Module 7: Taxable income and tax payable Individuals

Transcription

1 Module 7: Taxable income and tax payable Individuals Overview In Modules 2 to 6 you studied the components that enter into the computation of net income under section 3. Once that computation is complete, two steps are left in determining a taxpayer's tax payable: determining taxable income [subsection 2(2)] computing tax payable on that taxable income Computing taxable income and determining tax payable differ, depending on whether the taxpayer is an individual or a corporation. This module covers the rules that apply to an individual. Modules 8 and 9 will cover the computation of taxable income and tax payable for corporations. By the end of this module, you will be able to calculate the taxable income of an individual and determine the federal tax payable. Comprehensive computer illustrations that summarize the topics in this module and previous modules will allow you to improve your competency in the computation of net income, taxable income, and income tax payable. Test your knowledge Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study required. Module Deductions in computing taxable income 7.2 Deductions in computing taxable income losses 7.3 Capital gains deduction 7.4 Computing Part I tax 7.5 Refundable and non-refundable tax credits 7.6 Computing tax under Part I.2 and split income 7.7 Computer illustration 7.7-1: Preparing a complete income tax and benefit return, example A 7.8 Computer illustration 7.8-1: Preparing a complete income tax and benefit return, example B Learning objectives 7.1 Calculate taxable income and explain the order in which deductions must be claimed. (Levels 1 and 2) 7.2 Explain the concept of loss carryover and apply the process to carry over losses by category. (Level 1) 7.3 Calculate the capital gains deduction in simple cases. (Level 2) 7.4 Compute tax under Part I, describe the functioning of tax brackets, the importance of the marginal tax rate, and the general principles of tax planning. (Level 1) 7.5 Identify and apply the available tax credits. (Levels 1 and 2) 7.6 Compute Part I.2 tax and tax adjustments related to split income. (Level 2) 7.7 Use Cantax to prepare a complete income tax return and calculate net income under section 3, taxable income, and federal tax payable for an individual. (Level 1) 7.8 Use Cantax to prepare a complete income tax return and calculate net income under section 3, taxable income, and federal tax payable for an individual. (Level 1) file:///f /Courses/ /CGA/TX1/06course/m07intro.htm[11/10/2010 4:43:07 PM]

2 Assignment reminder: Assignment #2 is due this week (see Course Schedule). Please allocate time to complete and submit the assignment by the deadline. Assignment #3 (see Module 9) is due at the end of week 9 (see Course Schedule). You may wish to take a look at it now in order to familiarize yourself with the requirements and to prepare for any necessary work in advance. Module summary Print this module file:///f /Courses/ /CGA/TX1/06course/m07intro.htm[11/10/2010 4:43:07 PM]

3 7.1 Deductions in computing taxable income Learning objective Calculate taxable income and explain the order in which deductions must be claimed. (Levels 1 and 2) Required reading Optional reading LEVEL 1 Text: 3,260 to 3,290 (review); 10,005 to 10,015.50; 10,075 (Level 1) Text: 10,020; 10,025 (Level 2) ITA: 110(1)(d) and (d.1) (Level 1) ITA: 80.4(4), 110(1)(j) (Level 2) ITA: Definitions, 248(1) home relocation loan (Level 2) ITA: 110(1)(f), Income calculated under section 3 is not necessarily the amount on which tax is calculated. A further step is required in order to arrive at taxable income. Deductions not allowed in the calculation of net income may be claimed under this step. These deductions are not allowed in computing net income because they are not related to the income earning process for the year, but to the personal situation of the taxpayer. Income is the basis for many deductions or credits (for example, medical expenses and charitable donations), and so should not be affected by these extra deductions under the principle of tax equity. Employee stock options In Module 2, you learned about the stock option benefit for employees. In certain circumstances, employees who have a stock option benefit are allowed a deduction. Where this deduction is allowed, the end result is that only one-half of the benefit is taxable, which elicits the same result as capital gains taxation. Since the benefit is employment income and not a capital gain, the capital gains deduction cannot be claimed against it when the shares qualify as qualified small business corporation shares. Note that the employment benefit under subsection 7(1) is part of the income calculation; the section 110 deduction is part of the taxable income calculation. Do not net the amounts under the calculation of section 3 income. The discussion in 3,288 of the text regarding the 2010 federal budget proposed changes is not examinable. The stock option deduction involves prescribed shares. In this course, the identification of prescribed shares is not examinable. The text summarizes the ITA as it relates to stock option benefits in sections 3,260 to 3,290. The table in section 10, shows the effects of the stock option deduction to complete the subject introduced in section 3,290. The table is based on situations where the issuer and the employee are dealing at arm's length. Activity Stock option deduction In this activity, you apply what you have learned about the different tax treatment given to stock options deductions, depending on the type of corporation. file:///f /Courses/ /CGA/TX1/06course/m07t01.htm[11/10/2010 4:43:08 PM]

