6 frequently occurring  (but easily avoidable )

 costly mistakes taxpayers make

1. Costly mistake #1:    filing late

 Here’s a true story. A gentleman comes into my office and shows me a Notice of Assessment that he received  a while back. The notice shows that he owes $10,000 in taxes plus—get this—more than $4,000 in late filing penalties and interest!

 The penalty hit was a whopping 40%!

 I take a look at the small print and it says he is assessed a penalty of 32% for late filing plus additional interest.

 How did it happen?

 Well, one year he filed late. That’s an automatic 5% penalty.  But, the taxes on it were only a couple of dollars. So, he hardly noticed it.

 Next year, what do you think happens? Right, he files late again. Except, this year he really takes his time and files 11 months late. So, what happens now?

 Well, now it’s his second time that he’s late filed. That automatically rings up a 10% penalty for filing even one day late. Plus, an additional 2% penalty per month.

 End result is: he takes a hit of 32% and now he has to pay interest on top of it until he pays off the bill.

 Moral: Don’t ever file late. Not even once—not even  one day late.

(But, there’s more to it than that. Much more. See, if you’ve filed late and you figure, well let me file now because better late than never, you’re still subject to fines, penalties and what not.

But, there may be a lifeline out of this mess. It’s called the Voluntary Disclosure Program. But, the details about this program are for another time.)

2. Costly mistake #2:   Selling  property without making sure there’s no tax hit

This happens a lot with elderly people.  What happens is that they get tired of managing a rental property they own.  A real estate agent says to them: Hey, I can get you $500,000 for that house.

 Sounds like a good idea to them. So they sell it. Only, they forget to check with their accountant first. So when tax time rolls around, they get a real surprise.

First, they have to pay tax on the capital gain. And, if they had that property for 30 years or so, through the inflationary 70’s and 80’s, that gain could be 90% of the selling price.

That capital gain is not a real gain, just a price mark up due to inflation.  And, you don’t get a break because of the inflation part. You have to cough up the tax money, just as if it were a real gain.

Second, they have to pay tax on the depreciation they’ve  taken over the years. It  all comes back when they sell the property. And, they pay tax on that as well.

Third, they lose the Old Age Pension for the year.

And as if this wasn’t bad enough, they’re usually not left with enough money to live off. How can they? With today’s interest rates of 2% or 3%, you can’t make ends meet even if you have a million bucks sitting in the bank.

But, what if they really can’t manage the property? Or, what if they really need the money, then what?

Then you check with your accountant. If he knows what he’s doing, he should be able to offer some guidance.

Moral: Before you even think of selling,  check with your accountant.

 If in doubt—don’t sell!

 (Let me get this in here: There could be some relief in some cases by using the principal residence rules or selling with a vendor take back mortgage, but that’s for another time.)

3. Costly mistake#3  Not responding to government letters and notices of reassessment

 It makes no sense to me why some people think the way they do. Recently, a fellow comes into my office and tells me he has been given demands over the past year  to file his tax returns for the past five years. If not, they’re hauling him off to court within two weeks.

 I tell him, better give me a your summarized papers ASAP. Two weeks later, I call him asking where’s his papers and he tells me he’s been too busy to put them together.

 Or, take the case of a client, who gets a notice of reassessment showing that he sold $200,000 of mutual funds with no record of what the cost is. Instead of coming to me right away, he lets it sit. The government then garnishees his bank by $23,000. At that point he calls me. But, he has to wait months till I write an objection , it’s looked at , and he  gets his money back.

 The point is that as soon as you get a letter or notice from the government, the clock starts ticking. Call your accountant right away.

4. Costly mistake#4: Not claiming enough expenses

Some of my clients incur legitimate business and employment expenses. Yet, they don’t deduct their expenses because they  fear getting hit with a tax evasion charge because they don’t have all their papers in order.

This fear is totally misplaced.  If you actually incurred the expenses, the worst that can happen to you is that you’ll pay the taxes plus interest at about 9%.  But, that will only happen if your return is selected for review and you’re asked to provide documentation and you can’t.

