Income tax case study

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FIP 503 Summer 2023

Group Assignment (20%)

Case 1

It is March of 2021 and you have been hired to prepare the 2020 tax return for Chelsea Lee. She has provided you with the following information:

Chelsea is thirty years old, divorced, and has an eight-year-old child from a former marriage. Child support payments from Chelsea are $500 a month. Chelsea lives in Cornwall, and is a salesperson for Tri-scope Inc. The earnings from the job include a base salary of $6,000 per month plus a commission of 1% on the sales Chelsea makes in the month, which were $50,000 every month in 2020.

Chelsea moved to Cornwall from Bermondsey on December 1, 2019 due to a promotion with Tri-scope. Chelsea’s tax deductible moving expenses totaled $9,500, and there was no reimbursement from Tri-scope. $4,500 of this expense was accurately claimed on the 2019 tax return. Chelsea took out a $120,000 mortgage to purchase a new home in Moncton. The total interest payments were $8,400 in 2020.

Chelsea’s personal vehicle is used to perform the work duties, and Chelsea pays for the expenses with no reimbursement from Tri-scope. However, an allowance of $400 is received each month which is treated as unreasonable for tax purposes. Chelsea purchased a new car in 2019 which is used seventy-five percent of the time for business purposes. The undepreciated capital cost of the vehicle at the beginning of 2020 was $28,000. Total costs to operate the vehicle are $800 per month. Interest expense on the car loan is $200 per month.

Chelsea spends $300 per month on fashionable clothing for work, and $500 per year on a new cell phone. The cell phone bill is $80 per month, of which seventy-five percent is for employment use. Chelsea takes files home from the office at the end of the day and reviews the sales calls in a home office. The files are then returned to the office at Tri-scope in the morning prior to leaving for the day to make sales calls. Chelsea’s monthly total expense for the home insurance, property taxes, maintenance, and utilities is $1,000. The home office occupies ten percent of the square footage in the home. Chelsea maximizes RRSP contributions each year. The 2019 Notice of Assessment showed RRSP room of $12,000. Earned income was $42,000 in 2019 which consisted of $6,000 in commissions. Tri-scope does not have a registered pension plan. CPP for enhanced contribution is $166.

Required:

A. Calculate Chelsea’s minimum net income & Tax for tax purposes for 2020. Use the aggregating formula from Section 3 of the Income Tax Act to show your answer (40 marks).

B. Indicate why any items have been omitted from your calculations (10 marks).

(All work must be shown for marks to be awarded).

Case 2

It is March of 2021 and Clayton and Shaleen Miller have come to discuss their tax situation with you. They predict that Clayton will not have to pay taxes for the 2020 year, which they believe will allow Shaleen to claim the non-refundable tax credit of ‘spouse credit’. They have provided you with the following information, including the statements from their companies (Exhibits I and II) which they have prepared themselves but are not sure if they are correct. Shaleen is the sole shareholder Windy Co.

Shaleen, Clayton, and family

· Shaleen and Clayton have been married for ten years. They are both 39 years old, and they have three children under the age of five. The children attended daycare four mornings a week during 2020 while their parents worked. The total cost of the daycare for all three children was $2,300. Shaleen and Clayton receive the monthly Canada child benefit for each child.

Shaleen

· Shaleen earns a pre-tax salary of $65,000 per year from Windy.

· Shaleen received the following benefits from Windy in 2020:

· Private health and dental care: $400

· Life insurance: $500

· $2,000 worth of products at cost

· Registered pension plan (RPP) contributions: $3,000.

· Windy also deducted $3,000 from Shaleen’s salary for the RPP.

· Shaleen contributed $2,000 to an RRSP for the 2020 taxation year (which is within the allowable limit).

Clayton

· Clayton began part-time employment at Fitness Inc. in 2020, and earned a gross salary of $15,000, and did not have any employment income in 2019.

· Clayton received free use of the owner’s cottage for two weeks in May, which is typically rented out for $500 per week.

· Clayton began a small home-based proprietorship – “Clayton’s Consulting” in 2019- which generated $250 a month in pre-tax profits in 2020. The business operates from a 200 square foot room in the family’s 2000 square foot home, and is used exclusively for the business.

