Tax Tip: The More Obscure Medical Expenses

Are you claiming all the medical expenses you or your clients might be entitled to? 

By Robert Ironside, ABD, Ph.D., Course Author and Faculty Member, The Knowledge Bureau The current financial problems in the US are of great concern to people all over the world. Even seasoned market professionals are watching in awe as the various regulatory agencies in the US attempt to contain the collateral damage from the failure of Lehman Brothers, until recently the fourth largest investment bank in the US and a 158 year survivor of many prior market convulsions, the near failures of Merrill Lynch and AIG and the conversion of J.P. Morgan and Goldman Sachs into bank holding companies. Will the bail out announced last week work or this just one more step toward the eventual collapse of the US financial sector as we know it? To answer the question, we first have to look at the root causes of the problem and then assess whether those causes have been rectified. Only when the root causes have been rectified will the US financial sector start working its way back to good health. There are three basic causes of the financial market meltdown in the US. The first was a misguided belief that real estate prices could continue to rise quickly for some infinite period of time without any negative consequences. The second problem was a banking sector that totally ignored risk in their lending practices. The third problem was an increasing reliance on debt financing. Lets look at each of these in turn. US residential housing prices have risen slowly for many years. For example, according to the Fidelity Research Institute, the returns on a dollar invested in US real estate since 1963 have been only slightly better than the returns on low-risk Treasury bills, the returns on which tend to approximately equal inflation. For example, one dollar invested in common stocks in 1963 would have appreciated to $12.63 by 2006. One dollar invested in real estate would have risen to just $1.79. Even in the highest-appreciating regions of the US, the NE & the West Coast respectively, an investor would have realized annual real returns of just 2.35% and 2.49% respectively, and underperformed the 2.74% real return on bonds. Nationally, real estate only became a hot investment vehicle in 2003, fed by ultra-low interest rates and a movement away from the stock market following the tech bust of the early 2000s. Rising house prices and the investors/speculators who were driving them higher were aided and abetted by banks that ignored risk and ceased adhering to any form of prudent lending standards. Even the names of the various products conjure up images of what was transpiring. Liar loans were mortgages for which the borrower did not have to provide any documentation to support their reported income or assets. Of course, many borrowers lied. One bank began promoting its NINJA mortgages. NINJA stood for ëno income, no job, no assets, no problem'. The banks were only willing to do this because they had no intention of keeping this toxic waste on their own balance sheets. Instead, they would quickly bundle pools of assets and sell them off to other investors in the form of mortgage backed securities or MBS. Wall Street got into the game by slicing and dicing these pools of securitized mortgages into various tranches or risk pools. The highest quality tranches were often awarded a triple A rating, implying the probability of default was highly remote. Only the highest risk tranches were awarded low credit ratings. According to some published reports, by the time Wall Street was done with their financial alchemy, as much as 90% of these pools of low quality loans had been awarded a AAA rating. The investment bankers turned what had been high risk, poorly documented mortgages into what seemed to be gold plated, triple A rated securities, which in turn were purchased by investors and central banks all over the globe. Even Moodys and S&P, the big credit rating agencies, got into the game, since they were the ones handing out the highly coveted triple A ratings that allowed the securitized mortgages to be sold with yields only slightly above that of risk-free Treasury bills. This belief in forever rising real estate prices and the cessation of any form of prudential lending standards allowed many individuals to purchase much more house than they could afford, financed almost entirely with debt, based on the belief that rising prices would allow the buyer to sell the property for much more than they had paid, thereby preventing any repayment problems. The use of extreme amounts of debt to finance a lifestyle that they really couldn't afford was not confined to individuals. Even the largest banks on Wall Street were gorging themselves on a seemingly infinite appetite for their debt securities, offered with low spreads over risk free rates of return and typically for periods of time much shorter than the assets which they were funding. Given a steeply upward sloping yield curve, the banks were able to make enormous profits from this mismatch in term, but they ignored the liquidity risks inherent in any funding scheme that has one's liabilities