When you haven’t filed (or paid) on time
By this time of the year, most Canadian taxpayers have filed their returns for 2014 and received a Notice of Assessment with respect to those returns. Many will have received a refund, while others have received the unwelcome news that money is owed to the Canada Revenue Agency (CRA) and have paid up, however unwillingly.
Although most Canadians do file their returns and pay their taxes on time (90%, according to CRA figures), a significant minority of taxpayers have not yet filed a return for 2014, either out of procrastination or because they believe they owe taxes and don’t have funds available to pay those taxes.
For those who have still not filed for 2014, the best strategy is to file as soon as possible. No matter what one’s tax situation, it won’t be helped by not filing a return. In fact, where taxes are owed, there is an automatic penalty imposed for failure to file on time—even if the return is only one day late. The tax filing deadline for most individuals is April 30 (extended by a few days this year because of an administrative error on the part of the CRA), while self-employed taxpayers and their spouses are required to file on or before June 15. No matter which filing deadline applies, a taxpayer who fails to file by that deadline is assessed an immediate penalty of 5% of the tax amount owing. So a taxpayer who owes $1000 in taxes and doesn’t file on time will have a penalty of $50 added to his or her bill the day after the filing deadline. As well, on ongoing penalty of 1% of the taxes owed is assessed for each full month the return is late, to a maximum of 12 months. A taxpayer who doesn’t get his or her return in during that 12-month period will therefore be assessed a penalty of 17% of the amount of tax owed—in this case, $170.
The news is worse for taxpayers who have a recent history of not filing on time. Where the CRA has assessed a late-filing penalty within the past three years, and the taxpayer fails to file on time for 2014, the failure to file penalty is increased to 10% of any taxes owed for 2014, plus 2% of that amount for each full month the return is late, to a maximum of 20 months. A bit of arithmetic will show that in a worst-case scenario, the late-filing penalty imposed can be as much as 50% of the taxes owed—in this case, $500. Clearly, any taxpayer who hasn’t yet filed his or her tax return for 2014 and owes taxes for that year is well-advised to file as soon as possible, to stop the accumulation of late-filing penalties.
While paying tax penalties isn’t anyone’s idea of a good use of their money, it’s not the end of the story. The CRA charges interest on any taxes owed, starting the day after payment was due—April 30, 2015, for all individual taxpayers. Although interest rates remain near historic lows, the CRA, by law, charges interest at levels higher than normal commercial rates. The interest rate charged by the CRA on overdue or insufficient tax payments is set quarterly. For each quarter, the interest rate charged on taxes owing is equal to the average treasury bill rate in effect during the first month of the previous quarter, plus four percent. For the third quarter of 2015, therefore, covering the months of July, August and September, the interest rate charged on taxes owing is 5%.
While that 5% rate is still lower by far than, for instance, the interest rate charged on most credit card balances or even lines of credit, it is the interest calculation method used by the Agency which can really inflate the interest cost of having tax debts. Where an amount is owed to the CRA, interest charged on that amount is compounded daily, meaning that on each successive day, interest is being levied on the interest charged the day before. Not surprisingly, interest costs calculated in that way can add up quickly.
Perhaps contrary to popular belief, the CRA does have some flexibility. When the amount of taxes owing can’t be paid, or can’t be paid in full, it’s in the taxpayer’s best interests to contact the CRA and let them know of that fact. Not surprisingly, the CRA tries to make it easy for taxpayers to contact them to make such arrangements by providing a toll-free telephone line (1-888-863-8657). The taxpayer can propose a payment schedule based on his or her ability to pay, and the CRA, if satisfied that the inability to pay is genuine, will generally be amenable to entering into some type of payment arrangement. Entering into such a payment arrangement does not, of course, stop the interest clock from running, as interest will continue to be assessed at the current rate, and compounded daily.
One final blow: neither interest paid on tax debts nor penalties paid to the CRA are deductible from income.
