Reference no: EM132346664
It is now July 15, 2019. You are a CPA student working for Mrs. Partner, a partner in the tax department of a CPA firm in Toronto, Ontario. Mrs. Partner and your team have been working together on a number of clients with various tax issues.
Mrs. Partner has summarized her notes with the clients below.
Mrs. Partner would like you to prepare a memorandum to her attention that addresses the relevant tax issues for these clients. Mrs. Partner has reminded you to indicate any additional information that you will require to complete your analysis. She has also asked that you organize your memorandum under the same headings that she used in the attached notes so that she can easily cross-reference them.
Sale of Carol's Cleaners Corp.
Carol and her husband, Carlo, each own 50% of Carol's Cleaners Corp. ("CCC"), a very popular dry-cleaning service in Toronto. Carol and Carlo have decided after 35 years that it was time to sell the business and retire. They did not think that the time to retire would come so soon, but they were approached by a potential buyer who offered them more than they thought they would ever sell the business for. The couple has agreed to sell the assets of CCC. Once the assets are sold, CCC will pay off its outstanding accounts payable, including the final tax bill, and will wind-up the company sometime in early 2020.
CCC has a December 31st year-end for tax purposes. Carol has provided financial information on the assets and liabilities of the company attached in Appendix I. The cost and UCC amounts are based on CCC's June 30, 2019 internal financial statements. Carol does not expect that the values provided will be significantly different by the projected sale date of October 1, 2019. The fair market values of the assets are the values proposed by the purchaser.
The following are important notes taken from the meeting with Carol and Carlo:
• Although there are accounts receivable shown, they will not be part of the sale. It will be up to CCC to collect the outstanding accounts receivable after the sale.
• The purchaser will assume the mortgages on the land and building but will not assume the accounts payable.
• It is projected that taxable income for 2019, excluding the income/taxable capital gains generated from the asset sale, will be approximately $380,000.
One area of concern from the meeting with Carol and Carlo is the cost of the building of which the dry cleaning operates. Prior to 2016, CCC was renting a warehouse. Instead of renewing the lease, Carol and Carlo decided to buy a parcel of land and construct their own building. The purchase of the land closed January 1, 2017, and construction on the building began February 1, 2017. The building was finished on March 30, 2018. The cost of the building is not in the financial information, as Carol and Carlo were not sure which expenditures are to be capitalized to the building. Furthermore, no CCA was claimed on the building for the December 31, 2018 year-end as per the tax return that was just filed, because the cost base was unknown. Therefore, we will need to determine the cost of the building in preparation of the sale of assets. Details of the expenditures are attached in Appendix II.
Assume that the proper deductible expenses in respect of the building were taken for the 2017 and 2018 fiscal years. The taxable income figure provided above for 2019 is also computed correctly.
The purchase price of the land was $320,000, plus land transfer tax of $30,000. There were legal costs associated with the purchase of $15,000. The purchase was financed with a $300,000 mortgage at 4%. The construction costs were financed with a line of credit that has since been replaced with a mortgage on the building.
Carol and Carlo want to know how much money will be left in the company after the sale so that they can plan for their retirement. It would be useful to know how much CDA will be available after the sale of assets, as the couple will be able to receive the CDA tax- free. Also, the combined Federal/Ontario corporate tax rates to use are 15% for active business income eligible for the small business deduction, 26% on active business income not eligible for the small business deduction and 50.67% on investment income. If you need it, assume the top combined personal marginal rate is 50%.
There is no need to calculate the tax impact on the wind-up of CCC.
2. Danny Mort
Danny Mort died on October 1, 2018. Danny was divorced. He had three children: two daughters and a son, who were all independent adults.
Danny's will left his shares of D Ltd. to his eldest daughter. Danny owns 60 common shares of D Ltd., and his friend, Doris, owns 40 common shares. There are no other shareholders. It is estimated that the shares of D Ltd. were approximately worth
$2,500,000 at the time of Danny's passing. On July 31, 2018, D Ltd. declared a bonus payable to Danny of $45,000. This bonus had not been paid to Danny at the time of his death. Danny received a non-eligible dividend of $6,000 from D Ltd. in April 2018. D Ltd. also declared non-eligible dividends on September 10, 2018 in the amount of $20,000. This dividend was received by Danny's estate on January 4, 2019.
Danny was receiving pension payments from his previous employer's pension plan of $5,500 per month. His October pension was paid on October 26, 2018.
Danny owned two properties at the time of his death - his home and a rental property. Danny's will provides that these properties are to be sold, and the after-tax proceeds distributed equally to his three children. The rental property, located in Toronto, was purchased in April 2008 for $600,000. Danny lived in this property as his residence until June 2014 when he retired. He kept the property and rented it out until the time of his death. In June 2014 its fair market value was $900,000. Danny made an election in his 2014 tax return in respect of this property under subsection 45(2) of the Income Tax Act. It had a fair market value of $1,200,000 at the time of Danny's death. The property Danny was living in at the time of his death was originally purchased by him as a cottage property and he stayed there throughout the summer every year and on weekends during the rest of the year. When he retired in 2014, he moved to the cottage full time. The cottage was purchased in 2001 for $250,000. It had a fair market value of $580,000 at the time of Danny's death.
The executor of Danny's will is his brother Manny. Manny would like to know what happens with these items for tax purposes and if there is any planning we could suggest.
3. Basement Rental Apartment
Ronda and her husband, Ronald, live in a 2,400 square foot detached home north of Toronto. They purchased their home in 2012 for $600,000. In 2015, the couple had their roof completely redone for $15,000.
In late 2017, Ronda and Ronald discussed how they never use their basement anymore, so on February 1, 2018, the couple began renting it out to a newly engaged couple.
