david ingram's US/Canadian Newsletter
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DID YOU KNOW? -- TAXATION IS BASED UPON WHERE YOU WORK - NOT WHERE YOU LIVE.
Canadians performing services in the United States, and in 43 of the states in particular, are required to file the respective state return(s) and a US federal 1040NR or 1040 income tax return, even if their remuneration was paid from Canada. This applies, but is not limited to:
With Chartered Accountants, US Lawyers, and US CPA's as associates, I feel that the CEN-TA Group has the experience and the qualifications to look after most, if not all, US / Canadian tax problems.
Contact George Hatton, CA, Sonja Clark, CA, CPA, LLB, D'Arcy von Schleinitz, David Ingram, or Gail Ritter at (604) 913-9133 - Fax (604) 913-9123 for US and CANADIAN INCOME TAX PREPARATION, ACCOUNTING and / or CONSULTATION.
Contact David Ingram for US Working Visas.
MORTGAGE INTEREST AS A DEDUCTION
NOTE: January 6, 2010 update - Watch David Ingram talk about how to make your Canadian Mortgage tax deductible on Around the World
People usually think that Americans have it all because they can deduct their mortgage interest and property tax on their income tax return. This is true. They can make these deductions, but to do so, most families give up a $7,000 standard deduction. This is fine if your mortgage interest is over $5,000 or so, but the practical fact is that 90% of mortgages in the US are $50,000 or less and interest on $50,000 isn't enough to justify giving up the standard deduction.
In addition, Americans might have to PAY TAX ON THE PROFIT when they sell their principal residence. If you have lived in the house for two of the last five years, there is a $250,000 per person exemption.
The US deductions are not free. There is a future potential tax liability. The principal residence house profit can be taxable even if you did not claim the deductions.
Canadians DO NOT PAY TAX on profits from the sale of the family home. AND, Canadians can re-arrange their affairs to make their mortgage deductible.
(and maybe make a million on the side at the same time)
It is useless if not downright dangerous to plan personal finances around "US", so let's get on with planning for "ME". We will either be divorced or a widow(er) or dead. We all have to plan for ourselves alone and assume the other person will be gone. Let's also make our decisions based upon investments that we understand as opposed to diamonds, or jewelry, or art or antiques, or strip bonds, or or or....
We all know that indulging in consumer credit at high interest rates to purchase diminishing assets is a luxury we cannot afford. Compound this fact with the non-deductibility of that high interest and we come up with rule number 1: INTEREST PAYMENTS THAT ARE NOT DEDUCTIBLE ARE A NO NO!
However, before I talk about how to make interest payments deductible, I want to point out that nothing can be deductible if you do not have a record of it. This whole subject makes me angry. If I start sounding like the movie "NETWORK", do not be surprised. People tell me, "lawyers cost too much" and then pay through the nose, because they did not consult a lawyer in time. They tell me that doctors cost too much and then find out just how much they do cost when they do not pay their medical premiums. People tell me that dentists cost too much and do not brush their teeth. But what really makes me angry is when they say that accountants cost too much and wander into my office or anyone else's office with a shoe box or garbage bag or attach? case full of receipts with three different years on them. Why don't they do a basic sort... at least into years? It is this same person who will complain when we charge for sorting the receipts. All we have to sell is our time; if you use an accountant's time, expect to pay for it.
Would you like to know the simplest way to look after your records if you are a commission sales person, farmer, fisherman, or just plain one man or woman business? It isn?t tying you to a computer program. TRY THIS!
Take over one drawer in a desk or vanity and get about 25 or 30 # 10 envelopes. Label them with an expense item in your business or work: Gas, Oil, Hotels and Motels, parking, telephone, and so on. When you get home at night or to the office in the morning, merely empty your pocket, purse, etc. into the relevant envelope. Around Jan 15th of the next year, simply add up the contents of each envelope and write the amount on the outside of the envelope. Those are your expense items for your profit or loss statement or expense statement in either Canada or the United States.