· Clayton did not file a tax return in 2019 since no taxes were owing.

· Clayton contributed $4,000 to a TFSA in 2020.

· More on Clayton Consulting in Exhibit 1 below:

Exhibit I - Clayton’s Consulting

Note 1: All of the administrative expenses are compliant with the rules of the Income Tax Act.

Note 2: Work space expenses represent ten percent of Clayton and Shaleen’s housing costs. The total housing costs include utilities of $2,400, mortgage interest of $8,400, property taxes of $2,500, and home insurance of $1,200. (The business has met the conditions necessary to allow for the deduction of home-based business expenses.)

Required:

A. Prepare detailed calculations (in accordance with the statutory formula of S.3 of the Income Tax Act) to determine the taxable income & Tax for both Shaleen and Clayton for 2020 (40 marks).

B. Determine if Shaleen will be able to claim the non-refundable ‘spouse credit’ for the 2020 taxation year? (10 marks)

(All work must be shown for marks to be awarded).

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Microsoft_Excel_Worksheet.xlsx

CASE 1

Solution:
A.
ITA 3(a):
Employment income:
Salary (12 x $6,000) $ 72,000
Commissions (12 x $50,000 x .01) $ 6,000
Unreasonable travel allowance (12 x $400) $ 4,800
$ 82,800
Salesperson expenses:
Phone expense ($80 x 12) $ 960
Automobile operating costs ($800 x 12) $ 9,600
$ 10,560
Employment portion 75% x $10,560 -$ 7,920
Limited to commission income -$ 6,000
Other automobile costs:
Capital cost allowance
30% x $28,000 $ 8,400
Interest on car loan
$200 x 365/30 $ 2,433
$ 10,833
Employment portion 75% x $10,833 -$ 8,125
Employment income $ 68,675
ITA 3(c):
Other deductions:
Moving expenses (carry-forward $9,500-4,500) -$ 5,000
RRSP contribution
Lesser of:
18% x $42,000 (2019 earned income) -$ 7,560
Limit $27,230 (2020)
CPP enhanced contribution -$ 166
Other deductions -$ 12,726
Net income for tax purposes (2020) $ 55,949
B.
The following items have been omitted from the calculations:
●Child support is not a deductible expense.
●Clothing is not a deductible expense.
●The cell phone purchase is a capital outlay, so denied as an expense, and CCA is not allowed on this type of capital asset for an employee.
●Home office expense: Kelsey would have to perform more than 50% of his duties from this office, or he would have to use the office exclusively to earn income on a regular and continuous basis to meet with clients. He has not met either of these tests.
●Personal mortgage interest is not a deductible expense.

CASE 2

Capital Gain $17,200
84000 550 2 12 9000 20004 1980
3000 3 1667 12 Less capital gain reserve: lesser of:
1980
990 9000 0.27 2430 33,000 x 17200 $ 8,347 $ 8,347
-2000 1980 0.5 990 68,000
10000
97969 0.8 x 17200 $ 13,760
Capital gain $8,853
Taxable capital gain $4,426

CASE 2 NEW

A.
ITA 3(c)
Employment income:
Remuneration $ 84,000
Gratuities $ 3,000
Standby charge
[($550 x 2/3 x 12) x 9,000/(1,667 x 12)] $ 1,980
Operating benefit
Lessor of $2,520 ($9,000 x .28)
and $990 ($1,980 x .5) $ 990
RPP contribution -$ 2,000
Employment income $ 87,970
Other income:
RRSP withdrawal $ 10,000
ITA 3(c)
Other deductions:
CPP enhanced contribution $ (166)
Net income for tax purposes $ 97,804
Taxable income $ 97,804
(Amounts are rounded)
B.
$ 48,535.00 15% $ 7,280
$ 48,534.00 20.5% $ 9,949
$ 735.00 26% $ 191
$ 97,804.00 $ 17,421
NON-REFUNDABLE TAX CREDITS
BASIC $ 13,229
CPP/EI ($3,754-$166) $ 3,588
EMPLOYMENT $ 1,245
15% $ 18,062 $ 2,709
FEDERAL TAX LIABILITY $ 14,712
C.1
Capital Gain $17,200
Less capital gain reserve: lesser of:
Lesser of:
33000 x $ 17,200 $ 8,347
68000
80% x $ 17,200 $ 13,760 $ 8,347
Capital gain $8,853
Taxable capital gain $4,426
C.2
Revenue $ 5,000
Expenses -$ 17,000
Net loss for tax purposes -$ 12,000
Since farming is not Mackenzie’s chief source of income, the amount of her loss will be restricted. She will be allowed to deduct $7,250*:
$2,500 + 50% ($12,000 - $2,500) = $7,250
The $4,750 difference between this year’s $12,000 loss and the allowable deduction of $7,250 can be carried over for twenty years and applied against Mackenzie’s farming income.

