We often breathe a collective sigh of relief each May. With both RRSP season and tax season safely behind us, we can now refocus on our role of creating wealth for our clients through updating their annual investment policy statements, rebalancing their portfolios and preparing for the semi-annual, summer client meeting in which we review their investment returns and make any recommendations for improvement.
But to best serve our clients, we need to keep taxes top of mind year-round when it comes to our financial advice. After all, with 2014 top personal income tax rates at 50% in at least three provinces and at 45% in almost all the others, it behoves us to consider the tax aspects of each and every financial piece of advice we give.
Here are two examples in which paying attention to taxes year-round can truly benefit our clients:
1. Tax-free savings accounts (TFSAs)
Let's start with TFSAs. Does every single one of your clients have a TFSA? Have they all maxed out their contributions with $31,000? If not, why not? Unless a client has no non-registered funds whatsoever in his or her portfolio, each and every client over 17 years of age should have a TFSA. There's simply no excuse for a non-registered portfolio if TFSAs haven't been maximized.
Once the TFSA is established, it's also important to ensure that it's properly invested. For example, did you know that foreign stocks or foreign equity mutual funds that earn foreign dividends are at a significant disadvantage when held inside a TFSA when there is non-resident withholding tax?
While in a non-registered account, an investor can claim a foreign tax credit for the amount of foreign taxes withheld; but if the dividends are paid to a TFSA, no foreign tax credit is available and, thus, the non-resident withholding tax has a direct impact on the clients' net returns. For U.S. stocks, although there's an exemption from withholding tax under the Canada-U.S. tax treaty for U.S. dividends paid to an RRSP or RRIF, this exemption does not apply to U.S. dividends paid to a TFSA.
2. U.S. persons
If your client is a U.S. person, you need to be even more cautious with your general advice as TFSAs, RESPs and even mutual funds can be toxic if not dealt with properly. As a U.S. person (citizen, green card holder, etc.) must file a U.S. tax return annually and report worldwide income, it's often disadvantageous for such a client to open up a TFSA or RESP as both of these tax-advantaged vehicles are not recognized as tax-free south of the border.
Even if your U.S. client has enough excess foreign tax credits from his or her other Canadian income to avoid a U.S. tax bill, many tax practitioners consider the TFSA a foreign grantor trust that necessitates onerous and often costly annual U.S. tax reporting, negating the tax-free benefit of the TFSA altogether.
Similarly, when it comes to RESPs, it's often best to have the non-U.S. spouse or partner, where possible, be the sole RESP subscriber/contributor to avoid any U.S. tax issues and complex reporting.
Even holding Canadian mutual funds has become a problem in recent years for U.S. tax filers as the Internal Revenue Service considers them to be passive foreign investment corporations (PFICs) and subjects them to potentially punitive tax consequences and complex reporting requirements.
The good news is that in 2013, several Canadian fund companies began providing PFIC annual information statements, upon request, for their mutual funds. These statements permit U.S. persons to make a qualified electing fund (QEF) election on their U.S. tax returns and include only their pro-rata share of the mutual fund's ordinary income and capital gains for U.S. tax purposes. It also simplifies the reporting.
Although these are only two examples of the way taxes can impact what might otherwise be great financial planning strategies, they demonstrate the importance of paying attention to tax matters year-round in every piece of advice we give to clients.