Tax Tip: The More Obscure Medical Expenses

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

The February 26, 2008 federal budget was short on the multiplicity of targeted tax fixes we have seen in previous budgets by this government, but contained one significant provision that will assist those in the throws of retirement income planning in particular, and families seeking new income splitting opportunities. Tax-Free Savings Account The new Tax Free Savings Account (TFSA) is an investment vehicle, unfortunately not available until 2009, that will allow Canadians over 18 to accumulate savings room of $5000 a year throughout their lifetime, and so with a life expectancy of approximately 80 years for the average Canadian, that means a funding potential of $310,000 over an average adult life span of 62 years. Contributions to the account are not deductible, but earning accumulate on a tax free basis including interest, dividends and capital gains and withdrawals of both earnings and principle are tax exempt. However, those withdrawals will make new TFSA contribution room, on an indefinite carry forward basis, which provides us with some interesting new savings strategies for virtually every family member. Moreover those withdrawals will not affect income-tested tax preferences like Child Tax Benefits, Employment Insurance Benefits or Old Age Security pension. This means you can earn the tax free investment income in the plan and avoid clawbacks, too. So how can Canadians take advantage of the plan? Several strategies come to mind: Family Income Splitting. There is no attribution rule attached to the new TFSA resulting income is tax exempt. So this is a great opportunity for parents and grandparents to transfer $5000 per year to each adult child in the family for the rest of their lives. Recipients can take the money out for what ever purpose they wish and create new TFSA contribution room; which means they can put it back to grow when the withdrawal need is met and new savings are achieved. This will be welcome news to grandparents in particular. Leveraging Tax Preferences: Consider funding this new bucket of savings' with your RRSP tax savings a great way to leverage two available tax provisions. But also look at your new investment options from the tax-exempt income within the TFSA. For example, it may make some sense to look at the tax-free income in the TFSA as a source for funding assets that will multiple on a tax exempt basis: for example life insurance, critical illness insurance or a tax exempt principle residence. TFSA or HBP? In the market to buy a new home. Consider whether it makes more sense to withdraw funds on a tax free basis from within an RRSP to fund a new home purchase under the Home buyers Plan or should the taxpayer save and withdraw funds under the TFSA instead? Certainly there are no tax penalties for failure to pay back the funds to the TFSA, and withdrawals automatically create new TFSA contribution room, so our vote would be to accumulate money in this new savings vehicle instead. TFSA or LLP? Education savings strategies should now be revisited as well for similar reasons as outlined in the last point. Saving within the TFSA allows you to accumulate funds on a tax-deferred basis and then withdraw them without penalty or a requirement to repay the funds. This is not so under the Lifelong Learning Plan, which allows for a tax-free withdrawal from the RRSP but requires an annual repayment schedule. The avoidance of income inclusion penalties therefore makes the TFSA a more attractive withdrawal vehicle for these purposes than the Lifelong Learning Plan. Better to leave the funds in the RRSP for tax deferred retirement savings. TFSA or RESP? This new account would also appear to be a better savings vehicle for education purposes than the RESP, which eventually could provide a tax penalty on withdrawal if intended recipients do not end up going to school. However, in making this choice the investor misses out on the Canada Education Savings Plan sweetener. Offsetting Pension Contribution Limitations. Contributors to employer pension plans are often precluded from making RRSP contributions because of their pension adjustment amount. Likewise those who have contributed the maximum to an RRSP 18% of earned income to $20,000 in 2008 and want to do more to supplement their savings on a tax-assisted basis now have the opportunity to tap into another tax deferred savings opportunity. In particular the TFSA a good place to park interest-bearing investments. Supplementing Executive Pension Funding: Executives who earn more than $111,111 in 2007 will be unable to save for retirement on a tax assisted basis for income above this amount. The TFSA provides a small window of opportunity to shore that tax assistance up. This option should