(But, you should always try to keep good records in case you get reviewed. See documentation)

Not only that, I’ve seen taxpayers with no documentation at all  who were allowed as much as 60% of their claim for car expenses.

So, if you actually pay for expenses for employment or business, you should deduct it—even without adequate documentation.

Just a couple of points:

 1) If you’re an employee the government will not allow you travel between your home and business.  But, even so, if you do claim it, in all the dozens of cases I read, I haven’t read of anyone getting hit with a tax evasion charge for doing so. Or, for that matter, with a gross negligence penalty.

2) If you claim any expenses for employment, make sure your employer fills out a form T2200  ‘Delaration of Employment Conditions’  for two reasons:

5. Costly mistake #5:  cashing in RRSP’s

Some taxpayers figure that they’ll contribute one year to an RRSP and cash it in the following year. That way, it’ll be a neutral transaction tax-wise.  Because the tax they save in year one, they’ll pay back in year two.

But, it doesn’t always work that way. Say, in 2oo5, your taxable income  is around $35,000. That’s the borderline between the 22% bracket and the 31% bracket.  If you put in $5,000 in your RRSP into your plan and deduct it, you save $1,100 ( $5,000 at 22%). But, if in the following year you withdraw the $5,000, you might pay up to  $1,550 ($5,000 @ 31%) in taxes.

In fact, what I tell my clients is that, if you’re going to contribute to an RRSP, make sure it stays there always.

(But,  as with everything else, there are exceptions, e.g. Home Buyer Plan, where it pays to contribute to an RRSP if you plan to withdraw the money to buy a home under the Home Buyer Plan.)

6. Costly mistake #6: Starting a business and not registering for GST

 This happens a lot. A guy starts his own business and just  assumes that he’ll never have to worry about GST.

 At the beginning,  maybe not. But, once he hits $30,000 in sales during the year, he has to register.  Otherwise, the GST he would have charged might come out of his pocket.

 Because, if the government notices that he shows on his personal tax return $100,000 in sales (for example), they’ll ask for his GST return. Since, he doesn’t have one, they’ll hit him with GST of (7/107 times $70,000)= $4,500 plus interest.

 Once that happens. he could go to his customers and ask them to pay it for him (because they’ll get it back). But that usually isn’t practical.

 Even if you don’t follow the arithmetic here, the point is simple.

 When your business reaches $30,000 in sales during any 12 month period, make sure you register for the GST and then add GST to all your  invoices.

7.Costly mistake #7: Lack of documentation

There's a separate article on this. see documentation

   May 31, 2007

 Here are two more very serious mistakes. I hadn't included hem earlier because they're so obvious-- it never occurred to me that these two mistakes are made.

Big mistake #8: opening a business and not opening up a business bank account.

Here's the scenario: A guy starts up a consulting business. Too busy to open a new banking account, he uses his old personal chequing account. His business, at the beginning, is slow. So, he gets a loan from his uncle to keep him afloat.

He dutifully files his tax returns which show very little income. The CRA people pay him a visit and ask to see his banking records. He shows them his personal checking account.

Whoa! What are these $10,000 deposits coming in? ask the fed's. Oh. They're just loans from my very nice generous relative. You needn't be concerned about them. answers our taxpayer.

I don't have to tell you how all this ended up. Because you've probably guessed that I'm leading up to-- a huge humungous tax bill to our beleaguered taxpayer.

And, he could have avoided all this by opening up a dedicated bank business account in which he would be careful not to mix business income with personal monies deposited.

Big mistake #8a: Similar to the preceding mistake. This is doing all your bank transactions on line. It may be cheaper. But, it's a good idea to get the type of account where you write paper cheques which are returned to you monthly with a bank statement.

CRA auditors like to see paper. That gives them a measure of assurance that no skullduggery has taken place.

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Copyright © 2006 B.C. Chastkofsky C.A.

Last modified: October 31, 2006