coming due before the assets that they support. Of course, in Canada this same funding mismatch led to the total freezing of the ABCP (asset backed commercial paper) market in August of 2007, when investors refused to purchase paper issued by the SIVs due to concerns about the quality of the assets backing them. The amount of leverage used by the large Wall Street investment banks far exceeded that available to commercial banks anywhere in the world, reaching levels of $40 of assets being funded by only $1 of equity. With this kind of leverage, even a 2.5% decline in the value of the firm's assets will totally wipe out the firm's equity, forcing the firm into either a forced merger, a bailout or bankruptcy. This is exactly what has happened to Bear Stearns, Lehman, Merrill Lynch, AIG and others yet to be discovered. With the forgoing as the precursor to today's problems, it is clear that problems in the financial sector will remain until residential real estate prices stabilize. This is likely some distance off. For example, John Burns of John Burns Real Estate Consulting, one of the most knowledgeable real estate experts in the US, states that US house prices are likely to fall by approximately 22% in total, 12% of which has already occurred. 1Using a different methodology and measuring sales only in the 20 largest metropolitan areas, Robert Shiller, founder of the Case-Shiller Real Estate Index, believes prices will fall by approximately 30%, 17% of which has already occurred2. If these experts are correct, and there is little reason to believe they are wrong, given the tendency of all markets to revert to their mean values over time, we are only just over half of the way through the eventual fall in US house prices. Will the bail out of the financial sector announced last week stop the bleeding? In my opinion, it will not, unless some way is found to stabilize the value of US residential property. That remains to be seen.   Mr. Ironside is a Faculty Member with The Knowledge Bureau and author of the Knowledge Bureau Courses entitled Financial Literacy: The Relationship Between Risk and Return and Portfolio Construction for Real Wealth Management. 1 As reported in Housing: Are we Near the Bottom, John Mauldin, September 12, 20082 As reported in Housing: Are we Near the Bottom, John Mauldin, September 12, 2008

What are investors to do with the news of the most significant negative developments in the stock market in a decade? Is the worst over . . . or yet to come? To help you sort it all out, The Knowledge Bureau has solicited insights from three experienced industry experts with feet on the street in New York, Vancouver and Winnipeg: From New York, Lisa Langley , Executive Director, International Money Management Institute From Winnipeg, Doug Nelson, Financial Advisor, author and faculty member, The Knowledge Bureau From Vancouver, Cameron Hutt, Wealth Management Specialist, Canaccord Capital KB LISA LANGLEY: What is happening with Merrill Lynch, Lehman Brothers in the US? LL First Merrill Lynch has merged with Bank of America, which they are calling a uniquely timely strategically complimentary combination of two organizations who aspire to be a global premier financial services provider. The value of the deal was positive for Merrill Lynch (a premium to current price) and though there will surely be redundancies, an ML advisor commented this morning that he felt it was very positive. Lehman Brothers had over 750 billion USD in exposure and there just wasn't a buyer who could absorb the hit. This is just the beginning of the process as their book gets re-priced. Employees went in to gather their things and walked down the streets with their boxes in their arms. The word "calamity" is being used a lot. Now the Fed is urging a consortium to provide $75 billion in loans to AIG, a company which was one of the largest market caps. KB What does this mean to the Canadian investment industry? LL The credit crisis is all about issuer strength now, and investors have less faith in credit ratings. The ability to provide a true value to all investment instruments of all types is critical. The strength of the Canadian national banking system and the reduced exposure to the credit crisis will help, however, there will be impacts. Pension funds are facing hits, as commodities drop now the effect is doubling up on the credit crisis shake-up. KB What does it mean to Canadians with investments in the US? LL Diversification by asset class and by region/country has always been important. As long as the positions held are in strong organizations, there are definitely some buying opportunities and certainly some areas of strength. US Bank went up today. The overall news is dim, but there are pockets of good news. Due to the regulations requiring segregation of securities for brokerage firms, individuals have not lost their capital. The securities in the accounts of individuals have not been lost and this has been repeatedly covered in the US media. KB What could happen if there is a run on the banks in the US? LL The Federal Reserve acted quickly to back up Fannie Mae/Freddie Mac and they have a significant position in these two organizations. There