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New Ebook: Cross-Border Implications of Holding a 529 Plan

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Many Canadians move for career opportunities to the U.S., work and raise families, and then plan to relocate back to Canada. A qualified tuition and educational savings plan for children (a 529 plan) is exempt from taxation in the U.S., in most cases even when a child attends a Canadian university. If you are a Canadian who is considering such a plan, and especially for anyone with an investment in a 529 plan who is moving back to Canada, clear expert advice from a cross-border financial specialist is a very prudent step.

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Cross Border Implications of Holding a 529 Plan

Lifetime Capital Gains Exemption for Small Businesses

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Overview
The Lifetime Capital Gains Exemption (LCGE) is a once-in-a-lifetime tax deduction that is available for every Canadian resident individual on up to $913,630 CAD (2022, and indexed to inflation on an annual basis) of capital gains realized on the sale of Qualified Small Business Corporation (QSBC) shares and certain other capital properties. In order to claim the LCGE, the capital gain must be realized by an individual, trust, or partnership (with the gain allocated to an individual) with an available LCGE balance.

Qualifying Criteria
There are three tests that must be met to ensure the shares meet the definition of QSBC shares and therefore qualify for the LCGE:

lifetime-capital-gains-exemption-QSBC

Summary and Takeaways

The Lifetime Capital Gains Exemption (LCGE) is a once-in-a-lifetime tax deduction available to Canadian residents that can be taken on gains from the sale of Qualified Small Business Corporation (QSBC) shares. But in order to take the deduction it’s necessary to meet certain eligibility requirements.

Key Takeaways

  • Shares must meet the definition of QSBC shares in order to qualify for the one-time exemption.
  • The deduction can be applied to up to $913,630 CAD of capital gains realized on the sale of QSBC shares, but if you use only a portion the rest may be applied at a future date.
  • There are also strategies one may use to maximize the use of the LCGE or even multiply it through a family trust.
  • Developing a tax efficient strategy to leverage the Lifetime Capital Gains Exemption is critical.
  • U.S. citizens residing in Canada may also utilize the deduction, but this can result in a U.S. tax with no offsetting Canadian foreign tax credit.
  • Because the rules regarding taking advantage of the LCGE are nuanced and complex, expert guidance from a qualified tax planning professional is strongly recommended.

1. Small Business Corporation Test
At the time of sale, the shares must be shares of a Small Business Corporation (“SBC”). Generally, an SBC is defined as a Canadian-Controlled Private Corporation (“CCPC”) where all or substantially all (at least 90%) of the fair market value of the corporation’s assets is attributable to assets that are:

  1. Used principally (more than 50%) in an active business carried on primarily (more than 50%) in Canada;
  2. Capital stock or indebtedness of one or more SBCs that are connected to the corporation; or
  3. A combination of (a) & (b).

Note that:

  • Active business assets exclude the following: excess cash, investments, investments in real estate, and other assets not essential to the operation of the business.
  • A corporation is connected to a particular corporation if it controls the particular corporation or owns more than 10% of the issued capital of the particular corporation in terms of both the fair market value and voting rights.
  • A CCPC is a private corporation resident in Canada that is not controlled directly or indirectly by non-residents or public corporations.
  • It is common planning to “purify” a company in order for it to qualify as an SBC at the determination time. As an example, excess cash can be paid out to the shareholders of the corporation or used to pay down outstanding debts. Alternatively, investments with accrued gains can be donated without triggering taxes payable and even providing a corporate tax deduction. Non-qualifying assets of the corporation can even be moved to another corporation.

2. Holding Period Test
The shares must not have been owned by anyone other than the individual or a person related to the individual throughout the 24 months preceding the disposition. Usually, newly issued shares must be held for at least 24 months in order for the shares to be QSBC shares. However, there are exceptions to this rule in a number of circumstances, including where the shares are issued as payment for other shares, as payment of a stock dividend, or in connection with an incorporation of the business.

3. Fair Market Value Asset Test
Throughout the 24 months immediately preceding the sale of the shares, the shares were those of a CCPC where more than 50% of the fair market value of its assets was attributable to assets used principally (more than 50%) in an active business carried on primarily (more than 50%) in Canada by the corporation or a corporation related to it.

Using the LCGE
As mentioned above, the LCGE is a once-in-a-lifetime tax deduction that is available for every Canadian resident individual on up to $913,630 CAD (2022, and indexed to inflation on an annual basis) of capital gains realized on the sale of QSBC shares and certain other capital properties. If only a portion of the exemption is used, the remainder is available for future use. Furthermore, as the exemption is indexed to inflation, every year the available LCGE grows larger. In other words, a “new” amount of LCGE will accrue even if an individual has previously used their total available exemption.

