1. © 2008 McGraw-Hill Ryerson Ltd.1 Chapter Ten Individuals: Determination of Taxable Income and Taxes Payable Prepared by Nathalie Johnstone, University of Saskatchewan Electronic Presentations in Microsoft® PowerPoint®

2. © 2008 McGraw-Hill Ryerson Ltd.2 Individuals: Determination of Taxable Income and Taxes Payable I.Determination of Taxable Income II.Loss Carry-Overs III.Loss Utilization – Impact on Decision Making IV.The Capital Gain Deduction V.Calculation of Tax for Individuals VI.Special Adjustments to the Tax Calculation VII.Final Returns of Deceased Taxpayers

3. © 2008 McGraw-Hill Ryerson Ltd.3 I.Determination of Taxable Income Net income for tax purposes must be converted to taxable income. Individuals determine their taxable income and tax payable by a different method than corporations.

4. © 2008 McGraw-Hill Ryerson Ltd.4 I.Determination of Taxable Income A taxpayer’s taxable income for a taxation year is: The special reductions are grouped together in Division C of the Act.  Stock options  Losses not utilized in other years  Lifetime capital gain deduction Taxable income = Net Income – Special Reductions

5. © 2008 McGraw-Hill Ryerson Ltd.5 Taxable Income Formula - revisited Net income for tax purposes: a) Employment Income Business Income Property Income Other items Plus b)Net Capital Gains- ITA 3(b)(i)(B) Less c)Other items of deductions Less d)Aggregate of losses from Employment Business, Property and ABILS =Net Income for tax purposes

6. © 2008 McGraw-Hill Ryerson Ltd.6 Taxable Income Formula for Individual Net income for tax purposes XXX Less 2.Special Reductions: a)Stock Options –ITA 110(1)(d),(d.1) (XXX) b)Losses not utilized in other years ITA 111 (XXX) c)Lifetime capital gain deduction ITA 110.6 (XXX) =Taxable Income

7. © 2008 McGraw-Hill Ryerson Ltd.7 II.Loss Carry-Overs Loss carry-overs are losses from other years. Losses incurred in current year are deducted first. –as part of the net income calculation.

8. © 2008 McGraw-Hill Ryerson Ltd.8 Net Capital Losses Net Capital Losses: –Allowable capital losses incurred in current year but cannot be utilized can be carried back three years and forward indefinitely – ITA 111(1)(b) only deductible against capital gains Exception upon the death, unused losses may be deducted against any type of income earned in the year of death or in the preceding year – ITA 111(2)

9. © 2008 McGraw-Hill Ryerson Ltd.9 Non-Capital Losses Unused business, property and employment losses and ABILs can be carried back three years and forward twenty years - used against any source of income ITA 111(1)(a)

10. © 2008 McGraw-Hill Ryerson Ltd.10 ABILs Special Treatment: Only carried forward ten-years. ABIL unused after ten-years: reclassified as a net capital loss and can be carried forward indefinitely –to be used only against future capital gains.

11. © 2008 McGraw-Hill Ryerson Ltd.11 Farm Losses and Restricted Farm Losses Farm losses - chief source of income is farming or fishing. Farm losses are treated the same as business losses.

12. © 2008 McGraw-Hill Ryerson Ltd.12 Farm Losses and Restricted Farm Losses Restricted farm losses - not primary sources of income. Max deduction in current year- $8,750 –$2,500 plus –½ x $12,500 Unused losses - classified as restricted farm losses. ITA 111(1)(c) - Unused restricted losses can be: – carried back three years and –forward twenty years –only be deducted against farming losses.

13. © 2008 McGraw-Hill Ryerson Ltd.13 III.Loss Utilization – Impact on Decision Making Organizational structure chosen has an influence on loss utilization. –Corporate structure – risk of loss expiration is increase as losses are locked in the corporation. –Proprietorship or partnership – losses can be used against all other sources the individual may have.

14. © 2008 McGraw-Hill Ryerson Ltd.14 III.Loss Utilization – Impact on Decision Making The risk of loss expiration: –can be minimized by creating taxable income or –reduce deductible expenses, thereby –permitting a greater amount of the loss carry-over to be used.

15. © 2008 McGraw-Hill Ryerson Ltd.15 IV.The Capital Gain Deduction Final step is to apply the capital gain deduction. Lifetime Capital Gain Deduction is available only for –Qualified small business corporation shares and –qualified farm property. –Deduction is one-half of $750,000 ($375,000) – ITA 110.6(4) deductible from taxable income. The deduction is discretionary. After March 19,2007

16. © 2008 McGraw-Hill Ryerson Ltd.16 IV.The Capital Gain Deduction A small business corporation is: – a private corporation that is Canadian-controlled and – that uses all or substantially all of its assets (at least 90%) to conduct an active business. Qualified farm property includes: –real property, –eligible capital property used in farming business, –share of a family farm corporation, and –Interest in a farm partnership.