4 7.2 Deductions in computing taxable income losses Learning objective Explain the concept of loss carryover and apply the process to carry over losses by category. (Level 1) Required reading LEVEL 1 Deductible losses Text: 10,030 to 10,045.30; 10,080; 11,080; 11,085 (except Example Problem) (Level 1) ITA: 111(1)(a) to (d), 111(1.1), 111(3), (Level 1) ITA: 31 (Level 2) ITA: Definitions, 111(8): net capital loss, non-capital loss (Level 1) ITA: Definitions, 111(8): farm loss (Level 2) The topic of deductible losses is very important. The utilization of current year losses is not discretionary. Paragraph 3(d) contains the aggregating formula, which states that a loss from a particular source, except capital losses, must first be applied against current sources of income in determining net income for tax purposes. Since net income for tax purposes cannot be negative, unused losses are subject to carryback and carryforward rules. Losses that are deductible in computing taxable income (under Division C) are losses carried over from other years. For this course, you are required to know the rules relating to non-capital losses net capital losses farm losses restricted farm losses Non-capital losses Non-capital losses are primarily comprised of employment and business losses, losses from property, and allowable business investment losses. Losses from a farming business are included in a separate category. The computation of a non-capital loss carryforward for a particular year, in the case of most individuals, is summarized in section 10,035 of the text. This summary shows that a non-capital loss is basically the excess of losses from an office, employment, business, and property, and business investment losses for the year over the amount computed under paragraph 3(c) with the following important adjustments as provided for in the definition of non-capital losses in subsection 111(8): 1. A taxpayer can claim the capital gains deduction or net capital losses against the excess of taxable capital gains over allowable capital losses for the year, included in income under paragraph 3(b), if preferable. The adjustment is necessary because the non-capital loss was reduced by the taxable capital gains since they are included in the amount computed under paragraph 3(c); 2. An individual has the benefit of the deductions for employee stock options, home relocation loans, and other payments, even if there is no net income under section 3. If these amounts were not added to the non-capital loss, they would be lost forever. This is why reference is made file:///f /Courses/ /CGA/TX1/06course/m07t02.htm[11/10/2010 4:43:09 PM]

5 to amounts deductible. 3. Another important adjustment required to compute the non-capital loss for a particular year is the addition of any net capital losses that are carried forward and deducted in that particular year. This rule provides the means for a loss under paragraph 3(d) that must be used against taxable capital gains for that year, to be reinstated as a non-capital loss. This is possible only if a net capital loss of another year is used in the particular year. Thus, net capital losses carried forward can be used against current year taxable capital gains before current-year non-capital losses. 4. The final adjustment is to determine if all or part of this loss may be considered a farm loss. If this is the case, the non-capital loss is reduced by the amount that qualifies as a farm loss, as farm losses are subject to their own specific provisions. Net capital loss The net capital loss incurred by a taxpayer in a taxation year is equal to the excess of the amount computed under subparagraph 3(b)(ii) over the amount computed under subparagraph 3(b)(i). The text outlines how to adjust losses from a year in which the capital gains inclusion rate is not the same as in the year in which the deductible loss is claimed. A simple and practical method of accomplishing the same result is to apply the current inclusion rate to the gross amount of the original loss. For example, a $750 allowable capital loss from 1991 to be used in 2010 is computed formally as $750 (1/2 3/4) = $500 and is computed informally using the gross amount of the original loss as $1,000 1/2 = $500. When reading paragraphs 111(1)(a), (b), (c), and (d), you will notice that there appears to be a difference between the periods mentioned in the ITA and the periods shown in the course material. This is because the course material refers the carryover periods to the year of loss while the ITA refers the carryover periods to the year of claim. For example, paragraph 111(1)(c) for restricted farm losses, which considers the year of claim, states restricted farm losses for the 20 taxation years immediately preceding and the 3 taxation years immediately following the year; If you are doing a 2030 taxable income calculation and want to consider what losses may be available to you, paragraph 111(1)(c) tells you that you could use restricted farm losses incurred from 2010 to 2029 (the 20 taxation years immediately preceding) and from 2031 to 2033 (the three taxation years immediately following the year). Considering the terminology in the course material, that is, losses from the year of origin, if you had a restricted farm loss in 2010 (year of occurrence), you could carry it forward 20 years to 2030 (year of claim). The timing of loss utilization is also important. Generally, a taxpayer should carry losses back if there is income to offset the losses, because a known refund available from a prior year is superior to the uncertainty of the future application of losses. Consideration should also be given to the tax rates in the year of loss application. Some taxpayers are reluctant to carry losses back as they do not want to leave a taxation year open to audit beyond the normal reassessment period. They reason that the administration costs connected with an audit outweigh the advantage of the certainty of the tax refund. This is a decision that can only be made after consideration of all the circumstances. Individual taxpayers should ensure they have utilized their personal tax credits before claiming their loss carryovers to reduce their taxable income. LEVEL 2 Farm losses file:///f /Courses/ /CGA/TX1/06course/m07t02.htm[11/10/2010 4:43:09 PM]

6 Note that the farm loss referred to in subsection 111(8) is a loss to a taxpayer whose chief source of income is farming or a combination of farming and another source (that is, not a restricted farm loss). LEVEL 1 Example Bertrand Tremblay has the following income for 2010: Salary $35,000 Taxable benefit under section 7 (a deduction under paragraph 110(1)(d.1) is allowed) $4,000 Taxable capital gains $8,000 Allowable capital losses (including a $40,000 allowable business investment loss) $42,000 Business loss $13,000 Farm loss (not subject to the rules on restricted farm losses) $6,000 Compute Bertrand's net income under section 3 for Solution file:///f /Courses/ /CGA/TX1/06course/m07t02.htm[11/10/2010 4:43:09 PM]