be employed in conjunction with planning for funding of top hat plans like Individual Pension Plans or Retirement Compensation Arrangements. New Tax Sheltering Opportunities for more Pre-Retirees: The TFSA is a great savings option for people who do not have the required earned income for RRSP contribution purposes and therefore have few opportunities for tax sheltered retirement savings. This includes those in receipt of inactive income sources like pension income, investment income or employment insurance benefits. New Tax Sheltering Opportunities for RRSP Age-Ineligible Taxpayers: The tax shelter can continue for those who reach age 71 and don't need the money in their RRSP. While withdrawals must be generated under the usual rules, reinvestment into a TFSA will allow those tax-paid funds to grow again faster in a tax sheltered account, as opposed to a non-registered account. Benefits for Single Seniors: RRSP Melt Down Strategy Enhancements: It has always made some sense to melt down RRSPs to top income up to bracket in circumstances where taxes will be higher at death than during life. We generally use that strategy for singles or widow(er)s for example. Now surplus funds can be deposited into the TFSA so that retirees can continue to build wealth on a tax deferred basis and keep legacies intact. TFSA Borrowing and Excess Contribution Penalties: Because income from the TFSA is not taxable, borrowing funds to contribute to a TFSA will not be tax deductible. Using borrowed money to invest in non-registered accounts makes more sense as interest is then tax deductible. Also be aware that the new provision will result in a penalty of 1% per month if excess contributions are made to the account. Therefore it pays to look carefully at your Notice of Assessment from CRA. Estate Planning Considerations. Also note that the TFSA loses its tax-exempt status after the death of the plan holder, meaning that the investment income will become taxable, however a rollover opportunity is possible when the spouse or common-law partner becomes the successor account holder. This will not be affected by the spouse's contribution room and will not reduce existing room either. However, when a child dies without a spouse, the plan should be collapsed or transferred to another appropriate savings vehicle. Marriage Breakdown: Investors in the TFSA will be able to transfer from one party to the split to the other on a no-penalty basis, however, the transfer in this case will not re-instate contribution room for the transferor. Nor will it affect the contribution room of the transferee. File a Tax Return: yet another reason to endear oneself to the tax system: a return is required to build TFSA contribution room and so it is folly to file late or miss filing a return. Remember there is a statute of limitations of ten years in filing late or adjusted returns. Don't cut into your tax exempt wealth accumulation potential by being tardy on this front. Investment Ordering Decisions. The New TFSA requires a second look at the order in which investors maximize accumulation activities. Taxable investors should consider family priorities and then contribute funds in this order: To an RPP To an RRSP (including spousal RRSP) To a the TFSA To RESPs (Registered Education Savings accounts to maximize Canada Education Savings Grants and Bonds) To RDSPs (Registered Disability Savings Plans to maximize Canada Disability Savings Grants and bonds.) To non-registered accounts OTHER BUDGET HIGHLIGHTS: RESP contribution, withdrawal and savings periods have been extended Northern Residents Basic Residency Deduction increases to $8.25 and $16.50 per day. Medical Expenses: There are four new prescribed expenditures, including the acquisition, cost, care, training and maintenance of service animals who assist people with autism or epilepsy. The capital gains exemption on donations of publicly traded securities to public charities and private donations will be extended to gains realized on the exchange of unlisted securities that are shares or partnership interests for publicly traded securities. Dividend tax credit and gross up rates will drop effective 2010. CCA accelerated rates have been extended in manufacturing and processing and clean energy generation The Scientific Research and Experimental Development Program has been enhanced. Businesses who make source remittances late will get a break on penalities in the first late week. Details of individual provisions follow. Next Time: Taxes Just Keep Rising for Pre-Retiring Baby Boomers and their Heirs. The federal budget predicts that personal tax revenues ñ by far the largest revenue line item for the government ñ will increase by $2 Billion in 2007-2008 and thereafter increase faster than personal income growth to $125,475 Billion in 2009-2010.