CASE 3 - WORD

A.
Frank and Betty will be considered full-time residents for all of 20x7. They were fully expecting to return to Canada following their sailing trip, which was in fact, a work venture for Frank. The couple maintained a "continuing state of relationship" with Canada [ITA 250(3); Income Tax Folio S5-F1-C1]. Some other factors that would support full-time residency are: the maintenance of their home in Canada, continuing economic ties (employment), and the length of time in Canada prior to leaving.
The fact that they only lived in Canada for 151 days in 20x7 does not affect their status as the 'more than 182 day' rule applies to those who do not typically have a continuing state of relationship to Canada.
B.
Boarding school: Child care costs are a type of 'other expense' which may be deducted directly against income sources in the aggregate formula (ITA 3(c)). Child care costs are usually deducted from the income of the lower income spouse. However, since Betty was a student while the child attended boarding school, Frank is able to make the deduction (within the prescribed limits of not more than $5,000 or 2/3 of Frank's earned income) on his tax return (ITA 63; Income Tax Folio S1-F3-C1).
C.
Selling the house and cottage: Both homes will have periods designated to them as the 'principal residence'.
In order to minimize the taxable income, it is important to determine the capital gain per year of each property.
House Cottage
$300,000 - $150,000 = $150,000 Capital Gain $260,000 - $160,000 = $100,000 Capital Gain
Years owned = 10 Years owned = 5
Capital gain per year = $15,000 Capital gain per year = $20,000
The capital gain on the cottage should be eliminated first as it is the highest gain per year of the two properties. Due to the "1+" in the numerator of the formula to reduce the capital gain on a principal residence, the cottage will be designated as the principal residence for four years and the house will be designated as the principal residence for six years (ITA 40(2)(b), 40(6)).

CASE 4

Cash $20,000 $20,000 OAS $5,000
Inventory $50,000 $50,000 Other pensions $50,000
Investment $400,000 Eligible dividends 20,000 1.38 $27,600
Furniture $200,000 $200,000 Non-eligible dividends 8,500 1.15 $9,775 2020
Equipment $500,000 $500,000 Net income for tax purposes $92,375
Building $800,000 $800,000 Less OAS repayment $79,054 2020
Total Assets $1,970,000 $1,570,000 Excess income over OAS base $13,321
80% Multiply x 15% 15%
Old Age Security repayment $1,998