7 Example solution Paragraph 3(a) Salary $35,000 Taxable benefit under section 7 4,000 39,000 Paragraph 3(b) Taxable capital gains $8,000 Less: Allowable capital losses in excess of allowable business investment loss ($42,000 - $40,000) (2,000) 6,000 45,000 Paragraph 3(c) No amount deductible under subdivision e 45,000 Paragraph 3(d) Business loss 13,000 Farm loss 6,000 Allowable business investment loss 40,000 (59,000) Net income under section 3 (cannot be a negative amount) $ Computation of non-capital loss under subsection 111(8): Business loss $13,000 Farm loss 6,000 Allowable business investment loss 40,000 Amount deductible under paragraph 110(1)(d.1) 1 2,000 61,000 Less: Amount computed under paragraph 3(c) (45,000) Farm loss 2 (6,000) Non-capital loss $10,000 1 Since Bertrand's net income under section 3 is equal to zero, he cannot deduct any amount in computing his taxable income. The amount deductible under paragraph 110(1)(d.1), (1/2 $4,000), which cannot be deducted, is added to the non-capital loss. 2 The farm loss is computed under subsection 111(8). It is the lesser of: the farm loss of $6,000 the non-capital loss before deduction of the farm loss of $16,000 ($61,000 - $45,000) From this example, you can see the allowable business investment loss, which is in fact a capital loss, enters into the computation of the non-capital loss. file:///f /Courses/ /CGA/TX1/06course/m07t02sol.htm[11/10/2010 4:43:09 PM]

8 7.3 Capital gains deduction Learning objective Calculate the capital gains deduction in simple cases. (Level 2) Required reading LEVEL 2 Text: 10,060 to 10,066; 13,340 to 13,385 (Level 2) ITA: 110.6(2), 110.6(2.1), 110.6(2.2), 110.6(4) (Level 2) ITA: Definitions, 110.6(1): annual gains limit, cumulative gains limit, cumulative net investment loss, investment expense, investment income, qualified farm property, qualified fishing property, qualified small business corporation share (Level 2) The capital gains deduction (CGD) provided for in section 110.6, is an important deduction in computing an individual's taxable income. The February 22, 1994 federal budget eliminated the $100,000 lifetime general capital gains deduction for gains realized on dispositions of property occurring after the budget date. The budget contained a provision that would allow an individual to file an election with their 1994 tax return to recognize an amount of accrued gain (up to February 22, 1994) that could be offset by the available capital gains exemption. You are not required to learn the technical details of the election for property held on February 22, What you should remember is that when an individual has made the election, the deemed ACB of the property covered by the election is equal to the amount designated in the election. Computation of the CGD Some of the numbers in the calculation will change based on the years involved and the inclusion rate. The important factor is to recognize the gross amounts versus the amount after the inclusion rate. For example, up to $750,000 in capital gains may be tax free for dispositions on or after March 19, 2007 if the full capital gains deduction is available. It is taxable capital gains, not capital gains that are included in income; therefore, at an inclusion rate of 1/2, $375,000 of taxable capital gains may be tax free. Following is a summary of the important points to consider when claiming the CGD: 1. The CGD can only be claimed by an individual who is resident in Canada. 2. The CGD is only available for capital gains realized on the disposition of "eligible property," that is, qualified small business corporation shares, qualified farm property, and qualified fishing property under subsections 110.6(2), (2.1), and (2.2). 3. The maximum CGD that may be claimed in a taxation year is the least of: a. Unused lifetime deduction Maximum deduction allowed less amounts used in previous years adjusted to take into account the changes in the inclusion rates of capital gains b. Annual gains limit file:///f /Courses/ /CGA/TX1/06course/m07t03.htm[11/10/2010 4:43:10 PM]

9 The lesser of: Less: c. Cumulative gains limit Net taxable capital gains for the year under paragraph 3(b) Net taxable capital gains for the year from the disposition of qualified farm property, fishing property, and small business corporation shares Net capital losses deducted in computing taxable income for the year used to offset taxable capital gains that are eligible for the CGD ABIL realized (or claimed) for the year Cumulative net taxable capital gains eligible for the CGD, as determined each year under the annual gains limit starting in 1985 Less: Net capital losses deducted since 1985 to offset taxable capital gains eligible for the CGD ABIL realized after 1984 CNIL at the end of the year All amounts deducted as CGD in prior years (not adjusted for change in inclusion rates) 4. The cumulative net investment loss (CNIL) only affects the determination of the cumulative gains limit. Note the terminology is investment income and expenses, not property income and expenses. As noted in the text, CNIL is the aggregate of all investment income and investment expenses since Some amounts are specifically excluded from investment income, such as the amount included in income with respect to shareholder loans under subsection 15(2). Also included in investment income are net taxable capital gains that are not eligible for the CGD. When the non-eligible taxable capital gain included in investment income has been offset by the deduction of net capital losses, such losses are added to investment expenses. 5. When determining the unused portion and the cumulative gains limit, capital gains eligible for the former $100,000 lifetime CGD and the CGD claimed on such gains are taken into account. The calculations required to determine the CGD are numerous and complex. A T1 software program facilitates the computation by automatically transferring information from one schedule to another, especially for carryforward amounts from prior years, in addition to doing the calculations automatically for each class of property for which the CGD may be claimed. file:///f /Courses/ /CGA/TX1/06course/m07t03.htm[11/10/2010 4:43:10 PM]

