity Scandals 101

Time and time again, clients walk into our offices because of their involvement in a charity scandal. Although there are many variations of these schemes, the most popular one is as follows:

Mr. Doe wants to increase his tax refund. His accountant suggests that he makes a contribution to a charity to help him decrease his taxes by increasing his donation credit. Mr. Doe then receives a donation receipt for a far greater amount than the actual cash outlay. Mr. Doe’s accountant then proceeds to record the inflated donation on Mr. Doe’s tax return. Then Mr. Doe finds himself in trouble with the government, and his accountant has disappeared.

It is not common practice for your accountant to ask you for money that he will donate on your behalf to a charity. If your accountant suggests this to you, you may want to look for a different accountant. If he/she claims to have a professional designation, contact their related institute to determine if they are in good standing and have not lost any type of licence.

When you do want to make a legitimate donation, investigate the charity first. The CRA website has a list of all authorized charities, as well as charities that have lost their statuses.

Charity receipts are required by Canada Revenue Agency to include specific information about their organization, including, the following: Statement that it is an official receipt for income tax purposes, charity’s registration number, name and address of the charity, serial number of the receipt, place receipt issued, day/year of donation, full name of donor, amount of the donation, the eligible amount of the donation, a signature of an individual authorized with the CRA from the charity, and the CRA website address.

Make sure that the amount on the donation receipt matches the donation you have made. If you make your donation with a cheque, keep the cancelled cheque so that you have proof of payment in case any CRA enquiries arise.

If you have contributed tangible goods to a charity, do not record the goods on your return as a donation and a capital gain. When this is done, it appears that you have both received funds and donated the same goods.

If the government discovers that you have participated in one of these scandals, they will likely revise your tax return to reflect the actual cash outlay of the donation. If this puts you into a tax owing position, interest and penalties will be applied to the balance from May 1^st of the tax year that this occurred.

It can take many years for the CRA to look into charity scandals and it is quite common for returns from 2002, 2003, etc to be looked at now. This means that 8+ years of daily compounding interest and penalties that apply can easily end up doubling the tax debt.

Protect yourself and do not involve yourself in these type of schemes. It may appear to save you some money now, but the consequences when you are caught are just not worth it. It is in your best interest to make a donation to a registered charity and take the donation credit you deserve.

RRSP Deadline Fast Approaching

It’s that time of year again when we all start to think about taxes. How much money did I make this year? How much tax do I have to pay? Will I ever be able to afford to retire?

The most popular savings options for Canadians is the Registered Retirement Savings Plan (RRSP). This plan allows for one to receive a tax deduction equal to the amount of the contribution.

For example, a $20,000.00 contribution to your RRSP account will allow for a $20,000 deduction from the total income calculated on your tax return.

The concept is that you will be making less money when you retire and therefore will choose to pay the tax on the contribution when you collapse your RRSP in retirement, instead of paying the tax now at a presumably higher tax bracket.

The CRA adjusts the contribution limit of the RRSP annually. The 2010 contribution limit is $22,000. In order to ‘earn’ room to contribute to your RRSP you must be earning an income.

If you earned $50,000 last year, the government will multiply your prior year earned income by 18% to determine your contribution room. $50,000 x 18%= $9,000.00. Any unused room can be carried forward and used in future tax years.

The CRA considers earned income to include employment income, self-employed income, rental income, taxable support payments, CPP or provincial disability income, etc.

Dividend and interest income do not count as earned income and therefore do not contribute to your earned income, unless they are an active part of your business. This is especially important for shareholders who want to contribute to their RRSP but pay themselves with a dividend and not a salary each year.

Another option to reduce taxes using your RRSP is to contribute to your spouse or common-law partners RRSP account. However, keep in mind that this will reduce YOUR deduction limit.

RRSP’s are a flexible way to save for retirement, but they may not be for everyone. For instance, if you know that in the near future you will need a larger some of cash to invest in a business, you may want to stay more liquid and decide to invest less in your RRSP this year. As well, if you are already in a low tax rate, you may decide to wait until you are in a higher bracket to begin deferring any taxes.

The important idea to take away from this is that RRSPs can be a beneficial and structured way to plan for your retirement, but they are not for everyone. There is still a month left to make a contribution for your 2010 tax return (March 1, 2011). So please take the time to consider your current cash and retirement needs to decide if the RRSP is a good retirement strategy for you.