will not be a run on US banks. I expect there will be consolidation of organizations across the sector. KB How will all of this affect current and future retirees? LL Retirees need to examine their comfort level with the current structure of their portfolio. There is a lot of discovery continuing in the market right now, and we will continue to hear more. So it is important for retirees to make sure they have a risk tolerance level suitable to their specific situation and a portfolio structure that reflects those objectives. All segments of the market have not been affected. Investors should meet with their advisors and develop an understanding of where they stand. Examine opportunities carefully, and make sure you understand the issuer strength of what you are invested in. KB What should people do, if anything? LL Professional advice is worth its weight in gold, especially now. Make sure you are investing with a long-term approach and a risk tolerance you can live with. Meet with your advisor and understand what you are holding in your portfolio. KB DOUG NELSON: How do Monday's events affect advisors and their clients? DN We are currently seeing the bursting of two bubbles: real estate and then financial products related to real estate. Many financial firms are a party to complex financial instruments that invested in these areas. Many / most of these investments were leveraged significantly. These were investment structures that were created by the investment banks, hedge funds and others. The value of these instruments has declined significantly as the real estate market declines in value and as the default rate on mortgages rise. The question is: "what are these assets really worth"? Since financial institutions are legislated to keep their balance sheet within certain ratios, the decline of these assets means that the institution needs to find new assets or reduce liabilities. But there comes a time, as we have seen, that the institution has lost the "confidence" of the market and the stock begins to see significant declines to almost unbelievably low values. The big problem, even though the company has seen such a significant decline in its value, is "what is the real value" and "what is it on the hook for as it relates to their obligations to some of these financial instruments". The million dollar question is the ripple effect. For one, we are seeing unemployment on the rise. This may see a further decline in consumer spending which in turn affects manufacturing and real estate. This may then impact demand on commodities which would affect the value of the Canadian stock market and Canadian economy. The ripple effect may continue to the European banks that were also party to these types of contracts. So: "what is NOT effected" when the financial sector melts? KB What does this mean to the Canadian investment industry? DN One of the major investment themes of the past 18 months has been the relative value of the U.S. market vs. the high driving commodity based Canadian market. Many money managers and advisors have begun to further "diversify" into the U.S. and globally. Any money manager that has done so will have seen a significant impact on returns. Alternatively, any money manager in Canada that remained focused and overweight in commodities, has also felt a significant decline since, in particular, the middle of June. This series of events may mean that the Canadian markets could be in a significant period of under-performance for the next few years. KB What does it mean to Canadians with investments in the US? DN Any U.S. investment held by a Canadian has not seen any significant gains for the past 10 years. In fact, when you factor in currency the return has been negative. This point is exasperated further by the recent events. KB What could happen if there is a run on the banks in the US? DN This is anyone's guess and I don't want to speculate. No doubt fear of further loss will be a major concern to any investor. A run on a "retail bank" is a significant crisis of confidence that will need to be avoided at all costs. We have already seen the impact of a "run" on the major "investment banks". If there is no confidence in a financial institution, how do they ever attract new deposits, investors or institutional clients? KB How will all of this affect current and future retirees? DN We know historically that anyone retiring at the end of a market cycle, such as what we are experiencing today, has a much greater possibility of running out of money some time in retirement. The best advice for those thinking of retiring today is to consider postponing retirement for 1 to 3 years until this situation is sorted out. Alternatively, some may wish to consider life time annuities as a way of providing consistent, secure and lifetime income. Annuity income in Canada is insured up to $2000 per month by the Compensation Corporation (CompCorp.) in Canada. KB What should people do, if anything? DN The time for "action" is probably over. The time to have been more defensive has probably passed. Yet, people should "learn" from this situation. They should recognize that large companies do fail. They should recognize that leverage creates "immeasurable" levels of downside risk. They should recognize how important it is to be aware of market cycles and the seasonality of different subsectors of the market. They should also recognize how important it is NOT to chase returns or assume that "things will always go up". The key here is to own liquid investments, to assess the level of risk in the portfolio frequently and in a systematic manner, and to never get complacent. KB CAMERON HUTT: Is there a historical perspective to this activity? CH What's happening right now is unprecedented in the case of Lehman Brothers. You may recall in 1998, Long Term Capital Fund, a global source of investments to banks and brokerages went bankrupt; they had to make up losses, and the future of financial services was questioned at this time. Like many did a decade ago, we are now embarking upon the same questioning about this week's extremes. KB Some clients may be worried about a run on the banks. Should they be? CH This a liquidity issue for the firmsóTier 1 capital may not be onside immediately and when this happens firms which don't have the cash on hand will play down and falter. To deal with this many will issue paper (preferred or new commons) to create new moneyóthis dilutes shareholdings but keeps regulatory Tier 1 ratios onside. So largely its business as usualówe are experiencing very bad losses never seen beforeóin Canada as well as US (with asset backed commercial paper in Canada or subprime issues in the U.S. held through subsidiaries). Canadian based banks that have had a lack of involvement in the U.S. have faired much better. Of all the markets Canada has faired very well compared to US and European equivalents. Still off 11% as a group, could be a buying opportunityóthis might be a good time to start. However Canada is not immune to U.S. markets, so enter cautiously. KB Should Canadians with US investments be worried? CH Yes. This has been a very poor investment and might be even pooreróit's very hard to watch, one would certainly rather be in cash, investing in these levels. Portfolios could lose more. Junior investors will sell and more seasoned will not sell as quickly. KB Should they sell? CH Try to reduce exposure to high risk areas and make your portfolio more immune to further declines. Holdings in brokerage firms, banks: try to reduce now. KB What advice would you give to retirees? CH Try to reduce risk in the portfolio, don't start to try to play the game. Principle protection really important. Bond yields are so low but better than a decline in principle. Reassess your asset allocationóbalanced portfolio is best. See their advisors. KB What about day traders? CH Good luck! KB Advice for Advisors? CH Many don't know how to deal with this, especially those new to the industry in the last 5 years. Advice to new players: think long term. Even in the case of bankruptcy there are often companies looking for takeovers, acquisitions. There are glory days ahead. If this is a forest fire (necessary to burn deadwood) this cleansing process is really good for markets to flourish again. KB What about the "Do nothing" folks? CH If there is no need for income from the portfolio and you have a long term perspective, it will work out for you. You are likely in a good spot if you are reasonably diversified and have a proper asset allocation. Three to five years from now things won't seem so bad. KB Last thoughts on Investor Behaviour in times like these? CH If you have properly managed portfolios, sit tight and hold on while you temper your mood. But if there is a betting game in specific sectors, then reassess, be proactive and reduce exposure, albeit at a lower level.

The Knowledge Bureau is pleased to introduce E-Z Data, makers of "Smart Office", as a new sponsor of Breaking Tax and Investment News. E-Z data has been serving the financial services industry for more than two decades in the areas of client relationship management and practice management solutions for IDA, MFDA, insurance and bank advisors, agencies and wholesalers in Canada. Smart Office offers advisors a bilingual, web-based practice management platform to address the challenges of relationship management and aggregation of client information ñ including investments and policies tracking with compliance notes and documents ñ to help build and maintain profitable client relationships. Jim Graddon, General Manager of Canadian Operations, says "The company is committed to delivering solutions that drive the continued success of financial advisors and institutions through more effective practice and agency management. E-Z Data solutions are built to help improve marketing efforts, provide valuable reporting capabilities that drive better business decisions and create a client-centric environment that helps users get, keep and grow enduring and mutually profitable client relationships." Click on the E-Z Data logo on the top right of this page to go directly to the company website, and watch for it weekly, as well as upcoming articles in Breaking Tax and Investment News from Jim on advisor practice management topics related to business practices and technology. You may also contact Jim at 905-257-5212, ext. 7350.

