Ian Martin

In the work I do, income taxes are a very popular topic of conversation.  Maybe “popular” is a poor choice of words.  People typically aren’t very happy to talk about taxes.  However, it’s an important part of the conversation if taxes are the reason for your financial difficulty.

Last week, I wrote about the powers of the Canada Revenue Agency (CRA) to collect income tax debts.  I also wrote about some of the special considerations with regard to income taxes and personal bankruptcy.  This week, I want to talk about a different aspect of income taxes.

If you’ve made the difficult decision to file for personal bankruptcy to deal with your debts, what comes next?  This is not an article about how bankruptcy works.  This is an article about not falling into the same tax traps that caused your financial difficulty in the first place.  I’ve completed a non-scientific study and want to review the three most common scenarios for causing income tax debt.  In no particular order…

#1 – Withdrawing Funds from RRSP

When you take money out of an RRSP, the bank is required to withhold a certain percentage for income tax.  For amounts up to and including $5,000, that amount is 10%.  The tricky part is that the actual amount of tax you should pay is probably much higher.  For many people, their actual tax rate is between 30% and 45%. 

Consider a simple scenario.  You take $5,000 out of your RRSP and the bank withholds $500 for income tax.  You do your tax return the next spring and your actual tax rate is 45%, meaning you are required to pay $2,250 of tax on that $5,000 you withdrew.  Since only $500 has been paid, you owe another $1,750.  However, the money is gone because you used it to pay bills.  Suppose you’ve done this for two or three years.  With penalties and interest from the CRA, you could have a tax bill close to $10,000.

What this means is that using RRSP’s to get caught up on debts is potentially very costly.  If you’ve filed for bankruptcy and still have RRSP’s, try to keep in mind the real cost of using those funds.  You can have the bank withhold a higher portion than the minimum required by law.  Here’s some information from the CRA website about minimum withholding rates.

#2 – Part Time Job

The amount of tax that you are required to pay for any particular year is a complicated formula based on your total income for the year.  The more money you make, the more tax you pay. 

Your employer is required to withhold amounts for your estimated taxes.  People can get into trouble when they have more than one job because each employer is estimating without knowing about the other job.  If you have a part-time job, that employer may withhold little or no income tax because they are not required to. 

It’s really the same issue as taking money out of your RRSP.  You receive funds without having enough tax taken off.  By the time you figure out how much tax should be paid, the money is gone and all you’re left with is a tax bill and hard feelings.  If you are concerned about this kind of scenario, you can request that one or both employers take off more tax.  It might feel like a difficult decision is money is tight.  With income taxes, it’s pay now or pay later.  It’s easier to a little bit each pay cheque instead of coming up with a large payment at the end of the year. 

#3 – Self Employed

There are many reasons why it can be great to be your own boss.  However, things haven’t gone as planned if you’ve had to meet with me.  Maybe you’ve lost a major contract.  Maybe you’ve had a significant injury or illness and have no benefits.  Maybe you need some help with bookkeeping.  The volume of government paperwork can be overwhelming.  Once you fall behind, it can feel as though it’s impossible to get caught up.

Legally, you are permitted to operate as a self-employed sole proprietor after you have filed for bankruptcy.  If you are going to do so, finding a bookkeeper to assist you with your paperwork is money well spent.  For others, it is easier to work as an employee.  It’s hard to fall behind on taxes if you are on somebody else’s payroll. 

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The biggest complication after filing for bankruptcy is that life will continue to throw you curveballs.  Filing for personal bankruptcy is about dealing with the past.  However, it is also an OPPORTUNITY FOR A FRESH START.  Filing for bankruptcy is a big decision.  Take advantage of that opportunity.

The mandate of the Canada Revenue Agency (CRA) is to assess and collect the correct amount of tax for individuals and businesses in Canada.  My colleague Bill Kilner blogged last week about how it’s easy to ignore your taxes after you start to fall behind.  I want to expand a little bit on why it’s important to deal with your tax debts.

I like to think of the CRA as a big sleepy bear.  When he’s hibernating for a long time, it’s easy to forget that he is there.  When he wakes up and flashes those razor sharp claws, you start to appreciate just how dangerous he can be.  Furthermore, he’s not going to give up chasing you once he gets your scent. 

Compared to an average creditor, the tax man has super powers to help collect money owing to him.  The CRA can freeze your bank account or garnishee your wages with just the signature from the director of your local tax office.  A bank or credit card company has to go through a lengthy court process to able to do the same thing.  I’m not here to argue whether it’s fair or right.  It is what it is.

