It’s tax time again, so this month I interviewed William D. Howse, Barrister and Solicitor and CEO of Taxperts Corp. in Toronto. He has been doing tax work since 1983 and prepares more than 800 personal tax returns a year. Bill is also a presenter of a CEU-approved course about Taxation for Realtors.
Q: What are common errors that agents make in planning, or more aptly, lack of planning their business year?
A: The first rule is to keep good records. Set up a business account and do not co-mingle personal expenses or revenue not related to real estate sales into the account. Arrange to get your cancelled cheques. If an invoice is lost you can claim an expense paid by cheque if it is clearly of a business nature. Dedicate one credit card to business so you know that all expenses on that card are deductible. Keep all receipts.
With credit cards, keep: a) the credit card chit; b) the cash register tape; and c) the monthly credit card statement. The more proof of payment the better. There is that expression, KISS – keep it simple, stupid. Better records make audits easier. Most audits are based on “sufficiency of documentation”.
It is a fundamental mistake if you do not harmonize by filing both personal tax returns and GST returns on an annual basis and setting aside money from commissions to make the installment payments on both personal taxes and GST. Simplify your filing requirements.
Agents should set aside 25 per cent or more of each net commission cheque for tax and GST installments and RRSP contributions. These steps must be balanced off against the other priority of paying down the principal on your home mortgage.
Q: What are the most glaring mistakes you see independent contractors make?
A: In light of my prior answer, there is bankruptcy looming when agents spend the GST collected. GST is a tax collected to be turned over to the CRA. Spending the GST collected is a signature of poor management and a sign of serious financial trouble. Most bankruptcies on the part of agents occur with GST and personal taxes making up the majority of debt.
Agents are too conservative in deducting expenses and often miss deductions.
And many agents, out of pure laziness, file GST on the Quick Method where income is less than $200,000 including GST. That method costs agents money if their expenses exceed about 29 per cent of revenues, which is almost always the case. When GST is paid on broker expenses, advertising costs, gifts, supplies, car expenses, cell phone charges of $3,000 and up, you can see where the ratio of expenses to commissions is going. High. Quick Method filing can cost an agent thousands of dollars in Input-Tax-Credits, which is GST paid on expenses.
Our free spreadsheet for agent expenses uses the Simplified Method, where agents recover every cent of GST paid on expenses. That’s a great deal and GST is therefore neutral to you.
Our spreadsheet is free at www.taxperts.on.ca. Take 60 seconds to learn how to use Excel and use the spreadsheet. Remember that you have to total your expenses for your tax return in any case. Our sheet breaks out GST to the penny.
Q: What mistakes do agents make in their GST remittances?
A: Agents frequently fail to claim GST on capital expenditures like computers and cars. On a car, agents recoup the GST on $30,000 of cost and that limit is due to the ‘luxury cap’ of $30,000, which is really, really due for an increase. When agents meet the threshold of 90 per cent business usage on their car, they recoup 100 per cent of the GST on gas, repairs, lease costs and purchases. The rule is 90 per cent = 100 per cent, while 89 per cent gets you only 89 per cent of the GST. For the 450 agents we have as clients, we claim between 90 and 95 per cent business usage.
The second major mistake is where the agent has 100 per cent of commissions declared in Box 20 of the T4A slip prepared by the broker or shown in an Annualized Statement of Commissions & Expenses. In that scenario the agent must enter the broker’s split of commissions as an expense as well as broker fees ‘passed through’ to the agent. The latter are titled “Broker Administrative Fees” in our spreadsheet. The mistake occurs when the agent fails to claim the GST as an ITC on the broker split of commissions and the administrative fees. It’s costly and common.
The last mistake involves a compliance issue. When personal tax returns are filed by the deadline, June 15th for self-employed agents and their spouses, there are no penalties levied. You need not pay the balance on filing but interest is charged from May 1. When a GST Remittance is filed – quarterly for quarterly filers and by June 15 for annual filers – you MUST enclose full payment with the remittance or it is treated as a late filing and penalties are levied. Always enclose full payment with a GST remittance.
Q: What can agents do to ensure they put aside enough money to pay their taxes? Is there an advantage to also setting aside money for RRSPs?
A: Agents have no employer pension plans. Old Age Security is less than $500 per month and the maximum CPP monthly pension is about $900. Not much to live on even of your home is mortgage-free. Those on payroll have tax deducted on each paycheck. Agents must learn to be disciplined.