10 7.4 Computing Part I tax Learning objective Compute tax under Part I, describe the functioning of tax brackets, the importance of the marginal tax rate, and the general principles of tax planning. (Level 1) Required reading LEVEL 1 Text: 10,110 to 10,125, 10,135 (Level 1) ITA: 117(2), 117.1(1), 117.1(3), 117.1(4) (Level 1) The first step in computing Part I tax payable is to apply the appropriate tax rates to the individual's taxable income. Subsection 117(2) gives the tax rates applicable to individuals for the purposes of computing Part I tax. However, the amounts of taxable income given in subsection 117(2) are adjusted, or indexed, annually under subsection 117.1(1). Therefore, you cannot assume that the taxable income levels stated in subsection 117(2) are current. For an overview of the individual tax rates and the major personal tax credits for 2009 and 2010, refer to "Tax rates" on the course navigation pane. You can also find the 2009 and 2010 indexed tax rates at the beginning of your print version of the ITA. Another source that is usually the most current is the CRA News Release (or Fact Sheet) following subsection 117.1(1). In this module, you will use both 2009 and 2010 rates. The 2009 rates will be used in the computer illustrations as well as in any review or assignment questions involving Cantax. The balance of the material will use 2010 rates. For examination purposes, the rates will be given on the front of the examination booklet. The annual adjustment provided for in subsection 117.1(1) also applies to personal tax credits and almost all other credits, as you will see in the next topic. This adjustment is intended to compensate in part for the increase in the cost of living, and is based on the increase in the Consumer Price Index (CPI) for the 12 months ending on September 30 of the preceding year [subsections 117.1(1), (3), and (4)]. Year 2009 Applies to income between Year 2010 Applies to income between 15% $0-$40,726 15% $0-$40,970 22% $40,727 to $81,452 22% $40,971 to $81,941 26% $81,453 to $126,264 26% $81,942 to $127,021 29% $126,265 and over 29% $127,022 and over There are two useful tax rates the effective and the marginal tax rates. The effective tax rate is the real tax rate payable on a specific amount of taxable income. It is the real disbursement, expressed as a percentage. For example, if the federal income tax payable on a taxable income of $40,970 is $6,146, the effective tax rate is 15%. The marginal tax rate is the additional income tax payable if one dollar of income is added to the taxable income already computed. For example, a wage earner deciding whether or not to work overtime needs to know what will be left after tax. The marginal tax rate is also the decrease in income tax payable if one dollar of deduction is removed from the taxable income. For example, if an individual contributes to an RRSP and if the taxable income is $45,000, the federal marginal tax rate will be 22% (except for a Quebec resident). Planning From a tax planning perspective, it is often advantageous to have income taxed in the hands of more than one individual to benefit from the progressive rates to minimize tax payable. For example, if an individual has a taxable income of $100,000, the federal income tax payable for 2010, before any credits, is $19,854. If this file:///f /Courses/ /CGA/TX1/06course/m07t04.htm[11/10/2010 4:43:11 PM]

11 income is split between two taxpayers, each declaring $50,000 of taxable income, the federal income tax payable, before any credits, would be $8,132 each, for a total of $16,264. Income splitting is generally arranged among members of the same family. The ITA has introduced rules to reduce the opportunities for income splitting in certain circumstances. Examples are the attribution rules or the tax on split income (also known as the "kiddie tax.") However, income splitting is still possible and is the basis for many tax planning structures. There are four categories of tax planning opportunities: 1. shifting income from one time period to another, which includes deferring the liability for tax 2. transferring income to another entity, which is in substance income splitting between entities and may result in a deferral of income or cumulatively a reduction in total tax payable on the income 3. converting the nature of income from one type to another (for example, income characterized as a capital gain versus business income) 4. management of deductions and credits A tax plan is always influenced by the tax system. Tax planning uses the features of the system in order to reduce tax payable. In this respect, important variables to consider when designing a tax plan are: the types of income, the entities subject to taxation, the forms of business structure used by taxable entities, and the tax jurisdiction. file:///f /Courses/ /CGA/TX1/06course/m07t04.htm[11/10/2010 4:43:11 PM]

12 7.5 Refundable and non-refundable tax credits Learning objective Identify and apply the available tax credits. (Levels 1 and 2) Required reading Optional reading LEVEL 1 Text: 10,140 to 10,385; 10,410; 10,500; 10,530 (Level 1) Text: 10,490 (Level 2) ITA: 118 to 118.9, , 121, 127(3), 252(2) (Level 1) ITA 20(11) and (12), 126 (Level 2) Text: 10,130 (provincial and territorial tax); 10,420 (income not earned in a province) ITA: 64, 120(1) and (2) IT: 270R3, 513R, 515R2, 516R2, 519R2(2), (5) to (9) and (19) to (66) IC: 75-2R7 Non-refundable tax credits reduce federal tax payable computed under section 117. They are called non-refundable because if they exceed tax payable, the difference is not refunded to the individual, unlike refundable tax credits. You will study some credits that are reduced based on income levels, and so not all taxpayers are afforded the same non-refundable credits because of family income. Note: You do not have to memorize the amounts of the various tax credits. There is a summary of "Current Tax Rates and Credits" for 2010 in the front section of the ITA and relevant amounts will be reproduced on the final examination. Personal tax credits Carefully review the computation of personal tax credits in the text reading. Note that a person entitled to a disability pension is not necessarily entitled to the disability tax credit. In addition, if an individual is entitled to claim the disability tax credit, the disability supports deduction is available under section 64 in computing net income. The expense must have been incurred for personal care necessary to enable the individual to work or carry on research and for disability supports expenses incurred for education or employment purposes (for example, sign language interpreter, electronic speech synthesizers) provided the taxpayer has not been reimbursed for the expenses. Note that this deduction differs from attendant care expenses that qualify for the medical expense credit. This deduction is not examinable. Planning When claiming the non-refundable tax credits, an individual should consider the following tax-planning opportunities: In the year that a separation occurs, a taxpayer may choose between claiming the spousal support paid as a deduction or the spouse or common-law partner credit. The choice will depend on which deduction or credit gives the greater tax benefit. file:///f /Courses/ /CGA/TX1/06course/m07t05.htm[11/10/2010 4:43:11 PM]

