Dealing with the Covid-19 pandemic has been, to say the least, a challenge. Having to social distance, balance our work and family lives as we work from home, and watch our investments ride a roller coaster have all created stress and other mental pressures that none of us could have ever imagined.
Tax planning opportunities are not restricted to times when life is wonderful and global economies are booming. So, let’s explore some tax mitigation strategies that could be considered during these unprecedented times.
Estate Freeze or Re-Freeze
When a person dies, they are deemed to have disposed of their capital assets at their fair market value, unless those assets are passed to a surviving spouse. This can result in significant capital gains that are taxable on the deceased’s final tax return.
A freeze is a common tax planning strategy that allows the owner of an asset to “freeze” the value of that asset at the time of the freeze, and pass the future growth in value of that asset to others, usually younger family members. As such, on death, the freezor would only be taxed based on the value of the asset at the time of the freeze, while the increase in value from the date of the freeze to the date of the freezor’s death would be deferred until the asset is subsequently sold or until the family member dies. A trust is often used to control access to the asset and to provide flexibility in distributions of the future growth of the asset and any income earned thereon.
While an estate freeze is most commonly used to freeze the value of the shares of a business or real estate, it can also be implemented in respect of other asset classes, like marketable securities. An estate freeze is particularly attractive in a down market because it provides the opportunity to limit the tax liability of an asset on death at a low value, and to shift more of the future growth of an asset to future generations. For estate freezes that have already occurred, it may be possible to undertake a “thaw and re-freeze” to take advantage of the opportunity to freeze at a lower value and to further shift future growth to your family members.
There may be opportunities to use the decline in the value of certain assets to offset capital gains. For example, public securities that have declined in value can be sold on the open market, or assets that have gone down in value may be sold or gifted to certain family members. The resulting loss may be applied against capital gains realized in the past three years (and potentially net you a refund of tax previously paid), or applied against future capital gains to reduce your tax owing in those future years. However, in creating losses it is important to seek professional tax advice as there are complex tax rules that may apply to deny or delay your realization of the capital loss (known as the “stop-loss” rules), and of course the investment merits of triggering the loss should also be considered.
There may also be planning opportunities if you have losses in one corporation in your corporate group and gains in another. However, if your loss is in a corporation, you may wish to pay out previously realized capital gains as tax-free capital dividends before you trigger a loss.
Prescribed Rate Loans
In the relatively new “Tax On Split Income (TOSI)” world, there are limited income splitting opportunities that a family can take advantage of. One of the opportunities that remains is using a prescribed rate loan. A prescribed rate loan is created when investment capital is loaned by a high-income family member (the lender) to a low-income family member or family trust (the borrower) using a formal written loan agreement.
In order for this loan strategy to work, the interest rate on the loan must be at least be equal to the CRA’s prescribed rate in effect at the time the loan is established. Once the loan is established, the prescribed rate is maintained for the life of the loan regardless of any increases or decreases that may occur to the prescribed rate.
The borrower must pay interest to the lender at the CRA’s prescribed rate and the annual interest must be paid on or before January 30 of the following year. The lender reports the interest on their tax return in the year the interest is received and the borrower deducts the interest paid against the investment income and capital gains realized on their tax return in the year the interest is paid.
The CRA sets the prescribed interest rate every quarter and, while it is currently 2%, it is anticipated that the prescribed rate will drop to 1% effective July 1, 2020. If this occurs, it will provide a good opportunity to establish this income splitting strategy, or for those that currently use this strategy, they may be able to reorganize the existing loan to take advantage of the prescribed rate drop. This is another case where input should be sought from a tax professional in advance.
Home Office Deduction
Employees who are required by their employer to pay for employment expenses (i.e. they are not reimbursed), including those for a home office, may be able to claim a deduction on their tax return for such expenses.
To be eligible to claim such expenses, the employee must obtain a properly completed and signed Form T2200, Declaration of Conditions of Employment, and to be able to claim expenses related to a home-office, the employee must be “required by the contract of employment” to maintain such an office, as certified by the employer on the T2200. The home office space must be either where the employee “principally” (more than 50 per cent of the time) performs their employment duties or be used exclusively to meet customers on a regular and continuous basis in the course of employment. In “regular” times, these requirements would be difficult to meet.
The question remains whether during the work from home requirement during the pandemic if either of these conditions can be satisfied. It is unclear, under the first condition regarding whether or not the work space is the place where an employee “principally performs” their employment duties, whether this calculation must be done on an annual basis or whether a shorter period of, say, two or three or four months of mandatory working from home would be sufficient to meet the under the 50 per cent or more test. The second condition raises the question as to whether online virtual meetings and conference calls could cause an employee’s exclusive home office to be viewed as a place where an employee regularly meets customers.
The CRA was asked in a somewhat-dated technical interpretation whether the phrase “meeting customers” should reflect “modern technology” and include meetings by such means as e-mail, telephone and Skype. The CRA responded that, in its view, the phrase “meeting customers” only includes face-to-face encounters. I am not aware of any formal court decisions that have opined that the phrase “meet customers” could include meetings held by phone, or other virtual medium, however given the impact that the current pandemic has on requiring the location of work to rapidly change, we can only hope that the CRA or the Tax Court will be called upon to express its views.
If you did qualify to write off home office expenses, and you were keen to test these “new” waters, you would be able to deduct a variety of expenses, such as the cost of electricity, heating and maintenance, but you are not able to deduct mortgage interest, property taxes, home insurance, capital expenses or depreciation (capital cost allowance).
That unfortunately means that the cost of your new monitor or ergonomic office chair would not be deductible as they would both be considered capital expenses. For eligible expenses, you need to allocate the expenses on a “reasonable basis,” which is typically based on taking the area of your work space divided by the total finished area (including hallways, bathrooms, kitchens, etc.) of your home. If you rent the house or apartment where you have your home office, you can also deduct the percentage of the rent you paid that relates to your work space.
So, while the government has introduced supportive programs to assist employees, employers and various sectors during the pandemic, it may be worth investigating some more indirect means of tax savings during these challenging times.