17. © 2008 McGraw-Hill Ryerson Ltd.17 IV.The Capital Gain Deduction Ability to claim is limited by two items: 1.Capital losses incurred (including ABILs) - only to extent that lifetime capital gains exceed capital losses. 2.Accumulated investment losses (CNIL) – ITA 110.6(1) - Capital gains deduction available is reduce by the total CNIL balance. - CNIL does not eliminate or reduce total available capital gain exemption; - it simply delays its use until a later year.

18. © 2008 McGraw-Hill Ryerson Ltd.18 V.Calculation of Tax for Individuals Income tax is imposed by the federal and provincial governments:  Federal tax - % of taxable income  Provincial tax - % of taxable income

19. © 2008 McGraw-Hill Ryerson Ltd.19 Determination of Tax for an Individual

20. © 2008 McGraw-Hill Ryerson Ltd.20 Primary Federal Tax Progressively higher tax rates to higher levels of annual income (tax policy principle: ability to pay). Each rate of tax is applied separately to the portion of the individual’s income that falls within the applicable range.

21. © 2008 McGraw-Hill Ryerson Ltd.21 Primary Federal Tax Taxable Income Range (2008)Rate Up to $37,88515% $ 37,886 - $75,76922% $ 75,770 - $122,18426% Over $ 122,18429%

22. © 2008 McGraw-Hill Ryerson Ltd.22 First Category of Federal Tax Credits ITA 121 Dividend tax credit – Eligible Corporations –Equal to 19% of the taxable amount of dividends received from Canadian corporations. Dividend tax credit – Non-Eligible Corporations –Equal to 13 1/3% of the taxable amount of dividends received from Canadian corporations.

23. © 2008 McGraw-Hill Ryerson Ltd.23 Dividend Tax Credit Eligible Corporations: –Canadian Public Corporations –Canadian private Corporations – not Canadian controlled –CCPC not eligible for SBD Non-eligible Corporations: –CCPC eligible for SBD –CCPC earning investment income

24. © 2008 McGraw-Hill Ryerson Ltd.24 First Category of Federal Tax Credits Basic - ITA 118(1)(c)  15% x $9,600 = $1,440 Spouse or equivalent to spouse - - ITA 118(1)(a),(b)  15% x $9,600 = $1,440  Reduced by 15% of the spouse’s net income.

25. © 2008 McGraw-Hill Ryerson Ltd.25 First Category of Federal Tax Credits Child Credit –A credit of $306 (15% of $2,038) for each child: Either parent can claim – providing residing with parent throughout the year Can transfer unused credit to other parent. If not residing with both parents – claimed by person eligible to claim wholly dependant person credit.

26. © 2008 McGraw-Hill Ryerson Ltd.26 First Category of Federal Tax Credits ITA 118(1)(d)(e) - Infirm dependants  Individuals supporting a  related person  At least 18 years of age and  dependent by reason of physical or mental infirmity Tax credit of $615 (equivalent to $4,095 of taxable income)  reduced by 15% of dependant’s net income in excess of $5,811.  necessary for dependant to be living with supporting individual.

27. © 2008 McGraw-Hill Ryerson Ltd.27 First Category of Federal Tax Credits ITA 118(1)(b.1) - Caregiver  Provide in-home care for::  a parent or grandparent who is 65 or older, or  dependent relative who is infirm $614 tax credit against federal tax.  Reduced by 15% of the dependent’s income in excess of $13,986.  Eliminated if dependant’s income >$18,081

28. © 2008 McGraw-Hill Ryerson Ltd.28 First Category of Federal Tax Credits ITA 118(2) - Age amount - 65 years of age or older –15% x $5,276 = $791 –$5,276 reduced by 15% of net income > $31,524. ITA 118.3(1) - Disability - a severe & prolonged mental or physical impairment –15% x 7,021 = $1,053 –Can be transferred to spouse if individual cannot use

29. © 2008 McGraw-Hill Ryerson Ltd.29 First Category of Federal Tax Credits Employment Credit –Employed individuals –Designed to cover expenses incurred by employees –15% x $1,019 = $153

30. © 2008 McGraw-Hill Ryerson Ltd.30 First Category of Federal Tax Credits ITA 118(3) - Pension –15% on first $2,000 –qualified pension income received in a year. –Spouses who split pension income can double up on this credit

31. © 2008 McGraw-Hill Ryerson Ltd.31 First Category of Federal Tax Credits ITA 118.1(3) - Charitable donations –15% x first $200 of annual contributions and –29% x the remainder. –Annual donations cannot exceed 75% net income –Unused Donations can be carried forward for 5 years

32. © 2008 McGraw-Hill Ryerson Ltd.32 First Category of Federal Tax Credits ITA 118.7 - CPP and EI –15% x CPP and EI contributions ITA 118.2(3) - Medical expenses –15% x qualified medical expenses exceeding: either 3% of the taxpayer’s net income, or $1,962, whichever is less.

