We have all seen the overnight changes made by the tax man not too long ago for income trusts. The change certainly hurt a few people, possibly including you. Could there be more nasty tax surprises coming our way? Unfortunately, we do not have a crystal ball to predict the future. Instead of just sitting and waiting, perhaps the best way is to plan ahead and be prepared for the worst to happen.
Let us take the $500,000 capital gains exemption (CGE) as an example. As you know, each individual (irrespective of age) is entitled to a lifetime $500,000 CGE to shelter capital gains realized on the sale of certain shares from all income tax. The shares could be shares of your dentistry professional corporation or technical or hygiene corporation. There are very strict rules limiting one’s ability to claim this exemption and specific forms must be filed within a time limit to claim the CGE. It is therefore important to work with your advisors to ensure all bases are covered.
If you are already operating your dental practice in a dentistry professional corporation and/or a hygiene/technical service corporation (PC), you (or other shareholders) may be in a position to claim the $500,000 CGE now rather than later (i.e. when you actually sell the shares of your corporations) even though you are not actually selling your practice at this time. This exercise should not cost you any extra taxes but it will cost you some legal and accounting fees. A cost/benefit analysis should be prepared to determine if this exercise is worthwhile for you. Perhaps the professional fees paid now are no different from buying insurance i.e. it protects you from any unexpected tax bill in the event that the government changes its mind.
The other reasons why you may want to claim the exemption now rather than later:
1. You expect to incur huge investment expenses but with minimal investment income; for example, you are about to start investing in natural resource tax shelters to reduce your current income taxes. The tax shelters normally allow you to claim tax deductions (e.g. interest, investment counsel fees, partnership losses etc.) in the first couple of years while providing you with little or no investment income (e.g. interest, dividends and rental income etc.). The fact that your investment expenses are greater than your investment income will likely prohibit you from claiming the maximum amount of your $500,000 CGE.
2. Other rules may prevent the shares of your dentistry PC to qualify. For example, you might be accumulating cash in your PC and this may affect your ability to claim the $500,000 CGE. Normally, it is easier to meet the requirements in the early years of your PC while it has accumulated little or no spare cash/investment assets.
3. Unexpected death — you may or may not be in a position to claim the exemption at this unexpected event either because of your personal tax problem as mentioned in #1 above or your PC is offside as mentioned in #2 above.
The ABCs in claiming your exemption:
1. Advisors — will have to assist you in determining the value (i.e. a current market value) of your shares of your dentistry PC as if you are selling your practice. You might consider engaging a specialist, for example, a Chartered Business Valuator, a broker or your accountant to determine the value of your practice. There may be other preparation work to make you and your corporation qualify for the exemption.
2. Barter — you have to exchange all the shares you currently own for another class of special shares via a tax free maneuver. The value of these new special shares will be fixed and equal to the current value of your practice/current common shares.
This would also be a good time to introduce new shareholders (i.e. family members) to your dentistry PC since the new common shares to be issued will have a nominal dollar value. This is a good way to take advantage of income splitting to reduce the overall family tax bill. What is income splitting? Simply stated, you are diverting your income presumably taxed at the high rate to your lower income family members and therefore taxed at the lower tax rates. By doing so, your overall family tax bill will be reduced.
3. Claim — your accountant must prepare and file a special form within a specific time period to trigger the capital gains and report same and claim the exemption in your personal tax return. Since a penalty will be levied on any form filed late, it is therefore important to file the form on a timely basis.
4. Document — all steps/paperwork must be clearly documented and signed to properly support your claim.
Often times, when the CGE is claimed, the tax department will take a closer look at your return i.e. an audit/special review of the claim might be done. The tax department has up to three years from the date of your Notice of Assessment to request a review of your tax returns. The areas the tax department will likely challenge you on are: the valuation of your practice (i.e. too high or too low) and the conditions in which you and your corporation must meet for the CGE. Discuss these with your financial advisors before you proceed.
What happens if the government increases the lifetime limit instead of eliminating it? This change will not affect what you have already claimed because the additional exemptions allowed could be claimed again prior to or at the actual sale.
Bottom line: you can, through legal maneuvers, claim your lifetime $500,000 capital gains exemption now before the government changes its mind and take away this huge tax savings worth about $115,000 (23% of $500,000).
David Chong Yen, CFP, CA with an international firm background and more than 26 years of experience, advises healthcare professionals and owner-managers. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail david@dcy.ca. This article is intended to present tax saving and tax planning ideas and is not intended to replace professional advice.