The tax benefits of working from home
A number of circumstances and developments have come together to make working from home an attractive prospect for both employers and employees. Soaring house prices in major Canadian cities have driven those who work in those cities further and further afield in the search for affordable housing. Consequently, there are increasing numbers of Canadians who must travel into a major urban centre for work each day, putting already crowded highways and city streets into near-gridlock much of the time. And the summer of 2015 has been more difficult than most for commuters. In addition to the usual delays caused by the summer construction schedule, special events held in major cities have closed or narrowed the usual commuter routes. Any commuter spending hours a day just trying to get to and from work might well wonder whether it’s worth it.
Allowing employees to work from home, at least part of the time, has direct and indirect benefits to employers, too. The ability to work from home is a prized employment “perk” for many Canadians, especially those with young families. Employers who have workplace policies which allow their employees to maintain a healthier work/life balance are more likely to retain those employees. And, having employees work from home on a regular basis raises the possibility of alternatives to traditional office arrangements, meaning that the employer can get by with leasing less expensive downtown office space.
It’s also now a fact of life that there is no longer any technological barrier to working from home. Changes in technology, particularly communications technology, over the past quarter century have enable the home-based worker to have access to all of the information and services available to his or her in-office counterpart
Along with the greater availability of work-from-home arrangements for employees, there has been a significant increase in the number of self-employed Canadians. And while not all of the self-employed work from home, it’s fairly common for those venturing into the world of self-employment for the first time to save costs by operating their business, at least initially, out of a home office.
While for most employees just the prospect of avoiding the commute one or more days a week would be enough to make a work-from-home arrangement attractive, the fact is that there are also tax benefits to be realized. While those benefits are not necessarily as generous as is popularly believed, it is the case that working from home can make costs which would be incurred in any event deductible for tax purposes.
As is usually the case in tax matters, the rules differ for employed taxpayers and for the self-employed, as the latter enjoy a greater degree of latitude in the deductions which may be claimed. That said, both the employed and the self-employed must meet the same basic two-part test in order to be eligible to deduct home office expenses, and that test is as follows:
- the home office must be the place at which the taxpayer principally (defined by the Canada Revenue Agency (CRA) as more than 50% of the time) performs the duties of employment or must be the taxpayer’s principal place of business; or
- the home office must be both used exclusively for the purpose of earning income from employment or from the business and must be used on a regular and continuing basis for meeting customers or clients of the employer or the business.
A self-employed taxpayer who meets these criteria is entitled to claim (on Form T2125(E), Statement of Business Activities) expenses such as property taxes, rent, or mortgage interest (but not mortgage principal amounts), insurance, utilities costs, etc. However, such expenses are not deductible in their entirety; rather, the taxpayer must apportion the expenses based on the percentage of the total space which is used as a home office. For example, a self-employed taxpayer whose home office takes up 15% of available floor space and who incurs $2,000 each year in qualifying expenses would be entitled to deduct $300 ($2,000 × 15%) in home office expenses for that year. There is one further caveat, in that the amount of home office expenses claimed in a year cannot be greater than the amount of income from the business. It’s not, in other words, possible to run a business which produces $5,000 in income for the year and to then claim $10,000 in home office expenses relating to that business. However, where home office expenses exceed business income in any given year, the excess expenses can be carried over and claimed in a subsequent year in which there is sufficient business income to offset those expenses.
Employed taxpayers who meet the two-part test set out above must meet a further condition before being eligible to claim home office expenses, as follows:
- the employer must provide the employee with a Form T2200, which indicates that the employee is required by his or her contract of employment to provide and pay for the expenses related to the home office;
- the employee must not have been reimbursed by the employer for such expenses; and
- the expenses must have been used directly in the employee’s work at home.
Once the T2200 has been issued, and the other conditions are met, an employee who is a tenant can claim a proportionate part of his or her rent. An employee who owns his or her own home can claim a proportionate percentage of utilities and maintenance costs. An employee is not, however, entitled to claim any portion of mortgage interest, property taxes or home insurance costs paid and cannot claim capital cost allowance.
