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Bitcoin Blues: How new cryptocurrencies are disrupting Tax Reporting obligations (to IRS and CRA)

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By Elena Hanson

Special to the Financial Independence Hub

The latest buzzword is “disruption” and nothing has caused more disruption in the investment world than virtual currency, most commonly referred to as cryptocurrency. If you’re considering cryptocurrency as an investment option, there are a few things to know.

In a nutshell, cryptocurrency is a digital asset that can work as a medium of exchange. It uses cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.

The main difference between virtual currencies and traditional currencies is the decentralized control system. Cryptocurrencies like Bitcoin, which has been around since 2009, and Ether use distributed ledger technology such as block chain as a public database for transactions. Distributed ledgers are virtual ledgers that are decentralized across multiple locations, resulting in multiple copies of a transaction. While there is no central authority governing these transactions, the public nature of the ledger serves as a check and balance. However, having a currency that isn’t tied to any country or banking system can make regulation a challenge.

Just ask the 10,000 U.S. taxpayers who recently received letters from the Internal Revenue Service informing them that they may have improperly reported transactions involving virtual currencies and may owe back taxes on unreported cryptocurrency earnings.

The letters were accompanied by a stern warning from IRS Commissioner Chuck Rettig, who issued a press release on the matter. He said: “Taxpayers should take these letters very seriously by reviewing their tax filings and, when appropriate, amend past returns and pay back taxes, interest and penalties. The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

The IRS treats cryptocurrency like physical property and taxes it the same way. For example, if you receive a virtual currency as compensation from an employer, it is considered income subject to withholding and payroll taxes. And if you sell it, you could face capital gains tax. According to the IRS: “If you sold, exchanged, or disposed of virtual currency, or used it to pay for goods or services, you have engaged in a reportable transaction.”

CRA treats virtual currency much like the IRS

So, how does the Canada Revenue Agency treat virtual currency? Unfortunately, much like the IRS.

As far as the CRA is concerned, when cryptocurrency is used to pay for goods or services, it is subject to the rules for “barter transactions” or transactions that don’t involve legal tender. When accepted as payment for goods or services by a GST/HST registrant, the GST/HST portion must be calculated based on the fair market value at the time of the transaction. Continue Reading…

Canadian ETFs versus US ETFs

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By Michael J. Wiener, Michael James on Money

Special to the Financial Independence Hub

When it comes to investing, we should keep things as simple as possible. But we should also keep costs as low as possible. These two goals are at odds when it comes to choosing between Canadian and U.S. exchange-traded funds (ETFs). However, there is a good compromise solution.

First of all, when we say an ETF is Canadian, we’re not referring to the investments it holds. For example, a Canadian ETF might hold U.S. or foreign stocks. Canadian ETFs trade in Canadian dollars and are sold in Canada. Similarly, U.S. ETFs trade in U.S. dollars and are sold in the U.S. Canadians can buy U.S. ETFs through Canadian discount brokers but must trade them in U.S. dollars.

Vanguard Canada offers “asset allocation ETFs” that simplify investing greatly. One such ETF has the ticker VEQT. This ETF holds a mix of Canadian, U.S., and foreign stocks in fixed percentages, and Vanguard handles the rebalancing within VEQT to maintain these fixed percentages. An investor who likes this mix of global stocks could buy VEQT for his or her entire portfolio without having to worry about currency exchanges. It’s hard to imagine a simpler approach to investing.

Investors who prefer to own bonds as well as stocks can choose other asset-allocation ETFs offered by Vanguard Canada, BlackRock Canada, or BMO. But the idea remains the same: we own just the one ETF across our entire portfolios. For the rest of this article we’ll focus on VEQT, but the ideas can be used for any other asset-allocation ETF.

Why would anyone want to own a set of U.S. ETFs instead of just holding VEQT? Cost. It’s more work to own U.S. ETFs and trade them in U.S. dollars, but their costs are much lower. To see how much lower, we need to find a mix of U.S. ETFs that closely approximates the investments within VEQT. Readers not interested in the gory details of finding this mix of U.S. ETFs can skip the end of the upcoming subsection. Continue Reading…

Will the CRA eventually tax TFSAs?