It is important to note that the $913,630 CAD (2022) is on a gross basis. The amount of total “taxable capital gains” that may be sheltered is $456,815 CAD, since only 50% of capital gains are taxable in Canada. Other balances that need to be analyzed when deciding to leverage the LCGE, as they could potentially decrease the amount of LCGE available, include your:

  • Cumulative Net Investment Loss (“CNIL”); and
  • Allowable Business Investment Losses (“ABIL”).

Planning Opportunities
Common planning opportunities surrounding the Lifetime Capital Gains Exemption include:

  1. Estate Freeze – Crystallization Using the LCGEAn individual can use the LCGE not only on a disposition of their shares, but also in succession planning when passing on their shares. The LCGE is not currently scheduled to disappear, but crystallization of the LCGE is a viable option should it be repealed in the future. By crystallizing the LCGE, an individual triggers a capital gain at a time when the shares qualify for the exemption without actually disposing of the shares. The crystallization transaction can occur during the shareholder’s lifetime or upon their passing, increasing the cost basis of the shares transferred to the deceased individual’s beneficiaries.
  2. Multiplying the Lifetime Capital Gains Exemption
    It is possible, through the use of a family trust, for each beneficiary to use their available LCGE to reduce or eliminate tax payable on a sale of QSBC shares. This multiplication can also be used in conjunction with the crystallization planning above. As an example, if there is a family trust with mom, dad, and their three children as capital beneficiaries, it is possible to utilize the Lifetime Capital Gains Exemption and pay no Canadian tax on up to $4,568,150 CAD of capital gains on the shares disposed of or crystallized during 2022.

Implications for U.S. Citizens
If you are a U.S. citizen resident in Canada, you are still entitled to utilize the LCGE on your Canadian tax return. However, the U.S. will not realize the LCGE, so you will not receive a corresponding tax deduction on your U.S. tax return. This can lead to U.S. tax payable with no offsetting foreign tax credit from Canada, which is why it is important to allow adequate planning time and model out the use of the Lifetime Capital Gains Exemption.

Developing a tax efficient strategy to leverage the Lifetime Capital Gains Exemption is critical. Whether you are a Canadian tax resident or a dual tax resident of Canada and the U.S., it is important to garner professional advice. Contact Cardinal Point for more information.

Stock Market Integrity

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Financial advisors and investment managers operate under a variety of different business models and job titles. Some advisors are paid commissions based on product sales, and some charge flat fees for paid advice. Cardinal Point utilizes an “assets under management” (AUM) fee structure where our fees vary based on the amount of assets we are managing. It is a graduated fee schedule, so the more assets we are managing the less the effective fee rate will be. We also operate on a “fee-based” basis which means we do not accept commissions or any other type of outside compensation.

Fiduciary Duty

Summary and Takeaways

Financial advisors and stock brokers are required by law to exercise fiduciary responsibility on behalf of their clients. If they violate that duty or engage in insider trading, there are severe consequences. Shouldn’t lawmakers with decision-making authority and access to privileged non-public information be held to the same or even a higher standard? Banning them from investing in individual stocks would remove potential conflicts of interest and restore ethical integrity and fairness.

Key Takeaways

  • U.S. lawmakers are required to publicly disclose any stock trade made by them, their spouses, or their dependent children within 45 days of the transaction.
  • But 57 members of Congress violated the rule (the STOCK Act) in 2021 alone.
  • The average penalty for such illicit conduct is a mere $200, and even that paltry sum is often completely waived.
  • Canadian lawmakers must abide by the much stronger Conflict of Interest Act prohibiting federal reporting public office holders (RPOHs) from acquiring and holding controlled assets during the term of their office.
  • Shouldn’t legislators operate as fiduciaries for their constituents, who are the taxpayers funding governments and paying the salaries of public officials?
  • Strict regulations prohibiting insider trading would help restore public trust – and should apply to all public officials with decision-making authority.

The reason we choose to operate on a fee-based basis is because we feel it is important to function as a fiduciary for our clients. We always want to put our clients’ interests before our own, and one of the best ways to do that is to remove as many conflicts of interest as possible. Being paid commissions based on which product you sell or which investment vehicle you invest your clients in is a huge conflict of interest. This article is not meant to be political, and we are not in favor of every new regulation that is proposed, but financial services is one area where we do favor more regulation so that every person holding themselves out as a financial advisor or investment manager is required to uphold a fiduciary standard.