13 Do not use deductions to reduce income to zero if the deductions may be carried forward. This way the taxpayer has full access to non refundable tax credits and can claim discretionary deductions in a high-income year when their marginal tax rate is higher to provide the greatest tax advantage. An individual who does not live with a spouse or common-law partner and who supports and lives with a related person who is either under 18 years of age or, if over 18 years of age, dependent by reason of mental or physical disability, should claim the eligible dependant credit. When a spouse/common-law partner or a dependant cannot claim the following credits, they may, under certain conditions, be transferred to the other spouse/common-law partner or to the supporting person: tuition, education, and textbook credits disability credit age credit (spouse/common-law partner only) pension credit (spouse/common-law partner only) Since medical expenses can only be claimed if they exceed the lesser of $2,024 (for 2010) or 3% of net income, the spouse/common-law partner with the lower net income should claim the medical expense credit for both. The medical expense credit can be claimed in respect of medical expenses paid for a period of 12 consecutive months ending in the taxation year. Therefore, the choice of an appropriate period will allow the taxpayer to maximize the credit. The charitable gift tax credit is 15% on the first $200 and 29% on any gift over $200. In order to maximize this credit (that is, claim the 29% credit rate on a greater amount), an individual should consider: combining charitable gifts for two or more years combining the charitable gifts of both spouses/common-law partners (administratively, the CRA allows a taxpayer to claim the charitable gift credit in respect of gifts for which the receipt is made in the name of the spouse or common-law partner, as long as the spouse/common-law partner does not also claim a credit for this gift) timing the charitable gifts, for example, make a gift in December instead of January of the following year to take advantage of the 29% rate and deduction of the credit a year earlier file:///f /Courses/ /CGA/TX1/06course/m07t05.htm[11/10/2010 4:43:11 PM]

14 7.6 Computing tax under Part I.2 and split income Learning objective Compute Part I.2 tax and tax adjustments related to split income. (Level 2) Required reading Optional reading LEVEL 2 Text: 6,115 to 6, (review); 10,510 (Level 2) ITA: 60(w), 120.4, (Level 2) Text: 10,540 to 10,570 (minimum tax) ITA: 120.2(1), to Tax under Part I.2: Recovery of old age security benefits An individual whose income exceeds a certain threshold must repay all or a part of the old age security (OAS) benefits received. This repayment ("clawback") is calculated under section and constitutes tax under Part I.2. Under paragraph 60(w), the amount of Part I.2 tax payable is deductible from the income that is subject to Part I tax. The purpose of this deduction is to subtract the amounts repaid from Part I tax, since under paragraph 56(1)(a), OAS payments must be included in income subject to Part I tax, even if they are entirely repaid and no payments are received in the year. Part I.2 tax is withheld at source. The amount withheld is based on the income of the second preceding year for the first six months of the year and on the income of the immediately preceding year for the last six months. This means that high-income taxpayers receive no OAS payments and, thus, there is no recovery of OAS on the income tax and benefit returns for these taxpayers. Tax on split income Under the attribution rules of section 120.4, the "kiddie tax" on split income is imposed at the top marginal tax rate of an individual, which is currently 29%. Refer to Topic 5.9 for the rules when property is transferred or loaned to a spouse or child. Extend your knowledge Minimum tax The government introduced a minimum tax to address concerns that high-income taxpayers could shelter all their income through tax incentives. However, since the minimum tax was introduced, the tax authorities have considerably reduced the opportunities to create significant tax shelters; hence, the minimum tax has much less impact now than when it was instituted. Text sections 10,540 to 10,570 review the rules for determining whether a taxpayer is subject to minimum tax and the rules for computing adjustable taxable income under the provisions of Division E.1 (sections to ). These readings are optional and non-examinable. file:///f /Courses/ /CGA/TX1/06course/m07t06.htm[11/10/2010 4:43:12 PM]

15 7.7 Computer illustration 7.7-1: Preparing a complete income tax and benefit return, example A Learning objective Use Cantax to prepare a complete income tax return and calculate net income under section 3, taxable income, and federal tax payable for an individual. (Level 1) Required reading LEVEL 1 Description Appendix 7-1 (Level 1) Claude Baxter was born on February 8, 1956, and his Social Insurance Number is He resides at 100 Berry Street, Saskatoon, Saskatchewan, X0X 0X0. He is married to Mary Miller, born July 3, 1958, whose Social Insurance Number is In 2009, Mary received $3,000 of interest income. Mary s investments were made from personal savings from past employment. Claude and Mary have three children: Evelyn, born June 23, 1986 (23 years of age in 2009), was a full-time student at a Canadian university for a period of eight months. Her tuition fees, paid by Claude, were $2,000. Evelyn earned $2,500 from a summer job. Alex, born January 1, 1997 (12 years of age in 2009), had earned income of $400. Caleb, born March 30, 1999 (10 years of age in 2009), had no income. Employment income For the past 17 years, Claude Baxter has been employed as an accountant by XYZ Ltd., a CCPC. He deals with the latter at arm's length. Exhibit provides the T4 he received from XYZ Ltd. for In January 2009, Claude Baxter disposed of 500 common shares of XYZ Ltd., which he had acquired on May 1, 2000, under a stock option program set up on December 13, Under the option, the price paid for the shares was $10 per share. The FMV of each share was $12 on December 13, 1999, and $15 on May 1, Claude Baxter sold the 500 shares for $10,000, that is, $20 per share. He incurred no expenses on the sale. The employer did not include any amount with respect to this transaction on Claude's T4 slip. XYZ Ltd.'s shares are not qualified small business corporation shares. Exhibit T4 from XYZ Ltd. file:///f /Courses/ /CGA/TX1/06course/m07t07.htm[11/10/2010 4:43:13 PM]

16 Investment income (in Canadian dollars) Dividends received from an American corporation after deduction of American withholding tax of $750 $ 4,250 Required Solution a. Determine the appropriate tax treatment for each transaction listed above. b. Use Cantax to compute Claude Baxter's net income, taxable income, and tax payable for file:///f /Courses/ /CGA/TX1/06course/m07t07.htm[11/10/2010 4:43:13 PM]

