Up to Speed – 2010 Tax Changes

As the year draws to a close, here’s a quick review of the key tax changes and planning opportunities for 2010:

PERSONAL TAX PLANNING Basic personal / spousal / partner amount

The basic personal amount is the amount of income that an individual can earn before paying any federal tax. The 2010 amount, which is also used for the spousal and partner amounts, is $10,382.

Personal tax brackets

The federal tax brackets for 2010, indexed by only 0.6% over the 2009 brackets, are:

2010	Rate
Less than $40,970	15%
$40,971 to $81,941	22%
$81,942 to $127,021	26%
Over $127,022	29%

Employee stock options

After years of painstaking lobbying, the 2010 Federal Budget granted relief to many employees who exercised employee stock options, deferring their tax obligations until the date of sale of the underlying shares, which in many cases, have since plummeted in value.

Under Canadian tax law, if you purchase shares though either an employee stock purchase plan or by exercising an employee stock option, your taxable employment benefit (and thus your tax liability) is based on the difference between the price you paid for the shares and the fair market value of shares on the date you receive them.

A stock option benefit deduction equal to 50 per cent is available to tax the stock option at capital gains-type rates, even though it’s still classified as taxable employment income. While the value of the taxable benefit is fixed when the shares are acquired, the benefit can generally be deferred until the year you sell the shares.

It is this mismatch of capital loss against employment income that has sparked intense lobbying by various employee groups, especially in the high-tech sector who face massive tax bills on money they never “received.”

First, to deal specifically with individuals who elected to defer paying tax on their stock option benefits until sale, the government has introduced a new special elective tax treatment to ensure that the tax liability on a deferred stock option benefit won’t exceed the fair market value of the shares being sold.

This relief is also available to any employee who sold shares acquired upon option before 2010, provided the election is filed before April 30, 2011 (or June 15, 2011 if you or your spouse or partner had self-employment income.)

It also applies to individuals who have not yet disposed of their optioned shares as long as they dispose of them before 2015 and elect by the filing deadline for the year of disposition.

Secondly, the government has eliminated the tax deferral election effectively immediately such that an employee can no longer defer paying tax on the stock option benefit until the year of sale.

Finally, to ensure it collects its taxes when such options are exercised, the government now insists on collecting the required income tax withholding when the options are exercised. Employers are required to withhold tax at source for the period in which the employee exercised the option.

Cosmetic Surgery

Changes to the Tax Act in 2010 removed the ability to include purely cosmetic procedures as a valid medical expense for tax credit purposes. These would include liposuction, hair replacement procedures, Botox injections, and teeth whitening.

That being said, cosmetic procedures required for medical or reconstructive purposes, such as surgery performed in conjunction with a personal injury or disfiguring disease will still qualify.

Prescribed rate loans at 1%

Since April 1, 2009, the government’s prescribed interest rate has held at the all-time low of 1%, providing couples with a significant income-splitting opportunity.

Income splitting is the practice of transferring income from a high-income spouse to a lower-income spouse to reduce the overall tax burden of the family. Having the income taxed in the lower income-earner’s hands is a strategy prompted by our system of graduated tax brackets.

Unfortunately, “attribution rules” in the Tax Act make this strategy difficult by attributing any income or gains earned on money transferred or gifted to a spouse back to the original high-earner spouse.

Fortunately, the Act does provide an exception to this rule if funds are loaned, rather than gifted, at the prescribed government rate and the interest paid annually by Jan. 30 of the following year.

So, if the loan is made while the prescribed rate is 1%, any investment returns above the 1% rate can be taxed in the hands of the lower-income spouse. Note that even though the prescribed rate varies quarterly, you need only use the rate in effect at the time the loan was originally extended.

Tax-loss selling

For tax-loss selling, to guarantee that a trade is settled in 2010, the trade date must be December 24, 2010, or earlier. This will make sure that the settlement takes place in 2010 and that any losses realized are available to the taxpayer this year. Any trade made after December 24, 2010, will not settle until 2011 and therefore those losses would not be available until next year.

Payments required by year-end

December 31 is the final payment date to claim a 2010 tax deduction/credit for various items, including:

• alimony payments; • charitable donations; • child care expenses; • interest expense on money borrowed to earn investment income; and • investment counseling fees.

U.S. estate tax

Finally, if you’re a wealthy U.S. citizen living in Canada, or elsewhere, or you own U.S. situs property, 2010 may be the year to die.

While I say this facetiously, the fact is that the dreaded U.S. estate tax, which is based on the fair market value of all property owned on the date of death, has been eliminated for 2010 only.

The repeal of the estate tax was originally announced back in 2001 as part of a broader reform, which lowered the top tax rate on estates over US$1.5-million to 45% from 55% and increased the exemption from a paltry US$675,000 to a high of US$3.5-million in 2009.

As recently passed by Congress, in 2011, the estate tax is scheduled to come back with a $5 million exemption and a rate of 35%.

The estate tax applies to all U.S. citizens, no matter where they live, and could also apply to wealthy Canadian residents who are not U.S. citizens if they own U.S. situs property, such as stocks or real estate.

SMALL BUSINESS TAX PLANNING

Computers: Accelerated Tax Depreciation

To encourage investment by businesses in computer systems and related peripherals, the Income Tax Regulations were amended on May 13, 2009 to add new Class 52 to Schedule II with a 100-per-cent tax depreciation rate for eligible computers and software acquired after January 27, 2009 and before February 2011.

This 100-per-cent write-off rate is not subject to the traditional “half-year rule” which generally restricts the amount of tax depreciation that can be claimed to half the normal amount in the year of purchase.

Interest on Overpaid Taxes

As of July 1, 2010, the interest rate payable by the CRA on overpaid taxes to corporations is simply the prescribed rate, currently set at 1%, rather than the old rate of prescribed rate plus two per cent. This new rate for corporations applies to income tax owing, GST/HST, EI premiums, CPP contributions among other amounts.

Salary / Dividend mix

For incorporated small business owners facing an approaching December 31 corporate year-end, now is the time to take a final look at the salary-dividend mix for 2010. It may make more sense for small business owners to pay themselves exclusively through dividends rather than salary in 2010. While this precludes them from making an RRSP contribution next year as dividends are not considered “earned income,” they may be better off saving money inside their corporations rather than inside an RRSP.

There may be a tax savings advantage of paying dividends over salary as well as a tax deferral advantage of leaving funds inside the company as opposed to paying them out immediately.

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.