The top 10 per cent of agents are earning more than lawyers or accountants. Remember that the top two tax brackets in Ontario are 43.16 per cent on taxable income over $74,357 for 2007 and 46.4 per cent on income over $120,887. (The two lowest tax brackets have rates of 20.5 per cent, then 33 per cent.) Self-employed agents will also pay a further $3,980 on self-employed CPP premiums. Put aside enough money to cover income taxed at the top two rates if you are fortunate enough to earn such amounts.
RRSP contributions defer taxes and reduce your income taxed at these highest rates, plus growth within an RRSP plan is tax-free. The highest earners save $4,640 for each $10,000 of RRSP contributions. These are huge savings and our RRSP rules much more generous than similar plans in the U.S.
Q: If agents are buying and selling properties for themselves, how should they take ownership?
A: If they have a spouse, take ownership jointly as Joint Tenants with the right of survivorship.
Tax is deferred on death as the survivor gets the deceased owner’s half interest at their Adjusted Cost Base and the value of the half interest avoids probate fees, which are 1 ½ per cent in Ontario. Make the down payment out of a joint bank account to sustain the position that it is a joint investment.
You can use appliance depreciation to reduce net rental income, then any of the owners in the top two brackets over $74,357 of taxable income can use brick depreciation to reduce net rental income to zero. This gives a pure deferral on taxation and you pay tax on sale with deflated dollars. If there is a big gain on sale, the capital gain is split in two and a spouse with income in the lowest two tax brackets will pay far less tax.
Never buy rental properties through a corporation. Unless a corporation has six employees, it will pay tax on net rents at the highest corporate rate of over 35 per cent, then there will be at least another 15 per cent tax on dividends paid to shareholders. So, 35 per cent plus 15 per cent equals a tax mistake. Surprise! Rental income and profits on sale are more easily sheltered in a personal tax return.
Lastly, hold the rental property for at least two years to qualify it as a capital disposition with half the gain exempt. If you sell before two years, the CRA can allege that you are speculating or ‘flipping’ rental properties and the full amount of the gain on sale will be taxed as ordinary income. The CRA will not let you treat the sale as a capital disposition.
Q: What are some legitimate deductions that agents overlook?
A: Section 18 (1) of the Income Tax Act limits self-employed expenses to “expenses incurred to earn income” and the taxpayer must make the business connection. A small but telling point. Claim groceries for open houses under the business dinner and event heading that is limited to 50 per cent deductibility. Although not a large expense, they are deductible.
As discussed above, go 90 per cent business usage on your car. Some high-earning agents deduct two cars and you can if you can justify the practice as necessary for business. The 1991 Qureshi decision of the Federal Tax Court stated that agents did not have to maintain an automobile logbook but the 2005 Watts case said that to sustain a high claim for business usage of an auto, then taxpayers in business had “…to keep a record of his business trips, the mileage travelled, separate receipts and/or a logbook.” I believe that Watts is a weak decision, because the taxpayer only made $2,500 in each of the two years under review. Keep a detailed appointment book and claim at least 90 per cent business usage. Be prepared to give a very detailed description of your driving habits. Stick to the story that you never go to the cottage – too busy. Don’t golf, don’t ski, don’t have hobbies or friends, and then 90 per cent business usage is a slam dunk.
Claim a home office expense for a room or area used exclusively for business. Under section 18 (1) (a) (i) of the Income Tax Act, your home need merely be your “primary place of business”.
It is a usage test. The CRA will wrongly state that space is provided for you at your brokers and deny the expense. In Ontario, agents now must subscribe for and pay for MLS. They can now argue that they search MLS at home, prepare offers, book appointments, write advertising, do correspondence, do banking, keep sales records, and have their furniture and equipment at home. Thus they can argue that about 90 per cent of their business practices are done from home. Any CRA auditor who says that you need to meet clients at your home is dead wrong. Cite the “primary place of business” test to rebut the auditor.
A postscript. Tax preparers are frequently the culprits here. Many accountants are under the mistaken belief that it is prudent to claim only 75 per cent business usage of your car, which is like throwing $1,000 in the garbage can. That position is just plain stupid. Be aggressive. Claim 90 per cent or more, since you use your car 90 per cent or more for business. Many accountants do not claim a home/office expense since they believe that it reduces your right to claim the Principal Residence Exemption (PRE) on your house. Not true. You can rent out the basement and take a home/office expense so long as 51 per cent of the home is used for personal purposes. The law is that so long as your home is used “primarily” – read 51per cent – for personal purposes, the entire gain is exempt on sale under the PRE. If your preparer is guilty of either of the above two practices, fire them.
