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Income Tax Planning Recommendations - Post #11 - FPSC Level 1 Examination - December 2017

Posted by John Gobeil on

The third financial planning function is Recommendation, formerly called Synthesis, develops recommendations to help optimize the client’s situation. Recommendation competencies focus on the development of recommendations, in order of priority, that help meet the client’s personal goals, needs and priorities and strive to optimize the client’s situation. Questions on Recommendation will comprise 14% to 24% of the Exam.

 For income tax planning, the competencies requiring Recommendation are:

  • 113 Formulates tax planning strategies
  • 114 Evaluates advantages and disadvantages of each tax planning strategy
  • 115 Utilizes the optimal strategies to make tax planning recommendations
  • 116 Prioritizes action steps to assist the client in implementing tax planning recommendations

On a multiple-choice exam, it is very difficult to assess one’s ability to develop tax-planning strategies. This would be much more effective with a narrative exam where you have to write out a response and they can give marks for your recommendation, but also for your explanation of your recommendation.

On the FPE1, which is in multiple-choice format, they can only require you to identify the best of a list of four strategies.

Income tax and benefit planning is arranging your affairs to minimize your income tax payable and maximize your social security benefits.

You could achieve three objectives in income tax and benefit planning.

  1. Avoidance is the earning of income or capital gains that is not subject to income tax. Avoidance may or may not reduce social security benefits.
  2. Deferral ispostponing the recognition of net income or taxable income. Deferral can postpone or avoid the payment of income taxes. Deferral can preserve social security benefits.
  3. Conversion ischanging highly taxed income into more favorably taxed income.

Avoidance

There are few opportunities for avoidance. You could achieve avoidance with the following strategies:

  1. investing in a tax-free savings account;
  2. using the lifetime capital gains exemption; and
  3. using the principal residence exemption.

Question 1

Branson and his wife own a very large home on 1,000 acres located within the city boundaries of Vancouver. The property is worth $150 million and their adjusted cost base is $138 million. Branson expects that the property will increase in value by $120 million over the next five years. Branson could develop the property. Branson and his wife have never used the lifetime capital gains exemption. He wants to avoid income tax on the expected appreciation of the property.

Branson and his wife should:

(A) transfer their interests in the property to tax-free savings accounts.
(B) plan to use principal residence exemption.
(C) transfer part of the property to a Canadian controlled-private corporation.
(D) transfer their interests in the property to alter ego trusts.

In Branson’s situation, there is no opportunity to avoid income tax on the expected appreciation. The correct answer is none of the above. Do you know why?

Question 2

Marco and his wife own a home on 50 acres located within the city boundaries of Langley. The property is worth $800,000 and their adjusted cost base is $450,000. Marco expects that the property will increase in value by $100,000 over the next five years. Marco and his wife have never used the lifetime capital gains exemption. He wants to avoid income tax on the expected appreciation of the property. About 45 of the acres are zoned highway commercial.

Marco and his wife should:

(A) transfer their interests in the property to tax-free savings accounts.
(B) plan to use principal residence exemption.
(C) transfer part of the property to a Canadian controlled-private corporation.
(D) transfer their interests in the property to alter ego trusts.

In Marco’s situation, there is an opportunity to avoid income tax on the expected appreciation.          

Deferral

There are many opportunities for deferral. You could achieve deferral with the following strategies:

  1. investing in a registered plan, including an RRSP, a RRIF, an RESP, an RPP, an RDSP and a DPSP;
  2. postponing the recognition of capital appreciation on capital property;
  3. executing a capital gains rollover of shares of a small business corporation and of a former business property;
  4. executing a spousal rollover or a Section 85 rollover; and
  5. transferring assets to a rollover trust, including an alter ego trust and a spousal/common-law partner trust;

The challenge is determining the best strategy.

Question 3

Mark and Jessica are in their mid 50’s and have been married for 30 years. Last year, Mark earned $92,000 and Jessica earned $40,000. Neither has established a TFSA. Each has over $40,000 of RRSP contribution room. Mark has $5,000 for investment purposes.

Mark should:

(A) give $5,000 to Jessica to contribute to a TFSA.
(B) give $5,000 to Jessica to contribute to her RRSP.
(C) give $5,000 to Jessica to invest in a non-registered GIC.
(D) contribute $5,000 to spousal RRSP.

Only two of these strategies involve deferral. You may have to decide whether deferral, conversion or avoidance is best.                                                                   

Conversion

There are opportunities for conversion. You could achieve conversion with the following strategies:

  1. income splitting, including pension income splitting and transferring assets to family members while avoiding the income attribution rules;
  2. postponing the recognition of capital appreciation on capital property until having a lower marginal tax and clawback rate;
  3. acquiring or transferring property to a joint tenancy;
  4. bequeathing assets to testamentary trusts for beneficiaries, especially family trusts;
  5. using named beneficiary designations with trusts to create multiple taxpayers; and
  6. structuring your family finances to split income from capital, including inter-spousal loans.

Question 4

Michael has only a few months left to live. He has hired you to review his estate plan. Michael has a spouse, Monica, who is 57 years of age and has a net income of $65,000. Michael has a physically disabled daughter, Jacqueline, who is 28 years of age and has a net income of $12,000 per year. Michael has a granddaughter, Elizabeth, who is 12 years of age, has lived with them since the death of her parents and has net income of $7,000 per year. Michael has $450,000 in an RRSP and other investment assets of $1.5 million. After his death, Michael expects the RRSP funds to earn 8%.

To whom should Michael leave his RRSP?

(A) Monica.
(B) Jacqueline.
(C) Elizabeth.
(D) Jacqueline and Elizabeth.

This question involves Recommendation with income tax planning and retirement planning strategies. In your preparation courses, you probably did not see many questions of this nature. They are a challenge to write and to answer.

However, the questions on income tax planning require you to have an in-depth technical knowledge of the income tax concepts, rules and regulations. You had better start there.

Next Post

In our next Post, we will look at the solutions to these questions on Income Tax Planning Recommendations.

Regards,

John Gobeil, BSc, CFP®
David Gobeil, CPA, CA, CFP® 

Certified Financial Planner® and CFP® are certification marks owned outside the U.S. by the Financial Planning Standards Board Ltd. The Financial Planners Standards Council is the marks licensing authority for the CFP marks in Canada, through agreement with FPSB.

 


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