YOU DO NOT NEED DOUBLE ENTRY BOOKKEEPING FOR YOUR "SIMPLE" BUSINESS. The only reason for double entry bookkeeping is to try and stop people from stealing from you. If you have no employees, no one is stealing from you.
If you are audited by the Internal Revenue Service (IRS) or the Canada Customs and Revenue Agency (CCRA), you have all the relevant receipts for their query neat and totaled. Best of all, when you go to your accountant or tax man to have your return prepared, you will not be paying $75 to $150 an hour to have someone else sort and add your receipts. When it comes to an audit, the auditor will prefer to have the receipts segregated in this manner.
On the subject of why you should keep receipts, try this one on for size. We will pretend you earn $55,000 per year and are on the edge of a 45% marginal tax bracket. You take a business trip from Vancouver to Victoria. It costs $100 for the ferry there and back. You spend $15 for a meal on the ferry going and $30 for a meal there and $30 for a meal coming back (you meet a client on the ferry and buy him dinner); total expenses $175. If you do not keep these deductible receipts, you might just as well have torn up a ?seventy-five? dollar bill and thrown the pieces overboard.
At least most of that trip was deductible. Even though you spent $175, you got $75 back in the form of a tax refund or tax you did not have to pay. It only cost you $100. However, one of the rubs in this life is that if you just decided to take your family out to dinner and spent $70, you would have to earn $120 and pay $50 tax to have $70 to pay for the dinner.
This is the best example to arrange your affairs to make them 'deductible'. WORK AT IT! If you do not, no one else will and you will pay three to four times as much for the same thing.
By the way, the VISA / MC / AMEX receipt is NOT sufficient. The reason is that people going to lunch have been known to give the actual receipt to one person while the other person uses his or her VISA slip as a receipt. Both the CCRA and IRS insist on the actual receipt.
Try this. I will ignore any finance charges for the purpose of this example and assume everyone has the ability to pay cash, (the example is far worse with interest factored into the equation).
A commission salesman buys a $24,000 Magic Wagon and it is used 75% of the time for business. He is able to write off $18,000 of the purchase price of the car and gets back at least $8,100 as a tax refund. The car cost $16,000 or so in out of pocket cash. Or the salesman would have to earn $30,000 and pay $14,000 tax to have $16,000 net to pay for the car. His neighbor buys an identical car and has to earn about $44,000 and pay $20,000 tax to have $24,000 left to pay for the car. Add in the differences in gas, oil, insurance and interest and the cost can easily be two or even three times more to pay for the non-deductible car.
If you can't afford a new car and your salesman neighbor buys a new car every year, it is partly because the tax system is helping to pay for it.
Although there is no doubt that a self-employed person is entitled to certain expenses, as is a real estate agent or even a sea captain, YOU MUST HAVE RECEIPTS. In 79 DTC 899, Judge Delmar Taylor made the ruling that although employees earning commissions were permitted deductions for certain expenses not deductible by other types of employees, it was incumbent upon them to maintain records and documentation in support of such expenses. When no documentary evidence was produced, the whole claim was dismissed. It should be noted that Mr P Litvinchuk had earned $47,700 in 1974 and claimed unvouchered expenses for "parking meters, drinks, pay phones, etc. of $2,400". He earned $55,570 and claimed $2,000 for 1975, and during 76, he earned $67,834 and claimed $600. The tax office offered $600 for 74, $600 for 75 and $300 for 76 and Mr Litvinchuk appealed to get his original claim. Judge Taylor gave him nothing.
Many taxpayers seem to think that there is a reasonable or an `allowable' amount of 5%, 10%, 15%, etc. that the tax office allows without receipts. NOT SO! Although the policy of the tax office is to allow `something', they in fact do not have to allow anything as the previous case showed. (For more wonderful `real life' stories of tax cases, see my "The Ultimate Year Round Tax Book" which is also published by Hancock House). Certainly the amounts claimed by Mr Litvinchuk were small in relation to the earnings, but as you have seen, reasonableness does not enter into it.