A key point. If an agent sells a car or trades in a Class 10 vehicle – Class 10 means the car had an original cost of less than $30,000 – and goes to a lease or buys a car for greater than $30,000, which has its own Class 10.1 category, they can claim a deductible “terminal loss” if the sale proceeds or trade-in value on the lease or purchase of the Class 10.1 car is less than the Undepreciated Capital Cost (UCC), which is the value to which the car has been depreciated down to. The sale or trade-in satisfies the requirement of emptying out the last asset in a class at a loss – here Class 10 – and qualifies for a deductible terminal loss. Our office is one of a handful in Canada that spots this deduction.
Q: If agents have family, what constitutes acceptable income-splitting to family members who are usually in the lower tax brackets?
A: With “non-arms length” people – family – you must justify payment on a business basis, the “business efficacy test”. This test requires that they be paid on a fair-market-value basis for services rendered and paid like any other creditor. Spouses must be paid on payroll with taxes and CPP premiums withheld but they are exempt from EI premiums.
High-earning agents commonly have the home-based spouse do MLS searches, book appointments, do bookkeeping including using our spreadsheet, do banking, and courier documents around including taking signed offers to the broker. It is legit. We have many spouses on payroll for the agent at a rate of $3,000 or even $4,000 a month. Section 67 of the Income Tax Act is the reasonableness provision that involves the size of the expense and an element of proportion. So, if you are going to pay a spouse $4,000 a month as an employee acting as an administrative assistant, you should be earning $200,000 a year in commissions and up and be prepared to describe the services provided. Clever agents eventually get their spouses licensed and split the commissions 50/50. That’s very good and unchallangeable as long as the spouse is genuinely involved in real estate, even if their contributions of labour are mainly administrative.
Your children should provide you with a monthly detailed invoice with dates and a description of the service provided, and be paid on an fair market value basis and monthly by cheque. Cash payments are always suspicious and unnecessary. If they are old enough to provide services, they are old enough to have a bank account, cash cheques and file a tax return claiming their income as Casual Labour at Line 104 of their T1 return under “Other employment income”.
This raises a key point. Agents should have a stand-alone business and deposit all commissions into the account, pay all business expenses from the account and not have their spouse as a joint account-holder unless both spouses are fully licensed agents doing an equal split of commissions.
Q: Can you write off conventions, seminars and education events, training, and travel?
A: A review of the seminar, education and training expenses will give you your answer on travel. You can claim two seminar expenses annually that entail airfare, hotels, your own dinners and seminar sessions. They are fully deductible if they are within what the CRA refers to as your geographical area. Since almost all agents earn commissions for moves within Canada, any seminar in Canada can be justified. If you go to Asia for a seminar, you will have to make a direct connection between Asia and a commission generated and paid to you by your broker.
The cost of a spouse could be justified if the spouse is your primary administrative support but, if not, there is no deduction for them if they accompany you.
All Mandatory Continuing Education costs are fully deductible because they are required to keep your license. Expensive motivational costs, $10,000 a year or more, will be deductible if they meet the s.67 test of being reasonable and proportionate. One of our clients spent $12,000 in 2007 but went from about $70,000 of commissions in 2006 to over $250,000 in 2007. I included the expense under our subcontracting heading, because the provider charged GST and assured the client that the CRA cannot successfully challenge it. The client demonstrated that the training succeeded. I always remind my agents that they are smarter and more sophisticated in business than a CRA auditor. The rule is deduct what you spend. You CANNOT deduct holidays, wardrobe, dry-cleaning, club memberships, cosmetics or hairstyling expenses.
Q: Is it better to lease cars or buy?
A: Buy when the car costs $30,000 or less, since you lose all depreciation above that figure and the GST on any amount over $30,000 as an Input-Tax-Credit. The prudent agent will buy a luxury car three or more years old to get the cost down to that figure. Borrow to buy, because the interest is deductible. Use cash to pay down the mortgage on your house or buy RRSPs, since RRSP loans are non-deductible.
If the sticker price is over $30,000, lease. There is a complicated formula that I have not bothered to analyze that gives you the full lease deduction if the car costs about $40,000 or less and you stay under the monthly cap of $800 plus GST & PST. I think the leeway is attributable to the CRA, acknowledging that a lease payment has a borrowing cost blended in with the purchase cost, which means someone drafting the Income Tax Act in Ottawa is intelligent and fair. It is possible!
Q: What percentage of capital cost allowance can you claim on purchases like computers and office equipment?
A: This is another example of our rule of “deduct what you spend”. You get 30 per cent CCA on computers and cars, 100 per cent on software and 20 per cent on equipment and furniture. You get only half the prescribed rate in the year of purchase. We capitalize any expenditure over $500. We enter them as fully deductible as a “current expenditure” under “Office Supplies” if less than $500. Forget scale here. If the item purchased is reasonably connected to business, it is none of the CRA’s business.