For several years now, CRA and Elections Canada have been cooperating and asking taxpayers for permission to update the National Register of Electors based on the information provided on their income tax returns. For 2007, a new question has been added to the T1: ìAre you a Canadian citizen?î. With the addition of this question, CRA can now, with the taxpayerís permission, have the taxpayer's name added to the voterís list if it was not already registered. In prior years, this section of the return was used only to update addresses of those taxpayers who were already on the list. In addition, this year if the return is for a deceased person, the CRA will notify Elections Canada to remove the taxpayerís name from the voting list.

By Evelyn Jacks, PresidentThe Knowledge Bureau If happiness is a by-product of achievement, then planning for one of lifeís most important transitionsófrom economic activity in the workplace to ìeconomic inactivityî in retirementócan provide tremendous peace of mind. It can also result in the satisfaction of knowing your lifetime of work will not only fund your lifestyle, but provide an opportunity to transfer your lifeís workóboth wealth and wisdomófrom one generation to the next. This is, in large part, the key to opening the discussion around retirement income planning for many boomers. Often the soft issuesóthe difference between wants and needsóare the most difficult to approach in the discussion around finances in the last third of life. Busy, full lives are not often conducive to discussions about how to tap into the capital thatís been accumulated or what we leave behind. That of course has always been the reason behind financial planning: to ensure there are enough resources available to meet personal needs and goalsóno matter what lifecycle you find yourself inóand then, if possible, to preserve and pass on a legacy. When you add tax efficiency to that planning mix (which very few do, by the way) you have the recipe for a ìgourmetî retirement. At the beginning of a retirement period clients are more concerned about the former issueówill I have enough to retire? However, as people move through this lifecycle towards the end of retirementódeathóthe legacy issue becomes more important. Legacy planning requires gazing beyond the grave, culminating with an understanding of how existing wealth will crystallize, on an after-tax basis for the use of survivors and more importantly, the family wealth stewards. Therefore a process that helps to identify the structure of stewardship for the transition of wealth from one generation to another is the starting point in a discussion about estate planning. Only then can the right roadmap be crafted for the completion of the journey from a life of work, to lifeís work, to a lifeís legacy. Simply put, there are three prerequisites for successful tax and financial planning that transitions underlying capital from a retirement income plan to an effective estate plan: A structure for identifying issues of concern A formal strategic plan for financial results A process for real wealth management: after tax, inflation-adjusted, cost-controlled Such a process should also deliver, as required, in regular and pre-defined time periods: Ongoing evaluation of the structure by the stewards of the plan Annual measurement and evaluation of net worth In short, for boomers, itís really not about retirement. . .itís all about transitioning from economic activity to a healthy and active lifestyle and an intact financial legacy. Tax and financial advisors need to understand this. For these reasons, we are focusing The Knowledge Bureauís annual Distinguished Advisor Conference on how to tap into this most important planning period for the most affluent, highly educated and socially-engaged generation of pre-retirees in our history. Transitioning: The Path to Reciprocity is the issue; a deep understanding of the triggers that motivate boomers to come to the table for planning will enable the tax and financial advisor to quarterback the successful transition of both wealth and wisdom. The Knowledge Bureau is also pleased to present the Retirement Income Specialist Designation Program by self study which provides designated training in real wealth management focused on tax efficient retirement income planning.

For the first time in history seniors who receive eligible pension income can elect to have their spouse or common-law partner report up to half of that income. Should all taxpayers transfer as much as they can? Is pension splitting good for everyone? The answer to the last question is easy ñ no, not everyone will benefit from splitting pension income. For example, where both spouses have eligible pension income and both are in the highest tax bracket. Likewise when income is low enough that neither spouse is taxable, transferring pension will be of no benefit. The answer to the first question is not so simple. Reducing income for a high-income senior can have several benefits. Along with the obvious reduction in taxes payable at the taxpayerís marginal tax rate, reducing income may also reduce the clawback of Old Age Security and may increase the taxpayerís age amount. However transferring income to a spouse may have the exact opposite effect. So, no simple rule will work for all taxpayers. However, here are some guidelines that will help you to optimize the transfers for most taxpayers. Higher Income Spouse with PensionWhere the spouse who has the pension income is the higher-income spouse, transfer just enough to equalize their taxable incomes. If there is not enough income eligible for transfer, transfer all that is available. This is true even if the other spouse has eligible pension income By equalizing taxable income, the couple will generally pay the minimum amount of tax. td.boxed {border:1px solid black;} Example 1 John Mary Age 66 65 Eligible Pension Income $40,000 Nil Taxable Income $80,000 $46,000 Taxes before splitting* $22,018 $8,564 Proposed pension split -$17,000 $17,000 Taxes after splitting $14,138 $14,138 Tax savings $2,307 ñ in this case, the savings are due mostly to the elimination of the OAS clawback although the age amount is now clawed by for both spouses. * all tax calculations based on 2007 Ontario residents. In fact there is a lot of leeway in the amount selected for transfer with little or no tax effect, so long as both taxpayers are in the same tax bracket (both federally and provincially) and the transfer takes the higher income spouse out of a clawback zone. One Spouse Under 65In cases where the spouse is under 65, it may be beneficial to increase the lower spouseís income even more where the transfer will decrease the older spouseís clawbacks. Example 2 Bill Jessie Age 66 60 Eligible Pension Income $40,000 Nil Taxable Income $80,000 $46,000 Taxes before splitting $22,018 $9,119 Proposed pension split -$20,000 $20,000 Taxes after splitting $13,136 $15,177 Tax savings $2,824 ñ in this case, the savings are due to the elimination of both the OAS and age amount clawbacks. Lower Income Spouse with Pension IncomeWhere the pension income amount claimed by the couple is less than $4,000 it will generally be beneficial to transfer pension income to maximize the pension income amount claimed by the couple, even if you are transferring the income to a spouse who has a higher taxable income. Example 3 Edward Ellen Age 66 60 Eligible Pension Income $10,000 Nil Taxable Income $24,000 $76,000 Taxes before splitting $1,934 $19,294 Proposed pension split -$2,000 $2.000 Taxes after splitting $1,393 $19,750 Tax savings $85 ñ in this case, the savings are due to the increasing the family pension income amount (mitigated by the fact that Ellen pays tax on the income at a higher rate). If your income tax software does not optimize pension income splitting, be sure to look carefully at each return where pension income and spouses are involved. Apply these general rules and answer these questions: Can transfer of pension income equalize the spouseís income tax brackets? Can transfer of pension income reduce the clawback of the age amount or OAS on one return without increasing them on the other? Can transfer of pension income increase the total pension income amount available to the couple?