17 Computer illustration 7.7-1: Suggested solution Part (a): Tax treatment of the various items 1. Mary Miller s interest income must be reported by her. It will affect the amount of personal tax credit that Claude will be able to claim as the spouse or common-law partner credit spouse or common-law partner credit: Base amount $ 10, Spouse's income (3,000.00) Spouse or common-law partner amount $ 7, Tax credit (15% $7,320 ) $ 1, Evelyn is over 18 years of age and does not have a mental or physical infirmity. Claude is not entitled to an infirm dependent credit with respect to her [paragraph 118(1)(d)]. However, he may receive a tax credit for any tuition and education amounts that Evelyn cannot claim if she fills out the statement on Form T2202 or T2202A [section 118.9]. Alex and Caleb are under 18 years of age. No eligible dependant tax credit may be claimed for them as Claude is not single, separated or divorced. However, since both children are under 18 years of age and reside with Claude and Mary, Claude can claim the Child Amount for both children. Calculation of credits allowable under sections and Tuition $ 2,000 Textbook amount ($65 8) 520 Education amount ($400 8) 3,200 $ 5,720 Total credits allowable under sections and $5,720 15% $ 858 Calculation of tax payable by Evelyn before tax credits for tuition and education amount Income $ 2,500 Tax ($2,500 15%) $ 375 Personal tax credit ($10,320 15%) (1,548) $ Amount transferable to Claude Baxter under section A - B where A = the lesser of: = $750 $750 ($5,000 15%) total of amounts allowable under sections and file:///f /Courses/ /CGA/TX1/06course/m07t07ci.htm[11/10/2010 4:43:13 PM]

18 B = tax payable by Evelyn, considering only the deductions provided for in sections 118, 118.3, , and = $0 $750 $0 $ Claude's salary is included in employment income. The union dues are deductible from employment income under paragraph 8(1)(i), and the RPP contribution is deductible under paragraph 8(1)(m). The employment insurance premiums and CPP contributions are eligible for a tax credit equal to 15% under section Charitable gifts are eligible for a tax credit under section 118.1, as follows: Total gifts $ 1,000 Less: on the first % $ 30 on the balance % 232 $ The sale of 500 shares of XYZ Ltd. has the following tax consequences: Employment income under subsection 7(1.1) FMV at time option was exercised $ 15 Price paid (10) Taxable benefit per share $ shares $5 $ 2,500 Deduction under paragraph 110(1)(d.1) in computation of taxable income 1/2 $2,500 $ 1,250 Taxable capital gain Selling price (500 shares $20) $ 10,000 Adjusted cost base Price paid (500 shares $10) $ 5,000 Taxable benefit under subsection 7(1.1) [subsection 53(1)] 2,500 (7,500) Capital gain $ 2,500 Taxable capital gain (1/2 ) $ 1, This capital gain is not eligible for the CGD as these shares are not qualified small business corporation shares. 6. Claude Baxter must include the $5,000 of dividend income ($4,250 + $750) in his foreign investment income, and he may claim a tax credit for the foreign taxes paid. Since the U.S. withholding tax is 15% of the foreign investment income, all of the U.S. tax qualifies for the tax credit, and no deduction needs to be claimed under subsection 20(11). Part (b) Start-up steps 1. Start Cantax. file:///f /Courses/ /CGA/TX1/06course/m07t07ci.htm[11/10/2010 4:43:13 PM]

19 2. Open the file for Claude Baxter (TX1M7P1). 3. At the Index, the form "INFO: Personal (name, address, etc)" should be open. Note that the personal information for Claude Baxter has already been entered. Scroll down and observe that the personal information for Mary Miller has also been entered. 4. Click File, Save as, to save the file under your own initials. 5. Open the "T1-DEP: Dependants" schedule in the "Identification" folder of the Index. Note that information about Alex and Caleb Baxter is entered here and Part A under "Amount for children born in 1991 or later (line 367 of Schedule 1)" indicates "Yes" since the children resided with both parents throughout the year. However, you will notice Evelyn s information has not been entered. In a later step you will enter her tuition and income information in order to transfer Evelyn's tuition tax credits to her father. Income from employment 1. At the Index, open the folder "Income from information slips," then move the cursor to "T4: Employment income from T4 slips" and open the schedule. 2. In column 1, enter the information on the T4 slip from XYZ Ltd. 3. In column 2, enter the information concerning the taxable benefit resulting from the sale of the 500 XYZ Ltd. shares from the stock option program, calculated in part (a), on the line "Other EMPLOYMENT income not reported on T4/T4A slips." Enter on line 41, "Stock opt/shares d.1" the amount of the stock option deduction. Investment income Capital gains 1. At the Index, in the "Income from information slips" folder, open the "T5: Investment income" schedule. 2. Enter Claude's gross dividend income and foreign tax paid from the United States in column 1 on lines 15 and 16 respectively. At the line "Country," use the drop-down menu and select "Country 1" to set the country code for the foreign tax credit. 1. At the Index, open the folder "Taxable capital gains" and then open the "T1-S3: Capital gains (or losses)" schedule. 2. At "Publicly traded shares, mutual funds units, deferral of eligible small business corporation shares, and other shares" enter the capital gains information from the disposal of the shares from XYZ Ltd. Checking total income Spousal amount 1. From the Identification section of the Index, select "T1-2: T1 Jacket - Page 2" from the "T1 Jacket" folder and open the schedule. Scroll down to line 150. The total income amount computed by Cantax should be $97, If your tax return does not show this value, carefully retrace all steps prior to this point to locate the errors. If you cannot explain the discrepancies, you can still proceed to the next section. Later, you will have another chance to check the tax return in detail. file:///f /Courses/ /CGA/TX1/06course/m07t07ci.htm[11/10/2010 4:43:13 PM]