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By Dale Roberts, Cutthecrapinvesting

Special to the Financial Independence Hub

As it stands today the Tax Free Savings Account or TFSA is true to its name. It is tax free on all counts. The interest or income or capital gains created in the account are not taxed. When you take money out of your TFSA you pay no tax. Net, net, your money grows tax free and you can spend it tax free.

But will this change in the future when Canadians have amassed considerable sums and are able to generate significant tax free income in retirement? Will the CRA eventually tax your Tax Free Savings Account? The TFSA program was launched in 2009 with a maximum of $5000 of contribution space. The contribution allowance has been increased to reflect inflation and now sits at $6000 annual.

In 2019 it’s not uncommon to see a Canadian who has maximized their TFSA contributions and who has invested their monies sitting with a six figure balance. In fact they might even approach a balance of $110,000 or more in a TFSA. For a Canadian couple that is $200,000 or more in potential tax free income.

In another 10 years that couple could easily have a combined $500,000 in TFSA monies. Of course they’ll need the cooperation of the stock markets that have been more than generous over the last 10 years, especially if you throw that roaring US stock market into the mix.

A massive TFSA gives Canadian retirees options

When Canadian retirees begin to accumulate sizable TFSA accounts they can start to execute some very opportunistic retirement strategies. And that might include accessing the government program known as the GIS or Guaranteed Income Supplement. That’s designed to help lower income seniors.

In a guest post on Cut The Crap Investing Financial Planner Graeme Hughes outlined how spending our own RRSP monies can negate potential GIS payments and that is one of the most common mistakes made by Canadian retirees. From that post …

What’s less well-known is the impact RRSPs can have on lower-income seniors, particularly those retiring with only the Canada Pension Plan (CPP) and Old Age Security (OAS) amounts for pensions. In many cases these seniors would also get the Guaranteed Income Supplement (GIS), which is an add-on benefit to the OAS. However, the GIS is an income-tested benefit and RRSP withdrawals absolutely count as income for this purpose.

So often I have seen seniors withdrawing from their modest RRSPs in retirement while not realizing that, had they not been making those withdrawals, they would have been receiving valuable GIS benefits rather than drawing down retirement savings. By better allocating their resources prior to retirement they could have greatly improved their overall retirement picture.

And that seems like fair and needed financial planning for those with modest RRSPs. That’s all within the spirit of the OAS and the GIS program that is designed for retirees with lower incomes. But Graeme goes on to outline that some retirees with greater assets can also take advantage of the GIS program by using their TFSA accounts.

Even for wealthier retirees with substantial savings but no employer pensions, it is possible to obtain 7 years of GIS benefits by drawing down TFSAs or savings between age 65 and 71 and letting the RRSPs grow until mandatory withdrawals start at age 72. Those benefits can be worth tens of thousands of dollars and should absolutely be taken into consideration when planning for retirement.

TFSA withdrawals do not show up on your tax filing as income. The CRA only keeps track of your TFSA contributions and withdrawals. And certainly make sure you understand how the program works so that you can avoid any over contribution penalties. Here’s a link to the TFSA essentials on the CRA site.

Given that, a retiree could take out $20,000 for spending from TFSA ($40,000 for a couple) and those monies do not count as income. Those retirees only source of reportable income might be CPP and OAS payments – they might qualify for GIS or reduced GIS. But these retirees are certainly lower income seniors. They may have an owned-home worth $1 million or more, each with RRSPs in the $500,000 range (or more), those six figure TFSAs and perhaps some taxable investment accounts throwing off tax efficient dividend income that qualifies for the Canadian dividend tax credit. They might have a modest amount in a savings account that is earning very little and not greatly affecting their income statement.

These retirees might have a net worth of $2,000,000 or more and yet they still qualify for that Guaranteed Income Supplement. When that occurs, it’s totally legal and within the current rules, but it’s certainly not within the spirit of the GIS program designed to help lower income seniors.

Will most Canadians be outraged?