Either you are over-parked or you are not. The fact that you were going for change for a $1,000 bill is irrelevant. You should have had a Magic Wagon with a built in change dispenser. The difference between over parking or speeding and income tax is that when they catch you for speeding, they do not go back three years and give you a ticket for every day you sped in the last three years. Income tax goes back three, four, up to eight years on a regular basis.
And, when you get caught for speeding, you KNOW you were breaking the law. You would never tell the nice traffic officer, ?what do you mean, I can?t speed here, I have been speeding here EVERY DAY FOR TEN YEARS, but, when the CCRA auditor suggests that you can?t claim something, the first thing you will say is: ?I?ve been claiming that for ten years and EVERYONE ELSE at the office has been claiming it as well.?
On the other hand, also in 1979, a Sea Captain, Paul Allen from Lunenburg, Nova Scotia, who was an employee, was allowed 100% of his truck expenses because it was used to transport goods to and from the boat and was used exclusively for boat related activities. He also used his car for business trips and was allowed 20% of his car. He had an office in his home which he used to interview prospective crew members and was allowed 10% of the expenses of his house and last but not least, he had spent $447 for a party at his house (he did not have receipts) and Judge J B Goetz allowed the total amount because the party was for crew members, suppliers and maintenance personnel.
Obviously, the quality of the evidence, the mood of the judge, and the circumstances change in each and every case.
I will now return to the subject of making interest deductible. Twenty-two years ago I was very heavily into rearranging peoples' finances to make mortgage interest deductible. The 1979 election of Joe Clark and the actual production of a mortgage interest deduction form with the tax return stopped the momentum. Lately, it has been rare for people to come in and pay their money to make their interest deductible. And this is strange, because of course the interest is usually three times what it was in 1977 and 1978. In fact, in 1978, I would get thirty people a month and now I get 20 a year. I guess that people just like paying taxes or maybe those that would have come in and paid a $300 fee have now figured it out themselves by reading my book or a prior edition of this newsletter. Or, maybe they just want to pay more tax.
Our "deductible mortgage" program typically took four to five years to implement. Joe Clark's government was bringing the deduction in for mortgages up to $50,000 over a four-year period. The deduction was actually included on the 1979 Income Tax Form. But Joe Clark was defeated and so was the deduction.
The biggest part of our mortgage interest deductibility involved purchasing some rental real estate (you need an outside source of income). I am proud to say that as well as making the house mortgage deductible, in most cases the rental real estate has gone up significantly. Some of our purchasers in Brampton realized $120,000 profits from $10,000 down and made their mortgage deductible at the same time.
The mortgage interest situation in Canada is different from the US. In Canada, mortgage interest is not deductible where the mortgage was put on the house to buy it as a principal residence or as a seasonal cabin/chalet. On the other hand, we in Canada do not have to pay tax on the capital gains profit when we sell our house. In the United States, there is a standard deduction or a person may `itemize' deductions. Itemized deductions include mortgage interest, property taxes, medical and dental, and even income tax preparation fees. When a mortgage is getting small (because of age or buy down), it is possible that a family of six could have a larger standard deduction than the mortgage interest and property taxes works out to and they have to pay tax on the profit (capital gain) as well.
And in the States, mortgage interest is no longer deductible on that part of a mortgage, which exceeds the original purchase price. So after years of saying that there has been less need of my type of service in the US, it has become obvious that the US's changing to a `more Canadian' type of system makes the following proposal appropriate for both countries.
It used to be that all other interest in the US was also deductible. Your Sears interest was deductible, your Visa interest was deductible, and your mother's car loan was deductible. But all that has changed. With the rules `Canadianized' over a four-year period starting in 1986, US taxpayers can no longer claim all that interest. As a consequence, US taxpayers have to start rearranging their affairs in the same manner.
HOWEVER, ANYONE WHO WANTS TO REARRANGE HIS OR HER AFFAIRS, CAN MAKE HIS MORTGAGE INTEREST AND CAR LOAN INTEREST, AND BOAT LOAN INTEREST DEDUCTIBLE. It helps if you are self-employed. But if you are not self-employed, the same results can be had with the ownership of rental property or a good mutual fund portfolio. It is also possible to make a million on the side while you are rearranging your affairs.