As is the case with self-employed taxpayers, an employee’s deduction for home office expenses cannot be greater than the income from employment income for the year to which the expenses relate. And, once again, carryover to a subsequent taxation year is allowed.
One of the tax benefits which is commonly supposed to exist for the home office workers is the right to claim depreciation (or capital cost allowance (CCA), in tax parlance) on one’s home for tax purposes. For employees, however, such a claim is simply not allowed. And, while the self-employed may be entitled to claim CCA on a home, making such a claim can create a short-term benefit with long-term costs. Making a CCA claim on one’s home is likely to erode the principal residence exemption from capital gains tax which is claimable when a home is sold, and that exemption is almost always more valuable, in monetary and tax terms, than any CCA claim which might have been made.
Being able to claim home office expenses doesn’t result in the huge tax benefits that some popular tax myths claim. However, it can and does permit qualifying taxpayers to claim a portion of home ownership (or rental) expenses which would have been incurred in any case, while also avoiding the dreaded daily commute, making it a win-win situation.
Legal fees – what’s deductible and when?
For most Canadians, having to pay for legal services is an infrequent occurrence, and most of us would like to keep it that way. In most instances, the need to seek out and obtain legal services (and to pay for them) is associated with life’s more unwelcome occurrences—a divorce, a death, or a job loss. About the only thing that mitigates the pain of paying legal fees (aside, hopefully, from a successful resolution of the problem that created the need for legal advice) would be being able to claim a tax credit or deduction for the fees paid.
Unfortunately, while there are some circumstances in which such a deduction can be claimed, those circumstances don’t usually include the routine reasons—purchasing a home, getting a divorce, or establishing custody rights—for which most Canadians incur legal fees. Generally, personal (as distinct from business-related) legal fees become deductible for most Canadian taxpayers only where they are seeking to recover amounts which they believe are owed to them, particularly where those amounts involve employment or employment-related income or, in some cases, family support obligations.
The first situation in which legal fees paid may be deductible is that of an employee seeking to collect (or to establish a right to collect) salary or wages. In all Canadian provinces and territories, employment standards laws provide that an employee who is about to lose his or her job (for reasons not involving fault on the part of the employee) is entitled to receive a specified amount of notice, or salary or wages equivalent to such notice. In many cases, however, the employee can establish a right to a period of notice (or payment in lieu) greater than the statutory minimum. The amount of notice or payment in lieu of notice which is payable becomes a matter of negotiation between the employer and its former employee, and such negotiations usually involve legal representation and consequently, legal fees. In that situation, legal fees incurred by the employee to claim amounts owed to him or her by the employer are deductible by that former employee. If, as sometimes occurs, the matter goes to court and the court orders the employer to reimburse its former employee for some or all of the legal fees incurred, the amount of that reimbursement must be subtracted from any deduction claimed. In other words, the former employee can claim a deduction only for legal fees which he or she was personally required to pay and for which he or she was not reimbursed.
In some situations, an employee or former employee seeks legal help in order to collect or to establish a right to collect a retiring allowance or pension benefits. In such situations, the legal fees incurred can be deducted, up to the total amount of the retiring allowance or pension income actually received for that year. Where part of the retiring allowance or pension benefits received in a particular year is contributed to a registered retirement savings plan or a registered pension plan, the amount contributed must be subtracted from the total amount received when calculating the maximum allowable deduction for legal fees. However, where all legal fees incurred can’t be claimed in the current year, they can be carried forward and claimed on the return for any of the 7 subsequent tax years.
The rules covering the deduction of legal fees incurred where an employee claims amounts from an employer or former employer are relatively straightforward. The same, unfortunately, cannot be said for the rules governing the deductibility of legal fees paid in connection with family support obligations. Those rules have evolved over the past number of years in a somewhat piecemeal fashion – the current “state of play” is as follows.
Legal fees incurred by either party in the course of negotiating a separation agreement or obtaining a divorce are not deductible. Such fees paid to establish child custody or visitation rights are similarly not deductible by either parent.