What else can the tax man do?  If you have a business and the CRA knows who your major customers are, they can send a notice to those customers directing them to pay to them (to CRA, not you) the money your customers were to pay to you for the work you have done.  Again, no court order required.

There’s more.  If you have a house, the CRA can register a lien against the property.  No consent required by you.  No court order required.  Think of it as a second mortgage where the tax man is dictating the repayment terms.

Obviously, the best way to avoid these nasty consequences is to pay the debt.  Just like any creditor, the CRA has collectors with whom you can negotiate a payment plan.  However, the CRA is typically unwilling to accept less than the full amount owing. 

So, what do you do if a repayment plan just isn’t realistic?  There’s a common misconception that tax debts are not included in personal bankruptcy.   There are some special considerations that I will discuss in a moment, but the general rule is that the tax man gets treated the same as any other creditor if you file for personal bankruptcy.

I want to make something absolutely clear.  In no way do I advocate bankruptcy as a way of “getting out of paying” your tax debts, or any other debt.  Bankruptcy is a legal process available to Canadians to get a fresh start from their debts (tax and non-tax) when there is no reasonable expectation of being able to pay those debts in full.

The goal in bankruptcy is not to file for bankruptcy, the goal is to be discharged from bankruptcy.  It is not until you are discharged, that the debts are legally released.  In most situations, as long as you fulfill various financial and non-financial duties, you are eligible to receive your discharge without a requirement to go to court.  This is called an automatic order of discharge and is granted by the trustee. 

One of the “special considerations” is that you are not eligible for an automatic discharge if your personal tax debts are greater than $200,000 and represents more than 75% of your total unsecured debts.  This is one of the many changes to bankruptcy law in September 2009.  That means going to court and having a judge (called a registrar in bankruptcy court) deciding what conditions you have to meet to be discharged.  It could involve paying back a portion of the debt.  It could mean a time delay before you can be discharged.  It could mean that the refuses to grant a discharge altogether, but that would be in extraordinary circumstances.

Another “special consideration” is if the CRA has registered a lien against your house.  Bankruptcy deals with the unsecured debts.  Registering a lien makes the taxes a secured debt.  If this has happened and you want to keep your house, you should be talking to the CRA about payment arrangements.  Filing for personal bankruptcy will not remove the lien. 

If you have a business, your debts with the CRA might not be limited to income taxes.  You might also have debts for unremitted GST/HST or payroll deductions.  These are debts that are included in bankruptcy, but there are considerations that go behind the scope of an article like this.  My advice is to contact us so that we can go over your circumstances in detail.

Don’t let this bear chase you up a tree, or worse.  If you want to get started on a plan to deal with your debts, please feel free to contact us for more information or a free consultation.

When you owe money to Revenue Canada, the temptation is to simply not file your tax return, but that’s the wrong approach. Why? Once you are late there is an automatic five per cent late filing penalty the first time and each additional time the penalty escalates. Surely you can make better use of the money than send it to our government. Also, the government does not charge interest on the arrears until after April 30th. So any payment prior goes to the taxes. They will never turn down money so send it in. Finally if you can pay the taxes in six months or less, send in the cheques with the tax return. You can even set up preauthorized payments with them either in person or online.

If the debt will take more time, it is time to analyze the situation. Is this going to be an annual situation? How long will I need to pay off the taxes? Do I need to make a change to my budget or my lifestyle? If you cannot afford to pay the taxes within one year, you may be living beyond your income.

If it will be an annual problem you need to be aware of a certain fact, and that is that if you intend to retire, the first year after you retire, you will owe taxes from the last year of your business (or employment) but will not have the same income to pay them. In other words you may find yourself insolvent, looking for help out of a financial crisis. To avoid that now, pay your 2011 income tax when you make the money in 2011. Then when you retire your taxes are paid up to date. If you have last year’s taxes to pay, you are already fifteen months behind. You need to look at your budget and see how you can attempt to get up to date in twenty-four months (pay three years of taxes in two years). If you can pay within this time frame, call the Canada Revenue Agency and make an arrangement for your tax payments. If you cannot make payments within these guidelines, call us and make an appointment for a free consultation.