In our last issue of Breaking Tax and Investment News we covered tax treatment of various foreign pensions. The taxation of German pensions are featured today, as the rules have changed recently and it may be helpful to discuss this with your clients from a retirement income planning point of view. Retirement Pensions [Corrected]Under Canada's tax treaty with the Federal Republic of Germany, retirement pensions form Germany that are received by a Canadian resident are taxable in Canada, and taxable in Germany. The full amount of such pensions, in Canadian dollars, should be included in income. A foreign tax credit is available for any tax withheld at source. War PensionsLikewise, periodic or non-periodic payments received by a resident of Canada from Germany as compensation for an injury or damage as a result of hostilities are taxable only in Germany. Social SecurityAs a result of recent pension reform in Germany, for social security pensions which began in 2005 or earlier, 50% of the pension is non-taxable in Canada 2005 and 2006. After 2006, the dollar amount which was non-taxable in 2006 remains non-taxable in each subsequent year until the year the taxpayer dies. For pensions which begin after 2005, the percentage that is non-taxable in Canada is set in the year the pension starts, see the chart below. The 50% rate for 2005 increases by 2% each year for the period 2006 to 2020 and then increases by 1% each year until the taxable percentage reaches 100% for pensions which begin in 2040 or later. The non-taxable amount determined in the second year remains constant for all subsequent years. Year Pension Starts Taxable Portion Year Pension Starts Taxable Portion Year Pension Starts Taxable Portion 2005 or before 50% 2017 74% 2029 89% 2006 52% 2018 76% 2030 90% 2007 54% 2019 78% 2031 91% 2008 56% 2020 80% 2032 92% 2009 58% 2021 81% 2033 93% 2010 60% 2022 82% 2034 94% 2011 62% 2023 83% 2035 95% 2012 64% 2024 84% 2036 96% 2013 66% 2025 85% 2037 97% 2014 68% 2026 86% 2038 98% 2015 70% 2027 87% 2039 99% 2016 72% 2028 88% 2040 or later 100%  Example: Pensions which begin after 2005 John is a Canadian resident who began receiving monthly payments under the social security legislation of Germany in the amount of $1,000 on July 1, 2006. This pension is taxed as follows: 2006: Total pension received during the year (line 115) = $6,000   Taxable portion = 0.52 x $6,000 = $3,120   Non-taxable amount (line 256) = $6,000 - $3,120 = $2,880 2007: Total pension received during the year (line 115) = $12,000   Taxable portion = 0.52 x $12,000 = $6,240   Non-taxable amount (line 256) = $12,000 - $6,240= $5,760 2008 and later: Non-taxable amount (line 256) remains at $5,760 each year regardless of the amount of pension received (except in the year of death). Proration: Death of Pensioner. In the year the taxpayer dies, the non-taxable portion is prorated for the number of days the person was alive in the year. Audit-proofing. These German pensions and their exempt portions are often audited. The taxpayer must provide the notice issued by the German social security administration, which states when the pension was started. Look for the sentence that reads: "Die Rente beginnt am [xxx date]." (The pension starts on [xxx date].) Survivor s Pensions. If a survivor pension is paid to a surviving spouse, the pension is considered to have started when the original pension started. In the first year of the pension, the applicable percentage is applied to determine the taxable portion. In the second year (the first year that the pension is received for the full year), that percentage is once again applied and the non-taxable portion determined is the non-taxable portion for all subsequent years, until the year of death of the survivor.This topic and over 800 others are discussed in The Knowledge Bureau s EverGreen Explanatory Notes, now available at introductory prices for professionals in the Tax and Financial Services Industry. For more information, click here.

Tax and financial advisors will be interested in CRA s new handbook on securities transactions. The handbook discusses who has to file a T5008 information return to report securities transactions, including some interesting situations like: What are the reporting rules for a hot topic in today s marketótraders in precious metals? (did you know, pawnbrokers who buy gold rings don t have to file a T5008 slip) What are the tax reporting rules for investment counsellors? (they usually use the services of a broker or agent in serving clients but must file form T5008 if they act as agents for their clients in buying and selling securities) The guide goes on to explain the T5008 is not required to report the exchange of old shares for new shares occurring in the course of a reorganization of the capital structure of a corporation as long as the exchange meets the requirements of section 86 of the Income Tax Act, and no consideration other than new shares is receivable. Among other topics, reporting rules for the dissolution and continuation rules for partnerships are also discussed. For more information click here.