As we come to the end of 2006, individuals should finalize their financial and tax matters for the year.
We must make some decisions by year-end; others can wait until early in the new year. The following is a sample of employee-related tax planning issues.
Employee loans
If you have or had a low-interest loan from your employer during the year, you are taxable on an imputed value for interest as an employment benefit. The Canada Revenue Agency calculates the value of the benefit by reference to a prescribed rate of interest less any amount that the employee actually pays during the year and up to Jan. 30, 2007.
CRA bases the rate on the average Treasury Bill rate of the first month during the preceding quarter. Ensure that you pay any interest due by the deadline to minimize the value of the taxable benefit.
An employee who is taxable on his or her imputed interest benefit is deemed to have paid an equivalent amount pursuant to a legal obligation. This means that any portion of the imputed interest that is attributable to earning income (for example, the purchase of shares) is deductible as interest expense.
Employees should ensure that they retain the requisite paper trail to validate the use of their employer loans for at least four years.
Note, where an individual obtains a loan by virtue of her shareholdings rather than employment, the full amount of the loan is taxable as income even if the individual pays interest at the prescribed rate. This rule does not apply if the shareholder repays the loan by the following year-end of the lender.
Capital assets
Employees can claim tax depreciation - capital cost allowance (CCA) - on depreciable capital assets such as automobiles, aircraft, and musical instruments. In most cases, one can claim only half of the CCA in the year that one purchases the asset. To claim the CCA, the asset must be available for use in the year. Hence, it is best to purchase such assets before the year-end to obtain the maximum allowance for the year with the shortest holding period.
Shift income
If possible, employees should shift as much income as possible into 2007. This will defer the tax payable on the income until April 30, 2008. Ask your employer not to pay your year-end bonus until January 2007. If you are lucky, you may also benefit from federal rate reductions as our budget surplus increases along with the possibility of another election.
Automobile benefits
An employee is taxable on the imputed value of benefits from a company car that is available for her personal use. The benefit takes two forms: a fixed standby charge and a variable amount for operating expenses.
The standby charge is for simply having the car available for use, regardless of actual usage. The standby benefit is equal to two per cent per month of the original cost of the automobile less any amounts paid to the employer by the calendar year-end. There is a reduced standby benefit if one drives less than 20,000 kilometres in the year and personal use is less than half of total use.
For example, if a car cost $30,000 in 2003, the value of the benefit for the full year is $7,200. Hence, employees should consider whether they are better off purchasing the car at its fair market value to reduce the value of taxable amounts in future years.
If your employer also pays your operating expenses for personal use of the vehicle, you are taxable on an additional benefit. The benefit is equal to 20 cents per kilometre of personal use less any amount you repay your employer by Feb. 14, 2007.
Gifts and awards
The CRA allows employers to give up to two non-cash gifts to employees for special occasions - Christmas, birthdays, anniversaries, etc. - each year. The employer can deduct the cost of the gifts and the employee is not taxable if the gifts do not have a value of more than $500 (including taxes). Where the value of the gift is more than $500, the full amount is taxable to the employee.
Similarly, employees are not taxable on the value of social events if the cost of the event does not exceed $100 per person.
However, the exemption does not apply to near-cash gifts, for example, investment certificates or other items that one can easily convert into cash.
Employers can use these small concessions by the CRA during the holiday season to bring cheer to their employees. Even better, the employer can deduct the cost of the gifts in computing its income for tax purposes.
Stock options
Stock options raise special problems of timing and valuation. The basic stock-option rule is simple enough: Option benefits are taxable as employment income when the employee exercises his option to acquire shares. The benefit is equal to the difference between the cost of the option to the employee and the value of the shares at the time that he or she acquires them.
For example, assume an individual acquires 100 shares at a cost of $10 per share when the shares have a value of $15 per share. If the individual pays $1 per share for the option, the value of the taxable benefit is $4 per share or $400. At a tax rate of 45 per cent, the tax cost is $180. Thus, the tax is equal to the tax payable on an additional $400 of salary or bonus.
"Value" means "fair value." In the case of publicly traded securities, stock market prices are usually indicative of fair market value. Since listed stock prices inherently reflect the value of minority shareholdings, there is no need to further discount their value for minority interests.
The valuation of shares of private corporations is a more difficult matter. One values shares of private corporations by reference to estimated future earnings and the adjusted net value of assets. One must then adjust the pro rata value of the corporation to reflect a discount for minority interests and lack of liquidity.
Employees who acquire shares under stock option plans should sell sufficient shares to pay the applicable tax in the year that they acquire the shares. There can be serious problems if the employee holds on to all the shares and they drop in value or, worse still, become worthless.
The employee remains liable for the full amount of the taxable employment benefit. The problem is even worse if the employee cannot offset his capital losses against capital gains.