You may find a cure for the Tax Time Blues. A consumer proposal or possibly a bankruptcy in Ontario will allow you to take care of this problem and prevent it from happening again. Taxes owing to Revenue Canada (Canada Revenue Agency or CRA) are included when you file a consumer proposal or bankruptcy, so read our report on How to Deal with CRA for more information, or contact us for a free initial consultation, and let’s get started.

If we first understand why a creditor issues a garnishee and how they go about it, then we can understand how to deal with a garnishee. A creditor (like a bank or credit card company) goes to court to get a garnishee because they have not been paid, they have been ignored, or you cannot arrange a satisfactory repayment arrangement with them. For banks, credit cards and the like, issuing a garnishee is a last step because they are required to go to court, get a judgment and have the garnishee issued. The Ontario Wages Act usually keeps the rate of the garnishment to twenty per cent.

The best way to stop a bank or collection agency from garnisheeing your income is to be proactive. That means talking to the creditor prior to them getting to the point where they have no other choice but to put a wage garnishment into play. Often creditors take action because they do not know about what’s going on in your life, except the fact that they are not being paid. They do not know about the layoff, or the sickness or the other circumstances that make paying the creditor impossible. If your circumstances change, contact your creditors and tell them; do not wait for them to call you after the account has become delinquent. The sooner you call, the more time you will have to work with your creditors.

If you haven’t communicated with your creditors, they will notify you that they are taking you to court to get a judgment against you. There is the name of a law firm and phone number on the legal documents. Before things get worse, call and see if you can still work out a payment arrangement. If so, there will be no garnishee. If not, your creditors will get judgment against you and collect on this judgment by way of a garnishment.

Once a garnishment starts, other than paying it in full, there are only two ways to stop the garnishment: file a consumer proposal or file bankruptcy, both of which must be filed by a licensed trustee (such as our team here at Hoyes Michalos).

Once a private sector creditor (a bank or credit card company) notifies you that they want to get a judgment against you, do not ignore it. When you find out that a payment arrangement is not possible or if you know before that you cannot afford a payment arrangement, call us at 310-PLAN. We will review your situation and work with you to find the best and most affordable solution for you and your family situation.

We will help you make a plan. Often that plan will involve a consumer proposal. A consumer proposal is often the best alternative because the monthly payments you will have to make are usually lower than what would be required in a bankruptcy, and the creditors get a partial payment of the balance. However, if a consumer proposal is not possible because your income is too low, then a bankruptcy may be the only remaining option.

Others may claim that they can have a garnishee released, but if their offer is less than what the garnishee would generate, the likely answer would be no. A Trustee must file either a Consumer Proposal or a Bankruptcy. If these are your only alternatives, contact us and we will help you with your problem.

In this article we have discussed banks and credit card companies. The rules for a Canada Revenue Agency (CRA) garnishment are different, so if you have CRA tax debts, please call us at 310-PLAN today for more information.

My biggest complaint with the speed the government has implemented these rules is that they have taken a long time, which has created uncertainty for everyone. We thought the rules would come into force in 2006. Then 2007. Then 2008. By 2009 we had almost given up (which is why I wrote to the Prime Minister). You can read our full history on bankruptcy reform in Canada over the last few years. For four years I have had to tell everyone I met with that “the rules might change, so maybe you should wait, or maybe you should file now.” Bankruptcy is stressful enough without the added confusion of not knowing what the rules will be tomorrow.

Finally, in the middle of the summer, on August 19, 2009 all trustees in Canada received an e-mail from the Office of the Superintendent of Bankruptcy saying that the remainder of the new rules would come into force 30 days later, on September 18, 2009. I find it incredible that after waiting for four years the federal government decided, in the middle of Parliament’s summer vacation, to give us 30 days notice to get ready for the new rules.

Even worse, the timing of these new rules couldn’t be worse for many people. Here’s why: Under the old rules, most bankruptcies ended in nine months. Under the new rules, if you have never been bankrupt before and if you have surplus income, your bankruptcy will now last for 21 months. A second bankruptcy with surplus income now lasts for 3 years. The length of a bankruptcy just got longer for a lot of Canadians.

Each month a bankrupt is required to send their trustee proof of their income (copies of paystubs). If they have more than $200 in surplus income, their bankruptcy is automatically extended, and the bankrupt must continue making payments to their bankruptcy estate for the duration of the bankruptcy.

