If your practice involves tax preparation or you have do-it-yourself clients, there are some important changes for calculating 2005 taxes, as well as a few other matters to keep in mind leading up to this year’s May 1 personal income tax return filing deadline.

> Last fall’s tax changes.

On Nov. 14, 2005, in the Economic and Fiscal Update, Ottawa’s usual fall follow-up to the budget, the former Liberal government announced several changes, all of which were retroactive to Jan. 1, 2005.

The initial batch of income tax forms the Canada Revenue Agency sent to taxpayers did not reflect those changes, however. But, in keeping with CRA policy to proceed on the basis that tax changes announced retroactively by the Department of Finance are in effect even if they haven’t been passed into legislation, the agency has sent out a new version of the 2005 tax guides and forms.

“The CRA has confirmed that its computers are programmed to apply the new rates,” says Lorna Sinclair, a director in the private client advisor group of Deloitte & Touche LLP’s Toronto office.

Tax-preparation software firms have changed their electronic forms, too, she says. And the CRA’s payroll tables for 2006 calculate withholding taxes based on the new rates, she adds.

As of Jan. 1, 2005, the basic personal tax credit is $8,648, an increase of $500. The spousal/common-law partner tax credit is $7,344, an increase of $425.

The Liberals also lowered the lowest personal income tax rate to 15% from 16%. The same rate is used for taxing the non-refundable credits and minimum tax rates.

“Tax credits are generally calculated based on the lowest tax rate. First, you calculate your taxes owing, and then the amount of taxes payable is reduced by your tax credits,” says Christine Van Cauwenberghe, a lawyer and director of tax and estate planning at Investors Group Inc. in Winnipeg.

“For example, if a taxpayer has an income equal to $8,648, the amount of taxes owing on that amount would be calculated using the 15% tax bracket, or $1297.20. The taxpayer would then be entitled to claim the basic personal amount of $8,648, which is also multiplied by 15%. That results in a credit of $1,297.20, so no taxes are payable.”

“There are some exceptions to this rule,” says Van Cauwenberghe. “For charitable donations, the lower rate is used for the first $200, with amounts over that being eligible for a 29% rate.”

The tax credits for items such as the basic personal credit, a dependent spouse, a caregiver, old age and tuition are non-refundable. There are, however, a few refundable tax credits. The GST credit is one example: if the amount of the credit reduces a taxpayer’s liability to zero but there is still a portion left over, that portion can be paid as a refund to the taxpayer.

The minimum tax ensures high-income earners pay at least a minimum amount of taxes — despite the effectiveness of any tax-planning strategies they use.

> Medical expense tax credits.

In the 2005 federal budget, the former government doubled the amount eligible for the medical expense credit to $10,000 from $5,000. This is particularly relevant for disabled clients who must for the first time get Form 2201 filled out by a doctor or another qualified medical person, such as an occupational therapist or a physiotherapist. (For more information, please see www.cra-arc.gc.ca/E/pbg/tf/t2201/README.html.) If your client has already submitted this form, he or she doesn’t have to do it again.

It is important to note that receiving disability benefits under the Canada Pension Plan does not make your client automatically eligible to claim the disability tax credit. The CRA will require Form 2201 to make that assessment.

> Capital gains.

Calculating your client’s overall adjusted cost base on capital gains is one of most difficult challenges at tax time. For example, the ACB of a mutual fund must be increased by the amount of periodic income distributed to an investor in the form of additional units. The cost base is eventually deducted from proceeds of the sale of an asset. When the ACB is increased, capital gains will be lowered. (The upside is that less capital gains means less capital gains taxes.)

On the other hand, when payments of capital are made to investors — as with income trusts — the ACB for that asset will be correspondingly decreased.

@page_break@It’s not easy for the average investor to calculate the ACB, says Van Cauwenberghe. For a variety of administrative reasons, what a client sees on his or her statements may not reflect the taxes payable, she adds.

Clients should keep track of the slips recording all their transactions. Then their tax advisor can calculate their ACB to find the correct amount of capital gains and taxes payable. That way, the client won’t get reassessed, says Van Cauwenberghe.

“It’s a sore spot with a lot of clients — that they have to pay tax advisors to figure out their ACB. But if they don’t pay for the help, it can be extremely confusing,” says Sinclair.

Unfortunately, she points out, there’s no standard way among brokerage firms and mutual fund companies for reporting ACB.

There is one particular item to note regarding ACB calculation for the 2005 tax year. In the 1994 federal budget, Ottawa abolished a tax exemption for up to $100,000 in lifetime capital gains. However, taxpayers were allowed to file an election for capital gains from flow-through entities such as mutual funds and partnerships. The gains were recorded, for tax purposes, in an account called the “exempt capital gains balance.” The balance could be used to offset future capital gains on those properties.

At the end of 2004, Ottawa eliminated these accounts. Any unrealized gains must be added to a client’s ACB for that asset for the 2005 tax year.

It should be noted that the $500,000 capital gains exemption for Canadian-controlled small-business corporation shares and certain farm property still exists.

> Both should file.

If your client has a spouse or common-law partner who earns no income, that partner should still file an income tax return if he or she wants to receive either the child tax benefit or the GST tax credit.

The CRA needs to assess the family’s entire income to determine the total amount to which family members are entitled, Van Cauwenberghe says. IE