Legislators, particularly ones on committees, have advanced access to nonpublic and often classified information that will inevitably affect the values of public corporations. Sometimes this is in the form of contracts that are to be awarded to contractors or worldwide pandemics that have not yet been announced. Lawmakers from both parties have been accused of insider trading, either themselves or through their spouses or family members.

We also believe legislators should strive to operate as fiduciaries for their constituents. In the U.S., new bills are expected to be introduced in Congress to ban legislators from trading individual stocks. This is not to say they cannot invest in the stock market; they can still invest in pooled investment funds like mutual funds (MFs) and exchange traded funds (ETFs). There is still the possibility of profiting from classified and nonpublic information through MFs and ETFs as many concentrate on specific sectors or geographical regions, allowing investors to place sector bets.

For example, if a senator knew about the Coronavirus pandemic before it was officially announced, they could make sector bets by going long (buying) the tech sector and shorting (selling) the hospitality sector. Similarly, if a senator became aware that a specific automaker would be awarded a large government contract to replace all government vehicles, that senator could profit immensely if he could buy that specific stock before the information was made public. In contrast, it would be much more difficult for them to profit from MFs or ETFs because they hold many stocks and would make it difficult to target that specific company. The senator could still purchase the mutual fund or ETF that had the highest relative holding of that company, but it would require much more work to research the holdings of all applicable MFs and ETFs, and there may be other holdings within each fund that are undesirable or mitigate the potential profits.

secure act 2.0 status

Banning legislators from investing in individual stocks will not prevent all insider trading, but it will remove a potential conflict of interest. Currently, U.S. lawmakers are required to comply with the Stop Trading on Congressional Knowledge Act of 2012. The STOCK Act was passed to combat congressional insider trading. A key provision of the law mandates lawmakers to publicly disclose any stock trade made by themselves, a spouse, or a dependent child within 45 days of the transaction.

In 2021, 57 members of Congress violated the STOCK Act. There have been similar allegations of trading on material nonpublic information made against various Federal Reserve Board members. They are also setting policy that will have a significant impact on stocks. Likewise, governors, mayors, state legislators, and city council members may also have significant power over local policy, government spending, lockdown regulations, and contract awards. Regulations regarding insider trading and market integrity should apply to all public officials with decision-making authority.

Ironically, employees of Cardinal Point have a requirement to obtain approval from a compliance officer before any trades are placed on outside managed accounts. We do not have access to nonpublic information, nor do we have the power to influence policy that could affect the stock of companies we trade in, so we do not have any sympathy for legislators who fail to report their trades before the deadline. In fact, we believe regulations on lawmakers should be stricter to ensure they are not unfairly influencing markets.

Canada has legislation in place that provides more direction on how to prevent insider trading by lawmakers. The Conflict of Interest Act prohibits federal reporting public office holders (RPOHs) from acquiring and holding controlled assets during the term of their office. Within 120 days of becoming a public office holder, a federal RPOH must divest his or her controlled assets by either selling them in an arm’s-length transaction or placing them in a blind trust.

Federal RPOHs include:

  • The Prime Minister
  • Cabinet Ministers
  • Ministers of State
  • Parliamentary Secretaries
  • Full-time and salaried Cabinet appointees, including deputy ministers and various heads of agencies
  • Ministerial advisers and
  • Ministerial staff who work more than 15 hours per week

Controlled assets are those assets whose value could be directly or indirectly affected by government decisions or policy. They include, but are not limited to:

  • Publicly traded securities
  • Self-administered RRSPs and RESPs
  • RIFFS composed of at least one asset that would be considered controlled if held outside the plan or fund
  • Commodities, futures, and foreign currencies and
  • Stock options, warrants and rights

It is important to note that MPs and their staffs are not federal RPOHs and, as such, they are not obligated under the Conflict of Interest Act to divest their financial holdings by selling them or placing them in a blind trust. The Conflict of Interest Code for Members of the House of Commons also does not have a divestment requirement for MPs.

However, if the Conflict of Interest Commissioner is of the opinion that an MP’s holding in a publicly traded company is so significant that it may affect their obligations under the Code, the Member of Parliament can remain in compliance with the Code by placing these securities in a blind trust.

MPs may also request an opinion from the federal Conflict of Interest Commissioner regarding their obligations under the Code, including as they relate to their investments. Reports of abuse are not as common in Canada as they are in the U.S.

