What to do?

It took three months, but Gary finally got a letter from the federal minister of finance.

“It is a two page speech about all the Liberal policies addressed at making Taxes Fair for the middle class,” says the Kelowna self-employed blog dog.  “At no point does it address any of my concerns. So much for the govt listening to the people. Kind of disheartening. What to do?”

Gary wrote about some issues raised on this badass blog before the last budget – namely what the T2 gang intend to do about all the people who are now creating their own jobs through self-employment. After all, full-time, salaried employment with benefits and pensions is becoming a thing of the past. The typical Millennial’s grand-dad had one job for life and retired with a monthly allowance. The poor kid will probably have eight gigs and never have a safety net.

Anyway, Gary decided to speak out. He wrote this in his first-ever letter to a politician:

My wife and I have owned and operated two businesses in our working lives.  We personally did without things, saved and invested so that we could look after ourselves later in our lives.   We were reasonably successful in that we are now financially independent and can live off of our investments.

We collect dividends, capital gains, interest etc on our investments.  I have never collected a dime of EI benefits.   We have RRSPs and TFSAs.  However we also have non registered investments.   We will pay Capital Gains tax on whatever we cash out at a 50% rate.  This is on top of the income tax we paid on the original income that we saved and invested. How many times and how much tax are we supposed to pay tax on this money?

Now your government wants to raise this tax rate to penalize “the rich” as Mr. Trudeau refers to us.   We are by no means rich.  We have achieved where we are by our own hard work and diligence.

His concerns? That taxes will be increased on capital gains, or people like him who operate through an incorporation because the government thinks entrepreneurs should be treated the same way as politicians – paid by salary. But without the tax-free expense allowance, housing allowance, travel vouchers, free electronics, office staff and budget plus indexed pension, of course. I mean, fair is fair, right? Why should a guy who puts up eavestroughs all day be treated like some kind of tax-advantaged god? Who the hell do these corporate titans think they are?

The response was a two-page excerpt from the last budget with Bill Morneau’s signature at the bottom. And, as you know, the issue faded a little after the T2 gang retreated from their higher-tax agenda in the March budget.

But, sadly, it’s back. So prepare.

This week Bill donned his pointy Robin Hood hat and trusty codpiece and gave a speech in Toronto suggesting the next budget will be way less kind than this year’s. It was the boldest hint yet that the federal government is, in fact, gunning for the self-employed

“We have identified three areas of concern,” he said. And, yes, they are exactly those which this blog whined, moaned and gnashed over some months ago. It’s only a matter of time now before incorporated people will no longer be able to split income with others, keep retained earnings invested within the company at a reasonable rate, or enjoy the existing capital gains tax rate.

Here are his exact words:

“Take this example: if you are an employee living in Ontario and you make $220,000 a year, you would pay roughly $80,000 in income tax. Now, your neighbour owns a private corporation and sprinkles that same amount between themselves, their spouse and their adult child. In many cases, the family is involved in the business and it’s completely legitimate. But in cases where the spouse or child have no role in the business, suddenly your neighbour is paying roughly $30,000 less tax than you do. And we see no good reason why that should be the case.

“The second example is passive investment income. That’s when people hold money inside a corporation, not to grow the business by investing in it, but simply to shield it from the higher personal rate.Again, this sort of arrangement is not available to someone who collects a paycheque every two weeks.

“The third and last example relates to capital gains. Converting a private corporation’s regular income into capital gains can reduce income taxes—again, by taking advantage of the lower tax rates. This is about making sure that the rules – as they were intended – are being followed and that people are paying their fair share.”

Morneau cloaks everything in the syrupy mantra of ‘middle class fairness’ but these are desperate actions from a government mired in deficits and over-spending. In just 48 months of governing, the feds will spend about $130 billion more than they collect – so taxes are going up. And not just for the wealthy, who already hand over 50% of their income when they hit $220,000.

Many doctors and medical professionals, for example, earn money through corporations which means they have no pensions, no benefits and start their careers at a later age, with huge student loans. Income-splitting with a spouse allows for some relief, and also means docs cost the system $250,000 a year instead of $500,000. (They can always go south…)

Anyway, what this blog vexed about last winter is about to become reality. Ottawa will first release a discussion paper outlining its reasons for attacking incorporations, and then will move to do so. There will be no compensation allowed for non-employees; retained earnings will be taxed at the beneficial owner’s personal tax (or perhaps the top marginal rate) and you can kiss the 50% capital gains inclusion rate adios.

How do you like fairness so far?

The close

Brad and Jill sold their house five weeks ago for $1.895 million in a crappy-but-uppity part of the Big Smoke. In their late forties, this was their third place and not only had they grown disenchanted with old houses (“the deck was rotten… the roof was iffy.. the backyard was a swamp…”) but they had dollar signs in their eyes.

So they found some greater fools to pay them exactly double what they shelled out five years ago, will trash the $420,000 mortgage upon closing and walk with about $1.3 million. The plan is to invest, harvest four grand a month in income and move into a bigger, better place two streets away. “Just signed a three-year lease,” he says. “It’s perfect. I can’t believe we’ll be living for free.”

Not so much for the buyers. They’re Millennials, Jill says, shaking her head a little, who made a big withdrawal at the Bank of Mom and are taking on a mama of a mortgage. The deal is set for late June, and now B&J have only one thing keeping them up at night: “Will they close?”

Exiting a deal isn’t simple. Yes, you will lose your deposit – that’s a given. Unless the seller agrees to sign a mutual release letting you out of the deal (fat chance) also expect to be sued for breach of contract. The amount of damages claimed usually depends on what price the sellers are ultimately able to get for the property. If they sell for less, the original buyer will be expected by the courts to make up the difference, plus cover actual costs the sellers incurred in re-listing. If the sellers had already purchased another home, for example, and have to get out of that deal, the damages could be Trumpian.

Also there’ll be legal costs. Lots of them. Litigators ain’t cheap, so both parties will have to fork over five or ten grand just to get their claims and defenses rolling. The odds of a negotiated settlement, instead of a full-blown court case, are high since burning through judge time is even more expensive.

In this market anyone who bought in February, March or early April and decides to walk may end up severely pooched. Realtor-provided price stats haven’t moved a whole lot yet, but actual real estate values are tumbling. Look at this little report from blog dog Steve:

“Just thought I would share with you a couple of images as evidence that the housing market may be finally correcting itself. The first image is of a house in the Weston neighbourhood, which I took on April 20, when it was listed at nearly $1mil. Today, that same house is still available over a month later for $300K less, with an asking price of $699K. As a renter, I sure hope house prices continue to plummet across the GTA.”

Given that listings continue to flood in and buyers have lost their house lust, prices are destined to fall. The increases in late winter were so off-the-chart we could see a 20% decline within a few months, and still have an affordability crisis. Recall the charts published here yesterday. This is a classic bubble, the result of excessive speculation and human emotion detached from economic fundamentals. Worse, it’s a debt-fueled keg of risk. Of course it will end, as every asset bubble before it has. And there’s never a soft landing.

So, buyers who walk can look forward to a protracted process since jilted sellers may require months to find a new buyer. Guaranteed, it will be for less. So the damages could be substantial, with no place to hide other than personal bankruptcy or moving back in with mom on the Isle of Man and herding goats.

The question is simple: is losing your deposit, paying tens of thousands in legal costs, going through marriage-busting stress and facing a settlement for damages that could amount to hundreds of thousands – then ending up with no asset to show for it – better than actually closing? Maybe not. If this was a piece of property you’d planned on living in for a decade or more, running away could be folly since the needed correction won’t last forever, plus you get a house. On the other hand, if you’re a speculator everyone thinks you should fry.

Well, the next few weeks and months will test many people whose unshakeable belief was that real estate is safe, and ascendant. Surprise.