CASE 5

2019 2020
Revenue from manufacturing and sales $2,000,000 $2,300,000
Dividend income from a taxable Canadian corporation 0 9,000
Investment interest income 2,000 6,000
Cost of goods sold 1,300,000 1,500,000
Gross profit $702,000 $815,000
Salaries and wages 300,000 350,000
Other administrative costs 250,000 300,000
Net income before interest and amortization $152,000 $165,000
Interest expense 10,000 10,000
Amortization 15,000 15,000
Net income after interest and amortization $127,000 $140,000
2019 2020
Revenue $13,400 $22,050
Administrative expenses (Note 1) 12,550 14,000
Owner’s salary 2,400 3,600
Work space in the home (Note 2) 1,450 1,450
Net income (loss) -$3,000 $3,000
Taxable Income – Stan, 20x7
Segment A: Salary $65,000 – RPP $3,000 + Life Insurance $500 $ 62,500
Segment B: N/A $ - 0
Segment C: RRSP Withdrawal -$ 2,000
Segment D: N/A $ - 0
Net Income for Tax Purposes $ 60,500
Taxable Income $ 60,500
Taxable Income – Karen, 20x7
Segment A: Salary $15,000 + Taxable Benefit (use of cottage) $1,000 + Business Income $6,000*
$ 22,000
Segment B: N/A $ - 0
Segment C: Childcare expense** -$ 2,300
Segment D: N/A $ - 0
Net Income for Tax Purposes $ 19,700
Taxable Income $ 19,700
*Business Income: Karen’s Consulting
20x6 Adjustment:
Net loss -$ 3,000
Add back owner’s salary $ 2,400 (not an allowable deduction for a proprietorship)
Add back home-based costs $ 600 (cannot be used to create a loss; carried forward)
Net Income for Tax Purposes $ - 0
(Karen will be required to file a tax return for the 20x6 year to provide this carry forward information.)
20x7 Adjustment:
Net income $ 3,000
Add back owner’s salary $ 3,600
Subtract home-based costs
carried forward from 20x6 -$ 600
Net Income for Tax Purposes $ 6,000

CASE 5 - TKL

Net Income from the Financial Statements $ 140,000
Add:
Amortization $ 15,000
Bonus (to be paid after 180 days in 20x8) $ 11,500
Subtract:
CCA -$ 24,000
Net Income for Tax Purposes $ 142,500
Less:
Dividends -$ 9,000
Taxable Income $ 133,500
Part I Tax:
Taxable Income $133,500 x 38% $ 50,730
Less abatement $133,500 x 10% -$ 13,350
Plus refundable tax on investment income (rounded)
10 2/3% x lesser of:
aggregate investment income ($6,000) $ 640
taxable income less income subject to small business
deduction ($133,500 - $127,500)
Less small business deduction:
19% (2019) x Lesser of:
Active business income* $ 127,500 -$ 24,225
Taxable income $ 133,500
Annual limit $ 500,000
Manufacturing and Processing deduction** $ - 0
General Rate Reduction** $ - 0
Total Part I Tax $ 13,795 $ 13,795
Part IV Tax:
Dividends received from non-connected corporation:
38 1/3% x $9,000 $ 3,450
Total Part IV Tax $ 3,450 $ 3,450
Net Federal Tax Liability $ 17,245

CASE 6 - EXHIBIT I

Compass Tours Limited
(Projected) Income Statement
For the Year Ended December 31st, 20x8
Revenue:
Tours $ 900,000
Expenses:
Costs of tours $ 530,000
Salaries:
Norma Easton $ 80,000
Stanley Weston $ 80,000
Support staff $ 60,000
Amortization $ 4,000
Administrative costs $ 10,000
Advertising $ 20,000
Lease on building $ 30,000
Net income before taxes $ 86,000

CASE 8

Revenue $100,000
Cost of Goods Sold 55,000
Partner Salaries 40,000
Other operating expenses 10,000
Amortization 5,000
Net Income (Loss) -$10,000
Net Income for Tax Purposes:
ITA 3(a)
Employment income $ 75,000
Business income* $ 15,800
Property income (5,000 x 1.38) $ 6,900
ITA 3(c)
RRSP contribution $ 2,000
Net income for tax purposes $ 95,700
Less: Non-capital loss from 20x0 $ 1,500
Taxable income $ 94,200
Net income for tax purposes:
ITA 3(a)
Employment income ($75,000+$1,000) $ 76,000
Business income* $ 15,800
Property income (2,000 x 1.15) (2019) $ 2,300
ITA 3(b)
Capital gain ($3,000 - $1,000)
Taxable capital gain $2,000 x .5 $ 1,000
Net income for tax purposes $ 95,100
Taxable income $ 95,100
Net loss from the financial statements -$ 10,000
Add:
Partners’ salaries $ 40,000
Amortization $ 5,000
Subtract:
Capital cost allowance $ 3,400
Net income for tax purposes $ 31,600
Allocated 50/50 $ 15,800
Revenue $ 130,000
Cost of Goods Sold $ 66,000
Operating expenses $ 25,000
CCA $ 4,800
Net income for tax purposes $ 34,200
Allocated to each partner: $ 17,100