Where, however, one former spouse has the right to receive support payments from the other, there are circumstances in which legal fees paid in connection with that right are deductible. Specifically, legal fees paid for the following purposes will be deductible by the person receiving those support payments:
- collecting late support payments;
- establishing the amount of support payments from a current or former spouse or common-law partner;
- seeking an increase in support payments;
- seeking an order making child support amounts received non-taxable; or
- establishing the amount of support payments from the legal parent of that person’s child (who is not a current or former spouse or common-law partner). However, in these circumstances the deduction is allowed only where the support is payable under a court order, not simply under the terms of an agreement between the parties.
On the other side of the support equation, the situation is not nearly as favourable, since a deduction for legal fees incurred in relation to support obligations will generally not be allowed to a person paying support. More specifically, as outlined on the Canada Revenue Agency (CRA) website, a person paying support cannot claim legal fees incurred in order to “establish, negotiate or contest the amount of support payments”.
Finally, where the CRA reviews or challenges income amounts, deductions or credits reported or claimed by a taxpayer, fees (which in this case includes accounting fees) paid for advice or assistance in dealing with the CRA’s review, assessment, or reassessment can be deducted by the taxpayer.
Deciding whether to put off receiving Old Age Security benefits
The current election campaign has once again focused the attention of Canadians, especially the baby boomers, on changes announced in 2012 to Canada’s retirement income system. One of the results of those changes is that Canadians aged 65 and over can, as of July 1, 2013, choose to defer receipt of their Old Age Security (OAS) benefits. What’s more difficult is deciding, on an individual basis, whether it makes sense to defer receipt of those benefits and, if so, for how long.
To make sense of the change, and to help with the decision, a bit of background is helpful. The OAS program is one of two federal government programs which provide income to Canadians during retirement, the other such program being the Canada Pension Plan (CPP). While the CPP is funded by contributions made by Canadians and their employers during the working lives of those Canadians, the OAS is a non-contributory plan, for which benefits are paid out of general revenues of the federal government. Eligibility for OAS benefits is based on an individual’s age and number of years of Canadian residence. Anyone who is 65 years of age or older and has lived in Canada for at least 40 years after the age of 18 is eligible to receive the maximum benefit. As of September 2015, that maximum monthly benefit is $565.
Following the changes announced in 2012, Canadians eligible to receive OAS benefits would be able to defer receipt of those benefits for up to five years, until they turn 70 years of age. For each month that an individual Canadian deferred receipt of those benefits, the amount of benefit eventually received would increase by0.6%.The longer the period of deferral, the greater the amount of monthly benefit eventually received. Where receipt of OAS benefits is deferred for a full 5 years, until age 70, the monthly benefit received is increased by 36%.
The decision of whether to defer receipt of OAS benefits and for how long is very much an individual one—there really aren’t any “one size fits all” rules. There are, however, some general considerations which are common to most taxpayers. Essentially, the first consideration in determining when to begin receiving OAS benefits requires the taxpayer who is turning 65 to consider how much total income is needed to finance current needs and the extent to which other sources of income are available to him or her to meet those needs. It’s also necessary to determine what other sources of income (Canada Pension Plan retirement benefits, employer-sponsored pension plan benefits, required RRSP withdrawals) will become available in the future and when receipt of those income amounts will commence. Once income needs and sources and the possible timing of each is clear, it’s necessary to consider the income tax implications of how receipt of those sources of income is structured. In doing so, taxpayers need to be aware of the following income tax thresholds and cut-offs.
- Income in the first federal tax bracket is taxed at 15%, while income in the second bracket is taxed at 22%. For 2015, that second income tax bracket begins at taxable income of $44,701.
- The Canadian tax system provides (for 2015) a non-refundable tax credit of $7,033 for taxpayers who are over the age of 65 at the end of the tax year. That amount of that credit is reduced once the taxpayer’s net income for the year exceeds $35,466, and disappears entirely for taxpayers with net income over $82,353.
- Individuals can receive a GST/HST refundable tax credit, which is paid quarterly. For 2015, the full credit is payable to individual taxpayers whose net income is less than $35,465.
