Tax Tip Thursday

Cash Payout? Look Out!

Are you receiving a large payout for something? Lots of people are these days. It could be a pension commutation, a divorce, severance, capital gain, sale of property, inheritance… The list goes on! The most important thing to know about any or all of these is to ask your tax accountant about any impacts your payout might have! Not all the situations I mentioned have one, but some of them will and it is much better to know than not to know, I assure you!

Not to belabor the point, but no matter what the transaction is and no matter what tax is deducted (if any), make sure you talk to an accountant. Ideally you talk to them BEFORE the transaction occurs, but DEFINITELY talk to them before you start spending the money!

I have a very upset new client that had a huge transaction last year. They came to me to get their taxes done this year and they now have a huge tax bill that they didn’t expect at all. They were taxed at the source of the transaction, but nowhere near enough. The unfortunate thing is that I believe they went out and purchased a house using the available funds, so now they are not available to pay the tax bill. They thought the tax deducted at the source was the end of it.

What happens when you receive a lump sum?

A few things will happen, not necessarily in this order:

  1. Usually there’s a small celebration for your newfound wealth. Feel free to invite your favourite accountant! You might just get the advice you need…
  2. Your taxable income just went WAY up, and
  3. You will likely owe a boatload of taxes (and yes, that is an official measurement!)

Here is a simple and common example using rough numbers:

  1. You earn $100,000 per year at your job.
  2. You receive a pension payout of $300,000 (not uncommon at all these days!)
  3. They hold back $100,000 in taxes on the transaction
  4. You buy a house or cottage and use the balance of the money ($200,000 after what they took for taxes) as a down payment on the property.

Here’s what happens next, and where the trouble begins:

  1. Your $100,000 employment income is taxed at about $25,000 total.
  2. You just added $300,000 of taxable income, skyrocketing you to a total of $400,000 of taxable income
  3. You have paid $125,000 in taxes to date, but your tax payable is actually $175,000.
  4. You’re $50,000 short on your taxes, but you already spent all your cash on your new property.

Where are you going to find $50,000 to pay the tax bill now? Most people think this could never happen to them, but it happens all the time. Beware!

Did this happen to you?

There are solutions to this problem. Of course, it would have been much simpler to have just set the money aside in the first place, but I can help you find a solution! Give me a call or book an appointment as soon as you can and we can figure out what went wrong, how to address it, and how to avoid it in the future.

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.