Partnership Transactions There are certain transactions that are entered into by partnership and their partners which are unique to this form of business structure. We will review the bookkeeping for some of these. Contribution of Property When a partnership is set up, the partners typically contribute property ñ including cash - to the partnership to establish its operations. (A partner need not contribute property. A partner may contribute services, including services to be provided in the future.) From an accounting perspective, the contribution of property to a partnership by partner must be accounted for twice: it represents a disposition of the property by the partner and an acquisition of the property by the partnership. There are general principles which underlie the accounting for these transactions: For financial reporting purposes, both transactions should be accounted for at the fair market value of the property involved. The partner contributing the property will normally have to account for sales taxes that normally arise if the property is subject to tax. A partner and partnership can normally elect for income tax purposes to have the contribution of property accounted for at tax cost, so that the partnership takes over the partner's tax cost of the property and the potential for capital gain or loss and/or recapture on a subsequent disposition. However, this election should not affect the bookkeeping for the transaction. Withdrawal of Property A partnership cannot pay a salary or wage to a partner. When a partner withdraws cash or other property from a partnership, the partnership records the withdrawal as a disposition of that property and a debit to the partner's draw account. Typically, a partner draws cash. Where a draw is funded in kind, the partnership accounts for a disposition of the property at fair value. Sales taxes must be accounted for if they are otherwise due. Disposition of an Interest An interest in a partnership is a capital property, much like a share in a corporation, and it can be bought and sold separately. A purchase and sale of a partnership interest is a transaction solely between the partners involved and does not affect in any way the accounts of the partnership. Excerpted from Advanced Bookkeeping for a Selection of Business Profiles, one of the courses that comprise the Certified Bookkeeping Specialist program.

Advisors - a golden opportunity for you to move your business to the next level and lock in your client relationships. Imagine inviting a client to an evening of wine tasting with Tony Aspler or tickets to a Raptors game. An online auction is currently underway and running until noon on Friday, September 12th - so make your bids now! This auction has been organized as a fundraiser for a childrens' home in Tanzania and items of interest include: Lunch with Lloyd Robertson or Sherry Cooper Registration at the Knowledge Bureau's Distinguished Advisor Conference Snooker with former world champion Cliff Thorburn A trek up Mount Kilimanjaro Weekend at Four Seasons Whistler For more details on the exciting online auction click here.

Manitoba residents: are you aware that you can benefit from the Manitoba Tuition Fee Income Tax Rebate if you graduated from a post-secondary institution since January 1, 2007? If you are now employed in Manitoba and pay tax in the province, you can apply for a rebate of 60% of your tuition costs to reduce the income tax payable. To apply for the rebate, the total tuition paid over the years you attended school must be reported on your T1 income tax return. A portion of these fees paid will be used to reduce the amount of Manitoba tax you are required to pay. The provincial tax payable will be reduced over the next six or more years, and you can even delay the first claim by as much as ten years. Example: Aaron graduates in 2008, total tuition paid $20,000 Maximum claimable - $12,000 (60% of tuition) Claim in Year One Manitoba Tax Payable - $600 Tuition Rebate is the lesser of: 10% of tuition ($1,200) $2,500 (maximum available annually) Manitoba tax payable - $600 Rebate - $600 Remaining tuition claimable $11,400 ($12,000 - $600) Year Two Manitoba Tax Payable - $2,400 Tuition Rebate is the lesser of: 10% of tuition ($1,200) $2,500 (maximum available annually) Manitoba tax payable - $2,400 Rebate: $1,200 Remaining tuition claimable $10,200 ($11,400 - $1,200) Years Three to Ten: Assuming Manitoba tax payable remains above $1,200 into the future, the tuition rebate will be available for at least the next eight years. Here are the important points related to the Manitoba tuition fee income tax rebate: 60% of tuition fees paid up to $25,000 are claimable under the program Initial claim must be made within 10 years of graduation The benefit can be applied over the next 6 to twenty years Six years is the minimum period over which the rebate can be claimed Tuition fees DO NOT have to be paid in Manitoba (CRA must recognize the institution in order to make the initial claim) You must live in Manitoba to make the tuition claim on your return Note that eligible grads have up to 20 years in which to claim their rebate. The minimum period over which the full rebate can be claimed is six years, so in principle, someone could wait 14 years before starting to file their claims. Thus, eligible 2007 grads who neglected to file a claim or were unaware of the program have lost nothing. Per Manitoba Finance statistics, for the 2007 tax year the total amount of tuition claimed was $20.3 million, or an average of $4,265 per claimant. Saskatchewan has a similiar program called The Graduate Retention Program, which is a refundable income tax credit which rebates up to $20,000 of tuition fees paid. There are various rebates available to students based on the length and type of program they are enrolled in. In New Brunswick, all students enrolled for the first time at a university and attend a provincially funded university are eligible for a $2,000 one time benefit. For further information on any of these programs, check with your provincial government's Department of Finance.