Introduction: Tax Elections Offer Option and Flexibility to Taxpayers
Canadian taxpayers may be surprised to know that choice pervades the Canadian tax system. A common perception of the Canadian taxation is a complex labyrinth where a taxpayer has no choice but to follow the rules prescribed. Although the complexity of the tax rules is well founded view, the perception of lack of any choice is far from the truth. Several provisions of the Income Tax Act allow a taxpayer to choose when and how to be taxed. Many of such provisions are categorized as “elections.”
Tax elections give taxpayers option and flexibility. In certain circumstances, a taxpayer has a choice between two options: the choice for a default set of tax rules to apply to or the choice to make an election so that an alternative set of rules become applicable in the specific circumstances.
Often, by making an election a taxpayer can decrease her or his tax liability or the very least, defer taxes.
This article is the first in a four part “Elections Series.” Available tax elections in the following circumstances will be discussed:
- Inter-vivos transfer between spouses and common law partners,
- Transfer or distribution to a taxpayer’s spouse or common law partner on death of a taxpayer, and
- Elections when one of the spouses receives dividend income.
Each article will offer Canadian taxpayers a basic understanding of the mechanics of the available election, and outline circumstances where a particular election can be made. The tax savings or tax deferral advantage of an election will also be discussed in each article.
Tax Savings and Tax Elections: Some Examples
Elections under the Income Tax Act offer tax planning options in a variety of circumstances applicable to different categories of taxpayers.
For example, an election is available for the tax treatment of transfer of property between spouses. Such an election offers income splitting opportunity between spouse, especially when one spouse as a higher marginal tax rate.
Sole proprietor taxpayers who intend to incorporate their business, can make a number of different election to prevent any immediate or the very least significant taxation when reorganizing their business. The tax savings can instead be used as capital in the newly incorporated business.
Elections are also available to non-resident taxpayers who have rental property in Canada.
Numerous elections are available to taxpayers who derive their income from rental property. For instance, the Income Tax Act offers such taxpayer choice in how certain expenses are categorized, and the available deductions.
Myriad elections are available for couples who are going through a separation and are engaged in dividing their assets, or setting out the agreement pertaining to payment to dependants.
Estate planning, including preparation of a will, is another important context where elections can save the taxpayer and his or her beneficiaries thousands in taxes saved or deferred.
It is important to note that the cost of seeking professional advice in identifying applicable tax elections is often greatly outweighed by the immediate and long term tax saving.
Tax Election for Canadian Tax Payers: Costs versus Tax Savings
Generally, there are two sets of costs associated with evaluating the suitability of an election for a particular taxpayer: cost of deliberation and cost of execution. In some instances, such costs are negligible, in others, substantial. The provisions of the Income Tax Act that offer an election are complex, requiring a taxpayer to invest resources in determining the suitability of a tax election to his or her particular fact scenario. This is the deliberation cost of an election.
If the tax election is determined to be suitable, there may be costs associated with executing the election. Execution of some tax elections constitutes a simple check in a box on the taxpayer’s annual tax return. Others may require services of professionals such as appraisers, accountants, or Canadian tax lawyers.
From the standpoint of a taxpayer, making an election is beneficial where the tax saved or deferred is greater than the cost associated with the deliberation and execution of an election.
Tax Planning Tips: When Applied For Incorrectly, Elections Give Rise Result in Penalties
Elections are great tool that offer taxpayers the option to arrange their affairs in a most tax efficient manner. However, provisions underlying the elections are complex. Most elections apply only when a set of criteria are present, or specific pre-requisite conditions have been met. In most instances, the Income Tax Act imposes severe penalties when a taxpayer makes an election in the absence of the required conditions or the pre-requisite criteria.
Canadian taxpayers are strongly advised to seek professional advice from an experienced Canadian tax lawyer before making an election which they believe to apply. Often, the cost of such professional tax services pays not only for the penalties that may otherwise be imposed, but the tax saving when an election is made as it should. Speak to one of our knowledgeable Canadian Tax Lawyers for further assistance.
The second article in this series will address available election when a spouse or common law partner transfers a property to the other.