Prior to the new tenants moving in, Ronda and Ronald purchased a new bed, area rug and other furniture. When they were getting things in order to rent out the basement, Ronda and Ronald expressed how happy they are that they purchased this home back in 2012. Friends of theirs, Kim and Ken, rented out their basement a couple years ago in 2016 and had to build a separate entrance to their basement so that the tenants did not have to go through the main entrance of the home. Luckily, Ronda and Ronald's home came with separate walk-out entrance to the basement. Ronald only had to install a new lock on the door for the future tenants.
Ronda and Ronald's basement is approximately 800 square feet. In early 2018, Ronald recalls reading in the newspaper that similar houses in the area were selling for
$1,300,000.
The information relating to the 2018 basement rental is as follows:
• Rental income $650 per month
• Furniture (purchased in January 2018) $2,500
• Advertising in their local newspaper $150
• New lock/keys for basement door $50
The 2018 expenses relating to their entire home are as follows:
• Property taxes $4,500
• Utilities $3,200
• Mortgage interest $15,000
• Ronda and Ronald's cellphone bills $1,200
A couple of weeks ago Ronda and Ronald had dinner with Kim and Ken, and Kim had mentioned how they had to report a partial disposition of their home for their 2016 taxes as a result of renting out their basement. Kim and Ken ended up paying tax that year on the partial disposition of their home since they own multiple vacation homes. This makes Ronda really nervous, as she and Ronald do not want to incur any more tax since they know their 2018 tax returns are already late for the second year in a row.
Ronda is self-employed and earned a total of $120,000, after expenses in 2018. Ronald earned $90,000 of employment income in 2018. The couple does not have any other income or eligible deductions, other than the income (if any) from renting their basement apartment. The couple will file their 2018 taxes on their own, so there is no need to prepare their total 2018 tax liability; Ronda and Ronald are just waiting on us to provide their total 2018 net rental income (if any), and for us to address whether there are any issues relating on changing part of their home from personal use to a rental apartment. Ronda and Ronald do not want to pay more in our fees, so there is no need to quantify the interest and late filing penalties in respect of their 2018 taxes- a brief summary to this effect is fine.
Before walking out of the meeting, Ronald mentioned that they are likely going to sell their home by the year 2021. The couple does not own any other property and will purchase a condo once they sell this home. Ronald wants to ensure that he and Ronda can claim their principal residence exemption on their home in the year of sale.
4. David Skin
David Skin (age 61) is a dermatologist and a new client of the firm. He told me that, when he became a doctor, he figured that, with a name like his, he should specialize in dermatology! He is married to Susan (age 57). They have 4 children who live with them
- Megan (age 24), Mark (age 21), Matthew (age 19) and Maureen (age 15). All the family members have their birthdays in January.
David operates his dermatology practice in a professional corporation, David Skin MD Professional Corporation (PC). He also has a management corporation, Great Skin Services Inc. (MC). Both corporations Have a December 31st year end for tax purposes.
a) PC
David owns 100 voting shares of PC and Susan owns 100 non-voting common shares of PC. PC has no other shares issued. PC earned 2018 active business income and taxable income of $500,000, after all expenses. Included in the expenses is a $300,000 salary to David. PC has filed its 2018 corporate income tax return, claiming a small business deduction of $500,000. And has paid all corporate taxes owing and is up to date with instalments.
David, of course, works in the practice full time but Susan does not and never has worked for PC. PC used to pay dividends to Susan, but they forgot to pay Susan any in 2018. David would like to know how a dividend to Susan would be taxed if she were to be paid one in 2019. We reviewed the 2018 tax return for PC and it has no general rate income pool at the end of 2018. You can assume there will be none in 2019. I would also like to know if there are other considerations for dividends to Susan in future years.
PC has never registered for GST/HST. David was talking to some other dermatologists who indicated their practices are all registered. David need to know if he needs to register. I asked him if any of his services are purely cosmetic in nature. He said yes, but he wasn't sure how much of his 2018 revenue was from such services.
I need good explanations with a detailed analysis for all of this because I will need to explain it to David and I have other clients in similar situations.
b) MC
MC has 100 common shares issued. Each of the three adult children owns 30 shares. Maureen owns 10 shares. No other shares are issued. MC pays for all the expenses of the dermatology practice (rent, salaries for staff, supplies, etc.) and charges PC a management fee of the expenses plus 15%.
MC has filed its 2018 tax return and reported taxable income and active business income of $150,000. The return shows small business deduction on $150,000, but I am not sure this is correct. If it isn't we will have to amend the tax return. Please provide me with a detailed analysis in respect of this.
David is also wondering how dividends to the children from MC would be taxed. He would like the children to receive dividends. The three older children are in university and dividends would help with funding. Maureen is an avid equestrienne and a dividend could be used to pay for her horse and expenses. I need a detailed analysis of this so I can explain it to David.
5. Sarah Smithers
Sarah and her brother Sam each own 50% (50 common shares each) of Smithereens Inc.("Smithereens"). They inherited the shares from their mother when she passed away a few years ago. The paid-up capital of the shares is $100 in total ($50 for 50%), which was also their mother's ACB of the shares. The shares had a fair market value of $500,000 in total when their mother passed away. They are now worth $1,000,000. I have had a look at the most recent balance sheet and Smithereens should be a qualified small business corporation. Sarah tells me she has never used any of her capital gains exemption which I will confirm with CRA.
Sarah has never worked in the business. Sam runs Smithereens and would like to buy his sister out. He has offered to either redeem Sarah's shares, but them from her personally or have Samco, a company of which he is the only shareholder, buy the shares. For all three alternatives, Sarah would be paid fair market value.
Need an analysis of the tax consequences to Sarah for all three alternatives.
Attachment:- ADMS Assignment.rar