I’m guessing that most Canadians will be up in arms when they hear or read of this opportunistic financial planning. Jonathan Chevreau asked the question on Twitter and it generated a vigorous debate. Well that is, readers were already taking issue with the potential use of GIS for those with considerable assets. Continue Reading…

Retirement Planning in your 20s

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By Jenn Hamann

Special to the Financial Independence Hub

Young people are notoriously focused on the here and now. With their entire lives ahead of them, it’s easy for them to lose sight of how important it can be to plan for the future. This is especially true when it comes to retirement planning. The subject is far from exciting, but it can have a tremendous impact on your life as you get older. Failing to have enough retirement savings when you leave the workforce could make it much more difficult for you to enjoy your golden years.

At least you wouldn’t be alone. More than 40 per cent of millennials say they have not yet started saving for the future. The good news is that the sooner you start, the better off you’ll be when the day finally comes.

One of the most significant obstacles when it comes to millennial retirement savings is simply waiting too long to get started. Many younger workers don’t take full advantage of their employers’ 401(k) matching contributions, for example (in the U.S.; the Canadian equivalent are group RRSPs or Defined Contribution pension contributions). The simple math says that the earlier you begin, the more you potentially could have when you cash out your savings.

If you’re one of those who are convinced you still have time to ignore your future, think again. The adjacent infographic shares some sobering facts about the importance of financial planning, as well as some tips you can use to be more prepared.

Jenn Hamann is Executive Vice President of ToInsure.Me, a leading provider of auto, life and home insurance. She has more than 12 years of experience in the industry, and currently focuses on sales, managing, planning, coaching and retaining business. 

 

How Real Return Bonds compare with regular Bonds, protecting against unexpected rises in Inflation

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Real Return Bonds (RRBs) pay you a rate of return that’s adjusted for inflation, but that’s not always as promising as it seems.

When a real-return bond is issued, the level of the consumer price index (CPI) on that date is applied to the bond. After that, both the principal and interest payments are typically adjusted every six months, upwards or downwards from that base level, to compensate for a rise or fall in the CPI.

In general, Government of Canada real-return bonds pay interest semi-annually, on June 1 and December 1.

How a real-return bond works: A theoretical example

The Bank of Canada issues $400 million of 30-year bonds maturing on December 1, 2049. The bonds have a coupon, or interest rate, of 2%.

If after six months from the date of issue, the new CPI level is, say, 1% above the level of the CPI on the issue date, then each $1,000 of bond principal is adjusted to $1,010 of bond principal ($1,000 x 1.01). The semi-annual interest payment is then $10.10 ($1,010 x 2% / 2).

If after 12 months, the level is 2% higher, then the bond principal is adjusted to $1,020 ($1,000 x 1.02), and the interest payment rises to $10.20 ($1,020 x 2% / 2).

Three important considerations to recognize with real-return bonds

1.) The price you pay for real-return bonds reflects the anticipated rate of inflation. In other words, if investors feel that inflation will rise 2% over the long term, the price of the bond will reflect that future inflation increase and its effect on the bond’s principal and interest payments. So, when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.

2.) When the inflation rate falls over a six-month period, the principal and interest payments of a real-return bond fall. In times of deflation, the inflation rate turns negative. In a prolonged period of deflation, the principal of a real-return bond could fall below the purchase price. Interest payments would fall, as well.

3.) As with regular bonds, holders of real-return bonds must pay tax on interest payments at the same rate as ordinary income. That income gets taxed at the investor’s marginal rate. In addition, holders of real-return bonds must also report the amount by which the inflation-adjusted principal rises each year, as interest income, even though you won’t receive that amount until the bond matures. That amount is added to the bond’s adjusted cost base.

If the CPI level falls, that reduces the inflation-adjusted principal. You deduct the amount of that reduction from your taxable interest income that year, and also subtract it from the adjusted cost base.

Real-return bonds in comparison to regular bonds

In simple terms, a bond is a form of lending whereby you lend money to a corporation or government. In return, a bond pays a fixed rate of interest during its life. Eventually, a bond matures, and holders get the bond’s face value—but nothing more. Receiving the fixed interest and face value at maturity is the best that can happen. Note, though, that in some cases, corporate bonds can go into default. As well, inflation can devastate the purchasing power of bonds and other fixed-return investments. Continue Reading…