- Taxpayers who receive Old Age Security benefits and have income of more than at income) are required to repay a portion of those benefits. Benefits begin to be “clawed back” when taxpayer income for 2015 is more than $72,809. Taxpayers having income of over $117,954 are not eligible for OAS and must repay any OAS benefits received.
The goal, as always, is to ensure sufficient income to finance a comfortable lifestyle while at the same time minimizing both the tax bite and the potential loss of tax credits or the need to repay benefits received. Taxpayers who are trying to decide when to begin receiving OAS benefits could, depending on their circumstances, be affected by one or more of the following considerations.
What other sources of income are currently available?
More and more, Canadians are not automatically leaving the work force at the age of 65. Those who continue to work at paid employment and whose employment income is sufficient to finance their chosen lifestyle may well prefer to defer receipt of OAS. Similarly, a taxpayer who begins receiving benefits from an employer’s pension plan when he or she turns 65 may be able to postpone receipt of OAS benefits.
Is the taxpayer eligible for Canada Pension Plan retirement benefits, and at what age will those benefits commence?
Nearly all Canadians who were employed or self-employed after the age of 18 paid into the Canada Pension Plan and are eligible to receive CPP retirement benefits. While such retirement benefits can be received as early as age 60, receipt can also be deferred until the age of 70. As is now the case with OAS benefits, CPP retirement benefits increase with each month that receipt of those benefits is deferred. Taxpayers who are eligible for both OAS and CPP will need to consider the impact of accelerating or deferring the receipt of each benefit in structuring retirement income.
Does the taxpayer have private retirement savings through an RRSP?
Taxpayers who were not members of an employer-sponsored pension plan during their working lives generally save for retirement through a registered retirement savings plan (RRSP). While taxpayers can choose to withdraw amounts from such plans at any age, they are required to collapse their RRSPs by the end of the year in which they turn 71, and to begin receiving income from those savings. There are a number of options available for structuring that income, and, whatever the option chosen (usually, converting the RRSP into a registered retirement income fund or RRIF, or purchasing an annuity) will mean that the taxpayer will begin receiving income amounts from those RRSP funds in the following year. Taxpayers who have significant retirement savings in RRSPs should, in determining when to begin receiving OAS benefits, consider that they will have an additional (taxable) income amount for each year after they turn 71.
Finally, not all of the factors in deciding how to structure retirement income are based on purely financial and tax considerations. There are other, more personal issues and choices which come into play, including the state of one’s health at age 65 and the consequent implications for longevity, which might argue for accelerating receipt of any available income. Conversely, individuals who have a family history of longevity and who plan to continue working for as long as they can may be better off deferring receipt of retirement income where such deferral is possible.
Many Canadians put off plans, like a desire to travel, until their retirement years. Realistically, from a health standpoint, such plans are more likely to be possible earlier rather than later in retirement. Generally speaking, the early years of retirement are the most active years, and the years in which expenses for activities are likely to be highest. Having such plans might argue for accelerating income into the early retirement years, when it can be used to make those plans possible.
The ability to defer receipt of OAS benefits does provide Canadians with more flexibility when it comes to structuring retirement income. The price of that flexibility is increased complexity, particularly where, as is the case for most retirees, multiple sources of income and the timing of each of those income sources must be considered, and none of them can be considered in isolation from the others.
Individuals who are facing that decision-making process will find some assistance on the Service Canada website. That website provides a Retirement Income Calculator, which, based on information input by the user, will calculate the amount of OAS which would be payable at different ages. The calculator will also determine, based on current RRSP savings, the monthly income amount which those RRSP funds can provide during retirement. Finally, taxpayers who have a Canada Pension Plan Statement of Contributions which outlines their CPP entitlement at age 65 will be able to determine the monthly benefit which would be payable where CPP retirement benefits commence at different ages between 60 and 70.
The Retirement Income Calculator can be found at http://www.servicecanada.gc.ca/eng/isp/common/cricinfo.shtml.