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How Improper Tax Planning Can Lead You To Income Tax Debt

…and you thought fancy tax planning only backfires on the top 1%?

Not so fast. Middle class Canadians are now being caught as well. Sadly, not occasionally but in the TENS of THOUSANDS.

My practice is focused on helping individuals and businesses recover from debt overload. The frequency with which income tax debt has become a major factor is rampant.

Earlier in my career it were the higher earning, self-employed professionals or business owners whose tax advisors messed up (most commonly by not babysitting these entrepreneurs to make the installment payments, and feeling like heroes when they deferred taxes, or – even worse – employed aggressive tax planning skills).

Now it is the common man. Most earn way less than $100,000 a year. They are not sophisticated financial people. They work on jobs or run a small business.

How did this tax nightmare for the Average Joe happen?

The most common causes seem to be (I have left the game changer for last, so read on please):

  • Too busy working in the business to get to the accounting so do not file. Missing tax filings became a habit;
  • Not enough cash in the business leading to using GST/HST and payroll tax deductions for working capital;
  • An increasing number of self employed people who are great at their trades but terrible at the paperwork. Many of these people are really employees – but their “employer” is trying to dodge the responsibility of paying proper WSIB, employer portion of CPP and Employment Insurance;
  • Holding multiple part-time jobs where the employers are under-deducting;
  • Collapsing RRSP’s to make ends meet, when household income drops or to fund a business or life event;
  • ….and the new nightmare: failed tax shelters.

In the later 1990’s and early 2000’s an industry of tax shelter schemes came into being.  These took many forms, but the two main ones were:

  1. Get more back in donation credits than you actually laid out in the donation;
  2. Buying into pooled business losses, so you could claim a write off against your income taxes.

The promoters of these funds were not all unscrupulous. Many sought and obtained legal and tax opinions from big name law firms on Bay Street and international accounting firms. These opinions were used as promotional points and selling features. They made the average taxpayer feel safe.

Regular salaried employees have almost nothing they can write off for taxes. So when their tax preparer, trusted friend, or work buddy presented the idea of how they too could legally save a lot of tax money, they bought into the scheme. Just a little money in the first year, but when they saw it “worked” they increased the amount and brought their spouse, brother, friend, etc. to the party.

Needless to say, Canada Revenue Agency (CRA) did not like these plans one bit

In true bureaucratic fashion, CRA went about this in the following way (admission: there is some generalization here):

Step 1. CRA admits the tax returns as filed and sends out very nice tax refund cheques for, say, five years.

Step 2. CRA reassesses the returns for the past five years. This is the bureaucratic part – it took five years! They demand the tax refunds back  plus interest plus layers of penalties. And they want the money immediately. Remember you are a regular Canadian working hard to pay your bills – the only way you had something extra these last few years was because of the “scheme”.

Step 3. You call CRA (or more likely the promoter who told you this was all golden). You file an Objection.

Step 4. Objection is denied.

Step 5. You appeal. In many cases the promoters of the scheme handled this appeal for their customers. Some promoters shared the costs between the customers. Some paid for it themselves.

Step 6. You lost at tax appeal stage. CRA may have offered a settlement agreement (like waiving some of the penalties, or some of the interest if you dropped all further appeals). If you accepted the offer you can skip reading steps 7. & 8. But read on because you likely owe more than is fair or affordable to repay on CRA’s terms.

Step 7. Some typical cases were taken to a higher level of Court appeal. The rest of the cases (usually thousands of them) waited for an outcome, but had agreed to be bound by the decision. The appeals were lost.

Step 8. CRA sends all these taxpayers a statement demanding the money. Interest has accumulated – compounded daily, by the way. So often the total now owing with interest and penalties is two times the original amount received. Unless you won the lottery or inherited a big sum, this is not going to be easy.

Here are your choices for debt relief:

  1. Get payment terms (CRA generally offer 3 months and this usually does not work).
  2. Beg and borrow the money to pay the taxes.
  3. Or get help from a debt relief professional who has real experience in these matters. One solution does not fit all, so the professional has to have real working knowledge of all of them.

What the Licensed Insolvency Trustee can do:

  • Apply on your behalf for interest and penalty relief – this may make the amount more manageable to repay. In many cases, we have cut the debt in half.
  • Obtaining a reasonable good faith payment arrangement (fully refundable), so during this process CRA do not garnishee your income, freeze your bank account, scoop your RRSP or put a lien on your house.
  • Obtain significantly longer payment terms than three months.
  • A combination of the above items.
  • Make a settlement on your debts under Federal law that avoids bankruptcy and reduces the amount you tax debt have to pay. This has been the most popular solution, as it is the only way CRA can write off some of the actual tax (not only some of the interest and penalties).
  • If a settlement deal is not possible, ensure you get full protection under Federal law that allows you to keep assets that you can afford to keep, but grind down the debts to the legal minimum – whether the CRA agrees or not.

In all cases, a good debt relief professional has established sophisticated programs to ensure your credit rating stays intact or, if needed, is rebuilt quickly.

Do not worry about your tax debts – call us to find the solution that is best for you.