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Non-Linear Thinking - Post #08 - The CFP Examination - December 2017

Posted by John Gobeil on

The CFP Examination is the second of two exams that must be passed to obtain CFP certification. We have posted this entry to assist you in your preparation for The CFP Examination being held on Friday December 1, 2017. 

In the last Post, we reviewed the Sample Examination Item #3, Question 3.

In this Post, we will consider an exam writing skill: non-linear thinking.

Linear thinking

Throughout your education, you probably were successful by doing step 1, and then step 2, then step 3. Most of the world is A B C D and 1 2 3 4, not A D C B and 1 4 3 2. Most candidates display this linear thinking.

Marvin and Angela Smithers are professionals in their mid-40s. They have no children of their own, but dote on Angela’s sister’s two children, Samuel and Mariner. Samuel is 12 years of age and attending Upper Canada College. Mariner is 21 years of age and attending Queen’s University for another four years. The children’s father was recently killed and the family is experiencing serious financial difficulty. Marvin and Angela want to provide each child with $20,000 per year until he completes his education. The Smithers have significant capital and income.

What should Angela do and what would be the consequences?

A linear thinker would read the root of the question carefully. The root has 97 words. Some of the questions on CFP Examination will have more than 100 words.

If you were to analyze the root as you read it, you would identify a number of potential issues. The children’s father was recently killed. Is the mother OK? Did he leave a lot of life insurance? Can they file a wrongful death suit? Are the boys traumatized by the death and are they receiving counselling? Was the CPP death benefit large enough to pay for his funeral? You get the idea.

The statements and choices were as follows:

  1. Angela should transfer $250,000 to a trust for Samuel.
  2. Angela should gift $20,000 per year to Samuel.
  3. Property income earned from Angela’s gift by Samuel or his trust would be attributed to Angela.
  4. Any capital gains earned from Angela’s gift by Samuel or his trust would be attributed to Angela.

(A) 1 and 3
(B) 2 and 3
(C) 1 and 4
(D) 2 and 4

A linear thinker would look at:

  • statement 1 and try to figure out if Angela should transfer $250,000 to a trust for Samuel;
  • statement 2 and try to figure out if Angela should gift $20,000 per year to Samuel;
  • statement 3 and try to figure out if any property income earned from Angela’s gift by Samuel or his trust will be attributed to Angela; and
  • statement 4 and try to figure out if any capital gains earned from Angela’s gift by Samuel or his trust will be attributed to Angela.

A non-linear thinker (NLT) would approach it differently. An NLT would glance at the root of the question to see what kind of information is included, but assume that it is all irrelevant until proven otherwise. There is a couple, someone’s nephews and some money.

Looking at the rest of the question, it is a combination question. The choices include all of the statements and none of the statements is included in all of the choices. All of the statements are in play.

An NLT would look at the statements and try to determine if any one of them is true or false. When doing so, the key is to determine the information required from the root of the question.

Statements 1 and 2 require some thought and probably judgement. Skip them.

Statement 3 looks easy. In the case of gifts to a related minor, first-generation, property income and losses are subject to attribution. Is Samuel a related minor? Look at the root. Samuel is 12 years of age and one of Angela’s sister’s two children. Samuel is a related minor. Statement 3 is a consequence.

The root says, “What should Angela do and what would be the consequences?”

Our answer must be (A) 1 and 3, or (B) 2 and 3.

So, only statements 1 and 2 are still in play. Angela should transfer $250,000 to a trust for Samuel or Angela should gift $20,000 per year to Samuel.

The two statements are alternatives. What criteria would you use to decide whether to transfer funds to a trust or make an annual gift? The gift would come from some of Angela’s capital. How would the investment income be taxed? With the trust, any capital gains would not be attributed to Angela. With the annual payments, Angela would be taxed on any capital gains. First-generation property income would be taxed to Angela in any case. So, the trust could avoid income tax on any capital appreciation and any second-generation property income. The trust wins. The answer is (A).

The NLT never considered statement 4. The NLT never considered all of the issues. The fact that the children’s father was recently killed was irrelevant to the answer.

The NLT answered the question in about half the time. It did not matter whether the NLT knew the there is no attribution of capital gains or capital losses to the taxpayer if he loans or transfers capital property to a related minor. The NLT never looked at statement 4.

The same outcome results with basic questions where there is a single answer. Here is the complete solution.

(Concepts) A related minor is a person who is under 18 years of age as of December 31 of the year and who does not deal with the taxpayer at arm’s length or is the niece or nephew of the taxpayer (ITA 74.1(2)).

(Statement 1 is true.) Samuel is one of Angela’s sister’s children, a nephew. Samuel is 12 years of age. So, Samuel is a related minor to Angela. 

In the case of loans and gifts to a related minor, property income and losses are subject to attribution. Except for certain farm transfers, there is no opportunity to rollover property to a related minor. There is no attribution of capital gains or capital losses to the taxpayer if he loans or transfers capital property to a related minor and there is no rollover.

The trustee for a trust for Samuel could invest in a portfolio of shares to achieve capital appreciation, which would not be attributed to Angela. Samuel would pay minimal income taxes on capital gains compared to Angela. The most tax effective way to provide the funds is through a trust for Samuel.

So, Angela should transfer $250,000 to a trust for Samuel.

(Statement 2 is false.) Samuel would pay minimal income taxes on capital gains compared to Angela. The most tax effective way to provide the funds is through a trust for Samuel.

So, Angela should not gift $20,000 per year to Samuel.

(Statement 3 is true.) In the case of loans and gifts to a related minor, property income and losses are subject to attribution.

So, any property income earned from Angela’s gift by Samuel or his trust would be attributed to Angela.

(Statement 4 is false.) There is no attribution of capital gains or capital losses to the taxpayer if he loans or transfers capital property to a related minor.

So, any capital gains earned from Angela’s gift by Samuel or his trust will not be attributed to Angela.

Consider that you are writing an examination where you may have neither the time nor the knowledge required to pass. How about a little non-linear thinking, which can reduce both the time and the knowledge required to pass?

Next Post

In our next Post, we will consider time management for the multiple-choice questions.

Effectiveness of our study aids

We always appreciate feedback on the effectiveness of our study aids. Together, we can continue to have the best study aids available.

Regards,

John & David 

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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