Oh, I almost forgot. If you are the proud owner of a one-person corporation, this will not work. In fact if you are the proud owner of a corporation, with the exception of a couple of very esoteric credits like Scientific Research Tax Credits (SRTC) or Flow Through Shares, you will pay MORE income tax with a corporation than without. In addition, you will pay an easy $600 to $1,000 more for tax and legal work per year.
If you have a corporation, you should likely kill it, or at least put it on a back burner for a while until you get all your interest deductible. If you have a corporation for `insurance purposes', i.e. so that you can't be sued, forget it. The courts find it very easy to go after the major shareholder of a corporation where that shareholder is the only or chief employee and where the problem arose because of the actions of that employee/shareholder.
A dentist making $100,000 a year wants to buy a $100,000 sailboat but he has no cash. He could afford the $1,000 a month payment if he did 100% financing but he would have to make $2,000 a month and pay $1,000 tax to have $1,000 left over for the boat payment if the interest was not deductible. If the interest were deductible, he would pay the $1,000 a month interest and get a $500 per month cash deduction off his income tax.
We will assume he has a $200,000 house with a $50,000 mortgage (Lives in Lunenburg or Prince Rupert, etc.). We will assume that his practice grosses $20,000 a month and that after all expenses, he has exactly $100,000 left as his earnings.
As we have already discussed, if he puts a mortgage on the house to buy the boat, the interest is not deductible because the money was used to buy a boat and yacht interest is specifically forbidden as a deduction in Canada unless the boat is a full time working boat (could be a rental). In the US, if the original cost of the house was $100,000 and a new mortgage was put on up to $150,000 from the $50,000 that was outstanding, only interest on $50,000 would be deductible. If the original cost was $150,000 or over, than the interest on the whole $100,000 WOULD be deductible.
But let's take the worst case scenario and assume the original cost of the house was $50,000 and the $50,000 loan on it now was used to put the kids through university and fix the roof and plumbing. Therefore, any increased loans against the house bears non-deductible interest.
The dentist has $140,000 worth of expenses per year. The expenses are for rent, light, heat, telephone, labs, supplies, repairs to equipment, assistant's wages and dental technicians. If he were short money some week because a cheque from a dental plan was late, and he borrowed money to pay for the rent and his assistant's salary, the interest would be deductible.
First our dentist goes to his or her `creative' mortgage person or bank manager (Joan Marsh maybe at (604) 535-9981) and says, "I want to arrange a floating business loan for my practice as a dentist. The total amount of the loan may be as much as $100,000." The bank manager will usually say yes, because our dentist is going to give the bank a mortgage on the $150,000 equity in his house.
Each month for the next year, our dentist deposits all the gross receipts of the practice into a term deposit. He takes out his own personal expenses only. EVERY SINGLE TIME HE NEEDS TO PAY A BILL FOR THE PRACTICE, HE BORROWS THE MONEY FROM THE BANK THROUGH HIS PRE-ARRANGED FLOATING BUSINESS LOAN. When the Term Deposit is up to $100,000 (or $114,000 including GST and PST), he takes the $114,000 out and pays cash for the boat. The net result is that there is deductible $114,000 loan against the business and every single cent can be shown to have been borrowed to pay business expenses. If our dentist or doctor or lawyer or accountant has any other non-deductible interest (such as the first $50,000 on the house), he can now use the boat as security to borrow more money for the business while he pays down the other non-deductible loan.
The owner of the store wants to buy a nice little one bedroom Condo in Winnipeg for $60,000. He has no money saved and the shoe store is just making it plus a little extra but he is already paying out non-deductible apartment rent of $650 a month. If he could pay $800 a month deductible interest instead of $650 a month non-deductible rent, he would be about $200 to $300 ahead each month because of the tax refund/deduction.
What does he do? What DOES he do??