Why did the government increase the length of a bankruptcy if you have surplus income? I don’t know for sure, but I assume it’s because the government doesn’t want the bankruptcy process to appear to be “too easy”. If you have a lot of debt, and if you have the ability to pay something towards those debts, the government believes you should make payments.

I don’t disagree with that approach. Most people I meet with would be happy to repay their debts if they could. The problem, of course, is that most people who are considering personal bankruptcy can’t afford to repay their debts. They have lost their job, or gone through a divorce, or suffered a medical problem that has reduced their income, and repaying their debts in full is not possible.

The problem is this: when the government first introduced the new rules in 2005, Canada was in the midst of an economic boom. Times were good. Unemployment was low. Consumer debt was much lower than it is today. Incomes were high, so asking Canadians to pay a bit more in a bankruptcy was not a huge hardship.

Unfortunately it is now 2009, and Canada is in the midst of the worst recession since the Great Depression. Unemployment is high. Overtime is gone. We are using debt to survive more than ever before. And now, at the worst possible moment, the government has decided to make bankruptcy more costly.

If the government had asked me (which they didn’t), I would have suggested bringing into force now the rule changes that help Canadians (such as increasing the debt limit on consumer proposals), and leaving the more harsh rule changes until the economy recovers, and people are more able to afford the higher payments. If they wanted to bring all of the rule changes into force, I would have suggested at least giving us more than 30 days notice so that everyone could prepare for the new rules.

However, none of that matters now. The new rules take effect on September 18, so we are doing our part to be prepared. If you have more debt than you can handle, here’s what you need to know:

First, if you have more than $200 in surplus income, your bankruptcy will automatically extended, and you will pay more. Bankruptcy may still be your best option, but you should realize that the cost may be higher.

Second, if you owe more than $200,000 to the government in taxes, and your tax debts are more than 75% of your total debt, you are now required to appear before a bankruptcy judge before you can be discharged from bankruptcy.

That’s the bad news. The good news is that the debt limit on consumer proposals has increased from $75,000 to $250,000, so more people will now be able to file a consumer proposal as an alternative to bankruptcy.

Also, a secured lender can no longer cancel a contract simply because you filed bankruptcy. Under the old rules certain banks would automatically repossess your car if you went bankrupt. Now, if your payments are up to date, you can keep the car, provided you continue to make the payments to the bank. This will help a lot of people who need their car to get to work, but can’t purchase another car due to bad credit.

In summary, it would have been nice if the rules making bankruptcy more costly were delayed until the economy recovers, but the rules are here, so it’s important to understand them. If you are in financial difficulty, contact us and we will review your options, including consumer proposals as an alternative to bankruptcy, and we will help you decide which option is right for you.

In closing, my prediction for the next few months is that we will see an increase in the number of consumer proposals filed as Canadians attempt to avoid the harsher new bankruptcy rules. At least that will be a positive development for many people.

The theme of both shows was debt, and our goal was to give listeners some strategies for dealing with debt.

One of the callers said that he owed $65,000 to Revenue Canada. His problems started while he was out of work while he recovered from heart surgery. He was not able to pay his taxes, and now he owes taxes, penalties, and interest. Many people we help have had health problems that lead to financial problems. We have also helped many people deal with tax debts.

We told the caller that if he cannot afford to continue paying Revenue Canada in full, one option would be to get a debt consolidation loan. Unfortunately with his high level of tax debt, that may not be possible.

A consumer proposal is another option, and is best suited to someone with sufficient income each month to create a repayment plan. Without sufficient income, the final option is personal bankruptcy.

During both shows we emphasized that even though you may feel “stressed out” and overwhelmed by debt, there are solutions. You are not alone. Our professionals are here to help you make a plan to deal with your debts, so call us at 310-PLAN, or complete our one minute on-line evaluation and one of our professionals will contact you to set up a no-charge initial consultation to help you make a plan to deal with your debts.

Tax return debts occur for various reasons, including self-employed income with no tax withholdings, cashing out RRSP’s, working more than one job, receiving pension income, and other situations.

If there is a tax balance owing on an outstanding income tax return and it is filed late, Canada Revenue Agency (CRA) will automatically charge a 5% late filing penalty and then accrue interest & penalties on the unpaid balance.

We always recommend that you have your outstanding tax returns prepared and filed so that the debt is known and a plan to deal with debt can be arranged. If the tax debt and your other personal debts become unmanageable, there may be a formal option available for you to get a fresh financial start. To discuss your situation in detail, please contact us or call 310-PLAN.