20 1. At the Index, in the "Calculation of non-refundable tax credits" folder, open schedule "T1-S1:" and scroll to the "Spousal or Common-law partner amount" below line Enter Yes to the question "Did taxpayer support a spouse at all in 2009?" Double-click the cell "Minus: His or her net income" to go to the "Federal Amounts Transferred from your Spouse or Common-law partner." Scroll down to the "Details of your Spouses Income" section. Enter 3000 at "Interest & other investment income" and return to the T1-S1-1. Verify that the amount at line 303 is $7, Note, in practice, you would enter Mary's income on her return and the amounts would transfer to this schedule. Mary would file a full return even though she has no taxes payable to ensure she receives any refundable credits to which she may be entitled. Tuition and education amounts transferred from a child 1. Under the "Identification" folder, open the "Dependants information forms" folder and doubleclick the "T1-DEP: Dependants" form. With the cursor in column 2, right click and select "Add Column" for Dependant 3. Enter in the data and personal information for Evelyn Baxter. Click Yes on the line "Student?" The balance of the form will then open. 2. Click on the cell "Tuition fees," and enter Then click the cell "Educ./Textbook full time months" and enter 8. Click the cell called "Taxable Income" and enter Confirm that the tuition, education, and textbook transfer amount calculated by Cantax is $5,000. Foreign income and tax credit 1. Click on Goto, Form, and then select T to open the schedule "Federal foreign tax credits." 2. Part 1 should report $5, of net foreign non-business income. If it does not, you probably omitted to select the country for the foreign dividend income when you entered information into the "T5: Investment income" schedule or you entered the $5000 amount in the wrong field. If this is the case, return to the Index and make the necessary corrections on the T5 schedule before continuing with the next step. The federal foreign tax credit on line 10 should be $ However, Claude had $750 of taxes withheld on his American dividend. Click on Goto, Form, and then select FTC to open the schedule Foreign Tax and Income. Scroll down to the section Foreign non-business tax credit. Notice that Claude has received a provincial foreign tax credit for $ Therefore, his total foreign tax credit is $750. Detailed tax calculation 1. Open the "Summary of tax and credits" folder, and open schedule "T1-S1: Federal tax." 2. Observe the tax calculations performed by Cantax. Confirm that the federal non-refundable tax credits amount (line 26) is $4, Go to form T1-S1-2 and confirm that the federal tax amount (line 36) is $18, and the Basic Federal Tax (line 45) is $13,592.62, the Foreign Tax Credit (line 46) is $ and the Federal Tax (line 47) is $12, Press F4 and enter T1-4. Scroll down to the end of the schedule. Claude should have a refund of $15, Save the tax return. Checking the tax return If the refund amount is incorrect, proceed with the following steps: file:///f /Courses/ /CGA/TX1/06course/m07t07ci.htm[11/10/2010 4:43:13 PM]

21 1. Print the tax summary (F8) by right-mouse clicking on it and selecting "Print current form" from the list. 2. After printing, close the current tax return and retrieve the solution file TX1M7P1S. 3. Repeat step 1 for the solution file. 4. Compare the printouts from steps 1 and 3 and identify any discrepancies. Resolve any differences and correct your tax return file. 5. Exit Cantax and return to Windows. file:///f /Courses/ /CGA/TX1/06course/m07t07ci.htm[11/10/2010 4:43:13 PM]

22 7.8 Computer illustration 7.8-1: Preparing a complete income tax and benefit return, example B Learning objective Use Cantax to prepare a complete income tax return and calculate net income under section 3, taxable income, and federal tax payable for an individual. (Level 1) Required reading Description Appendix 7-2 (Level 1) Marilyn Fisher was born on December 12, 1959, and her Social Insurance Number is She resides at 200 Pine Road, Lancaster, Ontario, B3Z 1A5. She is divorced and has no children. Employment income Marilyn has been employed full-time as a designer by Webster Ltd. since Exhibit provides the T4 she received from Webster Ltd. for Exhibit T4 from Webster Ltd. file:///f /Courses/ /CGA/TX1/06course/m07t08.htm[11/10/2010 4:43:14 PM]

23 Farming income Until December 1, 2009, Marilyn operated a farming business that she had inherited from her father on January 1, The farm is known as Little Meadow; it has a total area of 50 hectares, of which 45 hectares (1 hectare = 2.47 acres) were cultivated. The usual fiscal year end is December 31. Following are details of Marilyn's 2009 income from operating the farm. Sale of harvest (other grains and oil seeds) $ 60,000 Purchases pesticide $ 5,000 seed 12,000 (17,000) 43,000 Tractor maintenance/repair gas and oil 3,000 repairs 1,000 Fertilizer 3,000 Property taxes 6,000 Legal expenses and accounting 2,000 Crop insurance 4,000 Interest on mortgage loan 10,000 Salary paid to employee 25,000 (54,000) $ (11,000) There was no opening or closing inventory. The farming operation was sold for total proceeds of $260,000, broken down as follows: Land (45 cultivated hectares) $180,000 Barn $ 30,000 Rolling stock (tractor acquired on January 31, 1999) $ 30,000 Machinery $ 20,000 The proceeds of disposition were received in full in Following is the relevant information regarding assets sold: ACB or capital cost UCC as at December 31, 2008 Land $ 60,000 $ Barn (class 6) $ 20,000 $ 11,000 Rolling stock (class 10) $ 26,000 $ 18,000 Machinery (class 8) $ 38,000 $ 16,000 Other information Marilyn reported a taxable capital gain of $16,000 in 1989 following the sale of shares of public corporations. She claimed a CGD of $16,000 with respect to this gain. On January 1, 2009, Marilyn had the following carryovers from previous years for income tax purposes: Investment expenses of previous years $ 18,000 Investment income of previous years $ 8,000 Net capital losses 1990 $ 6,000 Restricted farm losses 2004 $ 6, , ,000 file:///f /Courses/ /CGA/TX1/06course/m07t08.htm[11/10/2010 4:43:14 PM]