The only express limits are the $30,000 luxury cap on cars and the s. 67.1 (1) 50 per cent limit for deductibility on business dinners and events and gift certificates for dinners and events – the Stapley decision.
Q: Can agents write off club memberships – gym, golf, tennis?
A: No. Not a penny of initiation or annual fees. They can get the 50 per cent deduction on actual green fees, dinner in the clubhouse or entry fees for special events if it involves a client and the invoice clearly shows it was an agent/client activity.
Q: What about “bird dog fees” and gifts, presents, house warming gifts?
A: The CRA allows you to deduct referral fees paid to non-agents so long as they are clearly documented, dated and receipted. Our firm suggests a one-sentence contract signed by the recipient saying “Agent” promises to pay “B” $1,000 if the sister of “B” purchases a property through the agent. Write a cheque notated “Referral Fee as per January 10, 2008 Agreement” or get a detailed receipt from the recipient. You should know that this payment might break provincial rules, but the CRA allows it if reasonable in scale and documented in the manner described.
Put names of dinner guests and of recipients of gifts on the invoice/receipt to establish the business connection. The size of the dinner expense, gift or referral fee must be reasonable in terms of the amount of the commission earned. It is a matter of interpretation. The CRA is required to recognize “trade and industry practices” and I can assure you that an agent with even one year of experience knows more about real estate than any CRA auditor in Canada. Use your judgment, deduct and don’t blink if the CRA challenges an expense. A Supreme Court of Canada case stated: “…every taxpayer is entitled to aggressively attempt to minimize their taxes.” Canadians are honest. Expect to get 99 per cent of what you claim as expenses.
Q: What happens when Revenue Canada comes calling for an audit?
A: CRA auditors will aim to: a) reduce the business proportion of auto usage; b) disallow the home/office expense on any pretext; c) disallow dinners and gifts as personal if no names are provided; d) characterize other expenses as “personal in nature” if possible and thus not deductible; and e) attack other expenses as “not sufficiently documented”, “no proof of payment” or “not connected to business”. They are ornery, petty and militant buggers, and management pressures auditors to reassess with large balances payable plus interest.
So, clean up your records. That means names on ALL business dinners and gifts even if that means reviewing your appointment book and trade record sheets before submitting the receipts.
All expenses must be sorted by category and totalled. The latter means a calculator tape at a minimum or a spreadsheet. Do NOT talk to the auditor if you drop off receipts or vouchers. Any friendly talk they engage in is aimed at reducing the business proportion of car usage or disallowing other expenses.
Auditors are routinely unfair and ignorant of trade industry practices. They do not know the difference between an agent open house and a public open house. Get a representative if audited, and a lawyer specializing in tax is best. Their cost is deducible at Line 232 of your tax return as an “Appeal Expense”. High earners save at 46.4 per cent on the deduction and the money is worth it. Be prepared to go through a full audit and stop once the auditor digs in their heels. You get a second chance to appeal expenses disallowed to the Appeals Division at your CRA District Taxation Office (DTO). Appeals officers routinely reverse up to 90 per cent of disallowed expenses or more. So, the Audit Division at CRA DTOs are notoriously militant and unfair, while appeals officers at the CRA tend to be much more reasonable and fair. Expect to go two rounds to get the best result.
A final point. Set up a business account and deposit all commissions into it and pay all expenses out of it including all house expenses if claiming a home/office expense. Do not pay any personal expenses from the account or deposit any money that is not a commission into the account. Do a straight transfer of funds directly to a personal or joint account. The CRA has been demanding all bank records for both business accounts and personal accounts on an audit and adding to income any amounts deposited into the personal account that you cannot explain are, in fact, personal in nature. It’s disgraceful and a new ploy on the part of the CRA.
By keeping your business account ‘clean’ with no personal banking or payment of expenses run through it, it is our firm’s position that you can refuse to provide your personal banking account records on the basis that they do not fall within the ambit of taxpayers in business being required to “keep records of books and accounts” relating to business. We adopted this position with the Mississauga CRA Audit Division when we refused their demand for personal bank account statements and, after howls of pain, they went away. It was a case of good riddance to them.
Good luck to agents in their sales and may God be with you if the CRA comes calling.
Stan Albert is celebrating his 36th year in active real estate, and is with Re/Max Excellence in Woodbridge, Ont. He serves on committees at RECO and at the Toronto Real Estate Board. He is an established trainer and business consultant and can be reached at salbert@trebnet.com.
Stan Albert, ABR, ASA is a consultant with Re/Max Premier in Vaughan, Ont. He can be reached for consultation by email. Stan is now celebrating his 45th year as an active real estate professional.