CASE 9

ITA 3(a) Primary tax (2019 - rounded)
Employment income $ 97,000 [$95,000 + (1,000 x (10-8))] $ 116,840
Business income $ 1,200 [$12,000 x 10%] $ 47,631 0.15 $ 7,145
Property income $ 18,140 [(2,000 x 1.15) + (3,000 x 1.38) + 200 + (10,000 x 1.15)] (2019) $ 47,629 0.205 $ 9,764
ITA 3(b) $ 21,580 0.26 $ 5,611 $ 22,519
Taxable capital gain $ 2,500 [1000 x (15-10) x .5] (Sale of stock option shares)
Taxable capital gain $ 2,000 [$4,000 x .5] (Sale of shares in Public Corp. XY) Less: Personal federal tax credits:
Net income for tax purposes $ 120,840 Basic $ 12,069
Employment $ 1,222
Net income for tax purposes $ 120,840 CPP/EI $ 3,609
Less: Tuition $ 2,500
Stock option deduction $ 1,000 [$2,000 x .5] 15% $ 19,400 $ 2,910
Capital gain deduction $ 2,500 [On sale of shares in a QSBC] Donations ($200 x .15) + ($800 x .29) $ 262
Net-capital loss carry-over $ 500 [$1,000 capital loss on Public Corp. AB shares x .5]
Taxable income $ 116,840 Non-eligible dividend tax credit
($2000+$10,000)x1.15x.09 $ 1,242
Eligible divident tax credit
$3,000 x 1.38 x .15 $ 621
Less: $ 5,035
Basic federal tax $ 17,484
Other federal tax credits:
Political contribution
($400 x .75) + (350 x .5) + (250 x .3333) $ 558
Total federal tax $ 16,926

CASE 10

Bart's Tables - Income Statement for the Year 20x7 Salary: $ 90,000
Business income:
Revenue $300,000 Financial Net Income $ 9,000
Cost of goods sold (lower of cost or market) 185,000 Add:
Administrative costs: Salary $ 25,000
Bart's salary 25,000 Amortization $ 12,000
Assistant's salary 20,000 Golf membership $ 5,000
Amortization* 12,000 Income tax expense $ 6,000
Operating expenses 38,000 Subtract:
Golf membership 5,000 100,000 CCA -$ 10,000
Income tax expense** 6,000 Business NITP $ 47,000
Net Income $9,000 Bart’s NITP $ 137,000

CASE 13 - GRIP

GRIP Opening Balance $ 2,000
Add:
72% of:
Taxable Income $ 690,000
Less:
Income subject to small business deduction -$ 420,000
Aggregate Investment Income -$ 75,000
$ 195,000
72% x 195,000 $ 140,400
Add:
Eligible Dividends Received $ 32,000
Minus:
Eligible dividends paid in prior year $ - 0
Maximum eligible dividend $ 174,400
Dividend Refund (A) + (B) + (C)
(A) Lessor of:
(i) 38 1/3% x eligible dividends paid $ 34,497
(ii) Eligible RDTOH balance $ 12,267 $ 12,267
Plus
(B) Lessor of:
(i) 38 1/3% x non-eligible dividends paid $ - 0
(ii) Non-eligible RDTOH balance $ 39,920 $ - 0
Plus
(C) Nil as B(i) is less than B(ii) $ - 0
$ 12,267

Sheet5

GRIP Opening balance 2,000
Add ($710,000 ABI - $420,000) x 72% 208,800
Add eligible dividends received 32,000
Minus eligible dividends paid in prior year 0
Maximum eligible dividend 242,800

Microsoft_Excel_Worksheet1.xlsx

Sheet1

$ 97,970.00
$ 47,631.00 0.15 $ 7,145
$ 47,629.00 0.205 $ 9,764
$ 2,710.00 0.26 $ 705
$ 97,970.00 $ 17,613
NON-REFUNDABLE TAX CREDITS
BASIC $ 12,069
CPP/EI $ 3,609
EMPLOYMENT $ 1,222
0.15 $ 16,900 $ 2,535
FEDERAL TAX LIABILITY $ 15,078

Sheet2

Sheet3

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