24 2007 6, ,000 $ 28,000 Required Solution 1. Determine the appropriate tax treatment for each transaction listed above. 2. Use Cantax to compute Marilyn Fisher's net income, taxable income, and tax payable for file:///f /Courses/ /CGA/TX1/06course/m07t08.htm[11/10/2010 4:43:14 PM]

25 Computer illustration 7.8-1: Suggested solution Part (a): Tax treatment of the various items 1. The salary is included in employment income. 2. The fiscal period of the farming business ends on the date the business was sold December 1, According to the data provided, no adjustment needs to be made in calculating the farm loss. No CCA may be claimed because all the assets were sold. Selling off the assets has the following tax consequences: Land Capital gain POD $ 180,000 ACB (60,000) Capital gain $ 120,000 Taxable capital gain (1/2) $ 60,000 Barn Capital gain POD $ 30,000 CC (20,000) Capital gain $ 10,000 Taxable capital gain (1/2) $ 5,000 CCA recapture The lesser of the CC and the POD $ 20,000 UCC (11,000) CCA recapture $ 9,000 Rolling stock (Tractor) Capital gain POD $ 30,000 CC (26,000) Capital gain $ 4,000 Taxable capital gain (1/2) $ 2,000 CCA recapture The lesser of the CC and the POD $ 26,000 UCC (18,000) CCA recapture $ 8,000 Machinery Capital gain There is no capital gain because the POD ($20,000) are less than the CC file:///f /Courses/ /CGA/TX1/06course/m07t08sol1.htm[11/10/2010 4:43:15 PM]

26 ($38,000) and there is no capital loss on the disposition of depreciable property. CCA recapture The lesser of the CC and the POD $ 20,000 UCC 16,000 CCA recapture $ 4,000 Summary of sale The sale yields the following results: a. Taxable capital gains land $ 60,000 barn 5,000 tractor 2,000 $ 67,000 b. The capital gains on the land and barn are considered qualified farm property, as defined in subsection 110.6(1). Accordingly they are included in the annual gains limit. c. Farming income Farm loss $ (11,000) CCA recapture barn $ 9,000 tractor 8,000 machinery 4,000 21,000 Farming income $ 10, Restricted farm losses total $28,000, and farming income for the year, as computed in item 2, totals $10,000. The restricted farm losses for 2004 and 2005 may be used in 2009 to offset farming income [paragraph 111(1)(c) and subsection 111(3)]. 4. The net capital loss of $6,000 from 1990 may be fully deducted from capital gains for The amount deductible is $6,000 (1/2 3/4) = $4,000 However, you should claim only $2,000 to offset the taxable capital gain on the tractor, which is not eligible for the CGD, rather than deduct the full net capital loss. If you deduct the loss against taxable capital gains eligible for the CGD, the CGD would be reduced. The amount owing to the CRA is not affected, but claiming only $2,000 leaves more of the net capital loss available for future years and uses more of the CGD, which is more limited in scope. 5. The cumulative net investment loss (CNIL) at the end of 2009 is calculated as follows: Balance as at December 31, 2008 $18,000 $8,000 $ 10,000 Add: Investment expenses for 2009 Net capital loss used to offset non-eligible capital gain 2,000 12,000 Less: Investment income for 2009 file:///f /Courses/ /CGA/TX1/06course/m07t08sol1.htm[11/10/2010 4:43:15 PM]

27 Non-eligible taxable capital gain (2,000) Balance as at December 31, 2009 $ 10, The CGD is calculated in accordance with section The calculation of the CGD is done by Cantax in part (b). The manual calculation of the CGD is supplied so that you can appreciate the calculation that would be required if the T1 program were not used. Annual gains limit The lesser of: Net taxable capital gains for the year under 3(b) $ 67,000 Net capital gains on qualified farm property $ 65,000 $ 65,000 Less: Net capital losses of other years used to offset taxable capital gains eligible for CGD ABIL for the year $ 65,000 Cumulative gains limit Cumulative net taxable capital gains eligible for the CGD from 1985 to 2009 ($16,000 + $65,000) $ 81,000 Less: Net capital losses deducted since 1985 to offset taxable capital gains eligible for the CGD $ ABIL realized after 1984 CNIL at the end of the year 10,000 CGD claimed in prior years 16,000 (26,000) $ 55,000 Capital gains deduction qualified farm property [subsection 110.6(2)] The least of: a) Maximum allowable $ 375,000 Less: CGD claimed in 1989 $16,000 (1/2 2/3) (12,000) $ 363,000 b) Total taxable capital gain on disposition of qualified farm property $ 65,000 c) Annual gains limit $ 65,000 d) Cumulative gains limit $ 55,000 Capital gains deduction qualified farm property $ 55,000 Part (b) Start-up steps 1. Start Cantax. 2. Open the file for Marilyn Fisher (TX1M7P2). 3. At the Index, the form "INFO: Personal (name, address, etc.)" should be open. Note that the personal information for Marilyn Fisher has already been entered. file:///f /Courses/ /CGA/TX1/06course/m07t08sol1.htm[11/10/2010 4:43:15 PM]