Simple.... He stops paying his bills for a couple of months. Every cent coming in goes into a term deposit.... Every cent except for what he needs for personal expenses. When his creditors have yelled a couple of times he goes to the bank and borrows money to pay them. What does he use as security? He uses his term deposit of course. Depending upon the monthly gross of the business it will take six months to a year to get the $60,000 into the term deposit. Now he has cash to pay for the apartment. Of course the bank won't release it because it is security for their business loan.
What does he/she do? He slyly suggests to the bank manager (Joan Marsh) that he will have a paid for condo and the bank could take the condo as secondary security as well as a charge against all the business assets. The net result, a $60,000 loan with the main security being a condo, BUT the money was not borrowed to buy the condo. Every cent was borrowed to pay rent on the business, pay staff, buy stock, advertise, etc. It is an absolute paper trail of source and application of funds. (For an example of about thirty tax cases on deducting interest, see my "THE ULTIMATE TAX BOOK, published by Hancock House Publishers Ltd.")
So I repeat, anyone who is self-employed or owns a small business (proprietorship, not corporation), or WHO OWNS RENTAL PROPERTY or an income bearing portfolio, can make his or her mortgage deductible. It might not work in two years, it might take three, four, five, or even six years, but IT WILL and DOES WORK.
This is how you do it. Let's assume you have rental property (If you do not, we could and will arrange for you to buy it and manage it for you and set up the following program). That rental property might be the first MURB you bought or even a ski chalet. When you have a business, are self-employed or have rent coming in, no one tells you in what order you have to spend your income.
For instance, if not in this program and you had to borrow $1,000 to fix the roof on your rental property, WE KNOW `automatically' that the interest on the $1,000 loan is deductible. Where we have a problem in our mind is when we have the money available to fix the roof and I say "BORROW IT ANYWAY".
The problem is that we have been conditioned by some antiquated accountant to keep our business and personal accounts separate or set up a separate account for our rental house. Then we are told to pay those bills out of that account. THAT IS THE WORST ADVICE YOU EVER RECEIVED ABOUT FINANCE (well maybe second to the advice to buy a whole life insurance policy). When you have a separate account and you have used all the money from the rent to pay the bills for the rental house, and you still need money to fix the roof on your own house and you borrow the money to fix your own roof, the interest is not deductible. But if you took the rent money received and paid cash for the roof, then borrowed the money to make the mortgage payment for the rental property, the interest would be deductible. The money from the rent, from the dental fees, from the accounting fees, from the shoe sales, is YOURS FIRST to do with as you please. YOU, and ?ONLY? YOU! decide what you are going to pay first. Unfortunately, we have been conditioned to pay "DEDUCTIBLE" bills first when we should be paying "NON DEDUCTIBLE" bills first.
Look at the "flow through" for the first year of a typical MURB of which there were some 350,000 sold to investors so that they could CLAIM A RENTAL LOSS on their income tax return. Remember, a MURB is just a multiple unit residential building. MURB's still exist. They just do not have as much artificial tax deduction associated with them.
A typical situation might be that you take in $11,000 rent and spend $17,000 and you are encouraged to do this by the Governments of both Canada and United States because it is cheaper for the governments to give you, the investor, a tax deduction then it is to provide subsidized housing. In this example, where are you going to get the $6,000 shortfall? You have to earn it or borrow it. If you borrow it, the interest is a deduction. Why not take the $11,000 rent and pay down your own mortgage by $11,000 and borrow the whole $17,000 to fund the rental property.
Let's say you want to open up a camera store or a shoe store or a store to sell western hats. You finally heard about urban cowboys and realized Stetsons are big business. Of course, they stopped selling three weeks ago, but you just found out about them so you are going to open up a store and sell western hats. You borrow $30,000 and purchase $30,000 worth of hats from the Stetson Company. In the next year, you pay out $6,000 interest, $12,000 rent, $15,000 for wages, $5,000 for other miscellaneous things and $2,000 for heat and light. You've spent a total of $70,000 with the expectation of selling some hats. At the end of the year you haven't sold one. Where did you get the $70,000 in the first place? You put a mortgage on your house. The money was borrowed for business purposes, voila, the interest is deductible, even though the loan is a mortgage registered against the house.
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