Vern Krishna is tax counsel at Borden Ladner Gervais LLP and executive director of the CGA Tax Research Centre at the University of Ottawa. He may be reached at [email protected]
We must make some decisions by year-end; others can wait until early in the new year. The following is a sample of employee-related tax planning issues.
Employee loans
If you have or had a low-interest loan from your employer during the year, you are taxable on an imputed value for interest as an employment benefit. The Canada Revenue Agency calculates the value of the benefit by reference to a prescribed rate of interest less any amount that the employee actually pays during the year and up to Jan. 30, 2007.
CRA bases the rate on the average Treasury Bill rate of the first month during the preceding quarter. Ensure that you pay any interest due by the deadline to minimize the value of the taxable benefit.
An employee who is taxable on his or her imputed interest benefit is deemed to have paid an equivalent amount pursuant to a legal obligation. This means that any portion of the imputed interest that is attributable to earning income (for example, the purchase of shares) is deductible as interest expense.
Employees should ensure that they retain the requisite paper trail to validate the use of their employer loans for at least four years.
Note, where an individual obtains a loan by virtue of her shareholdings rather than employment, the full amount of the loan is taxable as income even if the individual pays interest at the prescribed rate. This rule does not apply if the shareholder repays the loan by the following year-end of the lender.
Capital assets
Employees can claim tax depreciation - capital cost allowance (CCA) - on depreciable capital assets such as automobiles, aircraft, and musical instruments. In most cases, one can claim only half of the CCA in the year that one purchases the asset. To claim the CCA, the asset must be available for use in the year. Hence, it is best to purchase such assets before the year-end to obtain the maximum allowance for the year with the shortest holding period.
Shift income
If possible, employees should shift as much income as possible into 2007. This will defer the tax payable on the income until April 30, 2008. Ask your employer not to pay your year-end bonus until January 2007. If you are lucky, you may also benefit from federal rate reductions as our budget surplus increases along with the possibility of another election.
Automobile benefits
An employee is taxable on the imputed value of benefits from a company car that is available for her personal use. The benefit takes two forms: a fixed standby charge and a variable amount for operating expenses.
The standby charge is for simply having the car available for use, regardless of actual usage. The standby benefit is equal to two per cent per month of the original cost of the automobile less any amounts paid to the employer by the calendar year-end. There is a reduced standby benefit if one drives less than 20,000 kilometres in the year and personal use is less than half of total use.
For example, if a car cost $30,000 in 2003, the value of the benefit for the full year is $7,200. Hence, employees should consider whether they are better off purchasing the car at its fair market value to reduce the value of taxable amounts in future years.
If your employer also pays your operating expenses for personal use of the vehicle, you are taxable on an additional benefit. The benefit is equal to 20 cents per kilometre of personal use less any amount you repay your employer by Feb. 14, 2007.
Gifts and awards
The CRA allows employers to give up to two non-cash gifts to employees for special occasions - Christmas, birthdays, anniversaries, etc. - each year. The employer can deduct the cost of the gifts and the employee is not taxable if the gifts do not have a value of more than $500 (including taxes). Where the value of the gift is more than $500, the full amount is taxable to the employee.
Similarly, employees are not taxable on the value of social events if the cost of the event does not exceed $100 per person.
However, the exemption does not apply to near-cash gifts, for example, investment certificates or other items that one can easily convert into cash.
Employers can use these small concessions by the CRA during the holiday season to bring cheer to their employees. Even better, the employer can deduct the cost of the gifts in computing its income for tax purposes.
Stock options
Stock options raise special problems of timing and valuation. The basic stock-option rule is simple enough: Option benefits are taxable as employment income when the employee exercises his option to acquire shares. The benefit is equal to the difference between the cost of the option to the employee and the value of the shares at the time that he or she acquires them.
For example, assume an individual acquires 100 shares at a cost of $10 per share when the shares have a value of $15 per share. If the individual pays $1 per share for the option, the value of the taxable benefit is $4 per share or $400. At a tax rate of 45 per cent, the tax cost is $180. Thus, the tax is equal to the tax payable on an additional $400 of salary or bonus.
"Value" means "fair value." In the case of publicly traded securities, stock market prices are usually indicative of fair market value. Since listed stock prices inherently reflect the value of minority shareholdings, there is no need to further discount their value for minority interests.
The valuation of shares of private corporations is a more difficult matter. One values shares of private corporations by reference to estimated future earnings and the adjusted net value of assets. One must then adjust the pro rata value of the corporation to reflect a discount for minority interests and lack of liquidity.
Employees who acquire shares under stock option plans should sell sufficient shares to pay the applicable tax in the year that they acquire the shares. There can be serious problems if the employee holds on to all the shares and they drop in value or, worse still, become worthless.
The employee remains liable for the full amount of the taxable employment benefit. The problem is even worse if the employee cannot offset his capital losses against capital gains.
Vern Krishna is tax counsel at Borden Ladner Gervais LLP and executive director of the CGA Tax Research Centre at the University of Ottawa. He may be reached at [email protected]