Members of Congress are some of the most powerful and influential people in the world. Those who swear an oath to serve the electorate should be held to a higher standard. Banning congressional stock trades is one way to ensure fairness and uphold market integrity. Sufficient oversight should be applied to ensure lawmakers are abiding by the laws they pass, and increased penalties should be assessed to those lawmakers who break the law. The average fee for members of congress who fail to comply with the STOCK Act is only $200; often it is waived completely. As fee-based fiduciary financial planners and wealth managers, we are in favor of any law or regulation that will help prevent market manipulation and fraud.

Cardinal Point Wealth Management and Cardinal Point Capital Management are industry leaders in Canada-U.S. wealth management services. We offer comprehensive financial planning, tax planning, and individualized investment management services for high-net- worth individuals and families. Contact us today to discuss how cross-border tax planning and wealth management can be beneficial for you and your loved ones.

Infographic: Income Tax Implications of RRSP Withdrawals as a Non-Resident of Canada

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Income Tax Implications of RRSP

If you have moved from Canada to the U.S., the normal intricacies of tax issues become particularly complicated in certain circumstances. In particular, this is so if you are considering taking a distribution as a non-resident of Canada for use in the U.S. Advice from Cardinal Point can ensure that you go about this on the most tax-effective basis.

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Thriving in Retirement Using Positive Psychology

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In an earlier blog post, we discussed some aspects of nonfinancial retirement planning.  If you completed the Retirement Transition Wheel exercise, you may have found there are a few areas of your life that could use some development for a successful retirement. In this post we will look at how using Positive Psychology can also enhance your retirement.

To do this we will look at PERMA, an acronym that that stands for the following five elements: Positive Emotion, Engagement, Relationships, Meaning, Accomplishment. The concept of PERMA was developed by American psychologist Martin Seligman and is a model for sustained happiness and well-being. These elements account for what makes up the “good life.”

Retirement Using Positive Psychology

Summary and Takeaways

This unique blog details how to utilize the power of the mind and positivity to help ensure a more successful and rewarding retirement lifestyle. The key is an exercise that explores the five elements represented by the acronym PERMA.

Key Takeaways

  • PERMA stands for Positive Emotion, Engagement, Relationships, Meaning, and Accomplishment.
  • The PERMA concept was developed by psychologist Martin Seligman, and is widely regarded as an excellent guide and model for sustained happiness and well-being.
  • This blog explores PERMA in depth, and offers a convenient chart to help visualize the concept and practically implement it in your own life and retirement planning.
  • Most people look forward to the freedom of retirement. But your work life and career do provide structure, relationships, and meaningful daily activities.
  • In the absence of those retirees often experience a transition that requires replacing those familiar aspects of life with new, intentional ones based on retirement goals.
  • The PERMA exercise is a useful tool for gaining awareness of how to create a fulfilling retirement lifestyle, centered on activities that ensure that you flourish in retirement.

The idea of this exercise is to become aware of the need to fill your retirement lifestyle with activities that promote human flourishing.  Many people approach retirement having only invested in their careers and in the accumulation of wealth. Now they need to invest in themselves to obtain the most enjoyment possible from the wealth they have built.

Let’s look at each of the PERMA elements:

P – Positive Emotion 

Positive emotions such as joy, gratitude, serenity, awe, and love make us feel vibrant and alive.  Think about what makes you feel inspired, on top of the world, or unstoppable.   At work and then in retirement.

E – Engagement

When we are engaged, our attention is captured, and the everyday boring routines of our lives disappear.  Which activities make you feel alive, engaged, or zoned in and like nothing else is going on?

R – Relationships

We all need connection and our own tribe to thrive.  Which family members, friends, or colleagues energize you, make you laugh, and provide support?

M – Meaning

A life with meaning requires us to be involved in an activity or a cause that is larger than oneself and which infuses life with a sense of purpose.   What gets you out of bed every day and makes you feel compelled to change, improve, or support something?

A – Accomplishment

A sense of accomplishment is important to well-being because goals fortify our lives with structure, and they can provide a sense of identity and satisfaction.  What goals, roles, or objectives at work give you the most satisfaction?  What things have you been most proud of, and what do you plan to accomplish in retirement?

When it comes to retirement, most people relish the idea of having additional time, less stress, few deadlines, and no more work meetings.  Work does provide routine, goals, activities, and relationships, but   these can essentially disappear overnight when we stop working.   During the “honeymoon” phase, retirees may not notice the absence of what work provided.  However, to better prepare for the transition to retirement, consider finding replacements for the things that added value to your life while working.

Below is a table listing the 5 elements of PERMA related to work and retirement.   Completing this exercise may make your transition to retirement a positive and stress-free experience.

PERMA Table

Read our articles in this series of non-financial retirement planning: