Estate tax as income tax

I just finished reading an article recommended by Richard about the estate tax, titled “Death and taxes“. It appears in New Statesman, a UK magazine “created in 1913 with the aim of permeating the educated and influential classes with socialist ideas.”

I’m glad I read the article in full before reading the magazine’s history, as it would’ve no doubt coloured my impression. The article refers to a John Rawls’ idea that would revolutionize estate taxes:

… hence inheritance tax could be made progressive, through orienting it towards receivers rather than donors. Large estates need not attract any taxation, as long as they were dispersed among a number of relatively disadvantaged recipients. At the same time, even small estates could be taxed heavily if they were all left to others who were themselves already wealthy.

I love this idea. Will it be implemented though? Most political discussion of the tax revolves around scrapping it or keeping it. It will take leadership to steer the discussion towards reorientation the likes of which Rawls suggests.

The article defends the estate tax on a number of points, but the free market one resonated with me most, which is no big surprise:

A free market in trade and employment gives us, let us suppose, a dynamic, innovative and thriving economy. It does this by incentivizing hard work, and letting economic rewards flow to those with the best ideas and the greatest capacity for hard graft.

But, if this is our vision of society, we surely must admit that the unearned windfall gains of inheritance tax distort this picture. Large inheritances distort the level playing field which would allow the dynamic and innovative to prosper.

Turning the estate tax into a income tax on the recipients would certainly shake things up, potentially improving the competitiveness of the economy while preserving the source of progressive government revenue. We should give it a shot, but the political will has to be there.


Stewie and Brian debate a flat tax

I wonder whether some people watching the following Family Guy clip were intrigued by the punchy argument and sought out more information about it.

Have a great weekend!


How to pick an accountant for your online business

Choosing an accountant for your business is always a delicate endeavour. It’s incredibly important for your accountant to understand your business thoroughly, inside and out, backwards and forward. So, for some non-traditional businesses (i.e. professional blogger), this can be tricky to say the least.

A post titled How to pick an accountant for your online business appeared recently in a blog called Fortuitous, which is written by one of the co-founders of MetaFilter, Matt Haughey. I thought the post had some great advice for web workers and bloggers in particular, but some additional insight could be provided from an accountant’s point of view.

I feel finances are important enough to warrant bringing in outside professional help. If you’re a geek, the temptation is to think “this is math — I know numbers!” but what you might be ignoring is the additional tax of having to learn an extremely complicated system. Leave it to the pros so you can focus on the thing you do uniquely well. […] A good accountant recognizes all the costs of running an online business, offers tips for good investments (that in turn, reduce taxes), and offers advice on how best to grow your business.

If you run a business as a sole proprietor or through a corporation, it will definitely save you money and hassle to hire an accountant to take care of the tax side of things. The article focuses on taxes, but your professional accountant will provide advice on areas other than tax, such as market strategy, operations management, financing options and retirement saving (which admittedly has a tax component to it).

The rules governing taxes on business are geared towards the traditional, capital-intensive types of businesses… If you don’t have to buy parts, pay a large staff, or purchase trucks to move products around, you don’t have a lot of options when it comes to built-in deductions against your revenue.

Built-in deductions are the typical ones certainly, and don’t on first glance seem to apply to a web worker. But logically any expenditure incurred to earn business income is deductible. As long as it can be reasonably proven to have a business purpose, deduct. I would argue an online business would have as many deductions if not more than a traditional one, especially if you work from home, where a portion of any expenses of the home are an expense of the business.

What I found after using several local accountants was that they just didn’t understand how the internet worked. They would ask me about equipment (minimal — just a laptop), how much I drove (none, I do it all online from my home office), and how many employees I had (zero, though I’ve paid programmers and moderators as contractors for the past couple years).

Your accountant is always going to ask you about the typical deductions, because that’s a good starting point to the discussion. They should start to give you an idea of the types of things that are allowed. In the case of an online business, equipment would be any peripherals for the laptop, the desk you worked at, the chair you sat in, and the whiteboard you brainstormed on. You can renovate a home office and deduct the cost. Plus, what was spent on contractors is clearly a deduction. Any driving done which is reasonably for the purpose of earning income – to a potential clients, for example – is deductible.

In the end, the big city accountant asked me the right questions and figured out a couple deductions I didn’t know I qualified for, and saved me $1500 below what TurboTax came up with. I probably could have gotten my TurboTax return to match but I probably mis-read one of the hundreds of questions lobbed at me during the online process. The local accountant I wasn’t a fan of turned out to be the worst option, coming up $1200 over my own TurboTax return. I suspect she left off a few business expenses I listed.

That’s a huge difference between the accountants. It would be interesting to know whether it was the local one’s conservative nature that contributed to the difference or something else. Regardless, it’s important to always examine your tax return even if it is prepared by a professional, and get explanations for anything you don’t understand or think is missing.

I’m glad someone wrote a post like this, as it seems the group of people earning their primary incomes from blogging is increasing, and we accountant bloggers frequently lament the dearth of accountants who “get” this sort of thing.

As a disclaimer to the above though, I should remind readers I’m a Canadian CA student, not too familiar with tax systems other than Canada’s and not a tax specialist.


Lotteries are just regressive taxes

I like The Tax Foundation. They advocate some really smart tax policy in the US. They also have a good blog that regularly keeps me up on US tax, which isn’t something I ever need to know in my job, but is interesting nonetheless. They blogged about one of their Background Papers titled Gambling with Tax Policy: States’ Growing Reliance on Lottery Tax Revenue recently:

Lotteries are a source of implicit tax revenue and exemplify poor tax policy for a number of reasons. They are not economically neutral; they are regressive; they lack transparency; they unnecessarily complicate the tax system; earmarked funds are often not used as promised; and lotteries are a business for the private market, not a state government.

I don’t think too many people view lotteries as taxes, but they should. Bad taxes. The part above about lacking transparency hits close to home, as Ontario has experienced scandal lately because a disproportionate share of winners are store clerks:

Roughly 60,000 lottery ticket sellers in Ontario, retailers won nearly 200 times in the past seven years, with an average prize of $500,000. A statistician with the University of Toronto called those numbers a statistical anomaly, saying there is a “one in a trillion, trillion, trillion, trillion” chance of that many retailers winning.

And my province isn’t the only one with a problem:

The head of B.C.’s Lottery Corporation was fired last week, three days after a scathing ombudsman’s report, which found that the Crown-owned corporation was not doing enough to prevent unscrupulous retailers from fleecing the system.

Privatization is one option the BC is looking into, and the pressure is growing in Ontario to consider the option as well. What do you think? Should the lottery be a tax tool used by governments or a revenue tool used by private (for-profit or not for-profit) organizations?


Are you an employee or independent contractor?

In Canada, there are no hard and fast rules in the Tax Act that help an individual determine whether they are an employee or an independent contractor. There are three tests, which have evolved through court decisions, that are used to assess the relationship between an individual and his/her employer. They are:

  1. Economic reality or entrepreneur test
  2. Specific result test
  3. Organization or integration test

Why is this important? Well, if you’re a contractor, or self-employed, you can deduct any reasonable expense incurred to earn income. There is a distinction in the Tax Act between the type of income earned depending on whether you’re self-employed or not. If you’re self-employed, you earn business income as a sole proprietor. If you’re employed, you (of course) earn employment income and are restricted in the types of expenses you can deduct for tax purposes.

An employer is also required to withhold income tax, Canada Pension Plan contributions and Employment Insurance premiums from their employees’ pay. If you’re a contractor you’re likely required by the CRA to make tax installments since no one is withholding for you your contribution to the treasury on a regular basis. (The issue of installments will be covered in a future blog post.)

But back to the tests.

Economic reality or entrepreneur test

There are three aspects to this test: control, tool ownership, chance of profit/risk of loss. If someone is not only telling you what to do but how to do it, they have control over the work and a strong case is made that they are your employer. If you own the tools you need to do the job and they are not provided to you, this points to the likelihood that you are independent. Finally, if you are profiting from the work and bearing the risk of loss due to cost overruns, it is even more likely you are a contractor.

Specific result test

If there is a defined piece of work you’ve hired to do and you’ve been given the freedom to accomplish it however you see fit, the employer-employee relationship likely does not exist. As an employee you’re typically hired to perform tasks with no specific result and on an ongoing basis. If there is a defined beginning and end to the work required, that’s a pretty good indicator you’re self-employed.

Organization or integration test

This test concerns itself with the dependence of the individual on the organization. If benefits ordinarily conferred on employees are available to the individual, then from the outside (i.e. the CRA) it appears the individual is an employee. In certain cases the proportion of an individual’s total income which comes from a single organization has been taken into consideration as well, although personally I don’t think this is particularly convincing metric.

To sum up: There is no specific section of the Act that lays out all the rules to help a taxpayer determine if he/she can deduct expenses from their income. The law has evolved through court decisions and they have been based on the above three tests, which should all be taken into consideration along with the specific facts of the situation.

As with any general tax discussion, your personal situation is unique and could require the expertise of a Chartered Accountant. If you need a CA, please contact me and I will be happy to help you find one in your area!