33. © 2008 McGraw-Hill Ryerson Ltd.33 First Category of Federal Tax Credits ITA 118.5 - Tuition fees –attend a university, college, or other certified post-secondary institution –15% x tuition fees paid. ITA 118.6(2) - Education amount and textbook credit –Full-time students – 15% x $465 x each month of full-time attendance. –Part-time education – 15% x $140 x each month of part-time attendance.

34. © 2008 McGraw-Hill Ryerson Ltd.34 Tuition and Education credits  ITA 118.9 - The student may not have sufficient income to utilize the above credits.  The unused portion is transferable - up $750 (15% x $5,000) annually to a spouse, parent, or grandparent.  Less any credits used by student.  Alternatively, the student may keep the unused credit and carry it forward indefinitely.

35. © 2008 McGraw-Hill Ryerson Ltd.35 First Category of Federal Tax Credits Student loan interest –Entitled to deduct 15% x interest paid on student loans. –Only on interest on loans under: Canada Student Loan Program and Provincial student loan programs. –The credit may be claimed in the year of interest payment or in any of the following five years.

36. © 2008 McGraw-Hill Ryerson Ltd.36 First Category of Federal Tax Credits Adoption Expenses –15% of expenses to maximum of $10,643 Public Transit Pass –15% of monthly cost for unlimited travel Local busses, streetcar, subway, commuter train and ferries Children’s fitness credit –15% of fees paid up to $500 for Physical activity program

37. © 2008 McGraw-Hill Ryerson Ltd.37 Second Category of Federal Tax Credits Political contributions –Based on a graduated scale. –Annual credit is: 75% of the first $400, 50% of the next $350, and 33 1/3% of contributions over $750. –Max. of $650 annually ITA 126 - Foreign tax credit Investment tax credits Logging tax credit Labour-sponsored fund credit

38. © 2008 McGraw-Hill Ryerson Ltd.38 Provincial Taxes Determine their primary tax by applying specified tax rates to the federal taxable income. Rates vary from province to province. Specify their own tax credits. Individuals are subject to tax based on the province they live in on December 31 of the taxation year.

39. © 2008 McGraw-Hill Ryerson Ltd.39 VI.Special Adjustments to the Tax Calculation Special rules apply that increase the amount of tax payable beyond the normal amount. Two basic areas where the normal tax calculation may be adjusted to a higher amount: 1.The Alternative Minimum Tax (“AMT”) 2.Special Tax on Old Age Security Benefits

40. © 2008 McGraw-Hill Ryerson Ltd.40 The Alternative Minimum Tax – ITA 127.5-.55 Designed to impose a minimum level of tax –When “normal tax” has been reduced by “tax preference” items. Example – non-taxable portion of capital gains Additional tax is not a permanent tax; –AMT paid in one year can reduce normal tax in following year. –can be carried forward for up to seven years

41. © 2008 McGraw-Hill Ryerson Ltd.41 Tax Preference Items Taxable income is increased by the following:  The non-taxable portion of net capital gains earned.  Deductions claimed from certain specified tax shelter investments, to the extent that any of these create losses.  Employee stock option deduction. Taxable income is reduced by the following:  The gross-up on Canadian dividends.  A basic exemption of $40,000.

42. © 2008 McGraw-Hill Ryerson Ltd.42 The Alternative Minimum Tax Entire income is subject to a federal tax rate of 15%. If revised federal tax > the normal federal tax, you have AMT. Provincial taxes are then calculated on the revised amount.

43. © 2008 McGraw-Hill Ryerson Ltd.43 Special Tax on Old Age Security Benefits (“Clawback”) Clawback is a special tax imposed on individuals who: –received OAS benefits and –Earn > $64,7181 in net income for tax purposes. The special tax is equal to 15% of net income in excess of $64,718, –up to a maximum of the OAS payments. Since all OAS benefits are included in income, the “Clawback” is deducted in arriving at net income.

44. © 2008 McGraw-Hill Ryerson Ltd.44 VII.Final Returns of Deceased Taxpayer Special rules apply A.Taxable Income and Net Capital Losses Unused capital losses can be used against any income source in year of death or previous year. Restricted by any capital gains deducted in prior years

45. © 2008 McGraw-Hill Ryerson Ltd.45 Final Returns of Deceased Taxpayer Tax Returns: Final return require plus up to 3 additional returns in addition to final tax return. Rights and Things return: –Amounts not paid but relating to period prior to date of death i.e. employment earnings owed but not paid, dividends declared but not paid.