Estate Planning—A Plan for Future…Part 2
In the previous part of our blog, we had embarked on the journey to discovering what estate planning can do for you. In this blog, we continue to explore the benefits of estate planning. Read on to find out more.
Planning for After Death
1 Contribute to your Spouse’s RRSP
- After an individual’s death, if there is still unused RRSP contribution room, the estate could contribute to the RRSP of the surviving spouse. These contributions will be deductible from the deceased’s income and sheltered from tax in the surviving spouse’s RRSP.
2.Transfer the RRSP to Minor Children (if there’s no legacy to the spouse) and Purchase an Annuity for them
- The transfer of RRSPs to a minor child is allowed only if the child is still financially dependent on the client on the day the client dies.
- This strategy prevents the tax consequences of the deceased’s registered savings from being included in his income.
- The RRSP amount will be included in the child’s income.
- If the RRSP amount is used to purchase an annuity, the tax due upon receipt of the RRSP can be spread out until the child turns 18. The child will then pay a minimum of tax, thanks to the low taxation rate.
3. Maximize Exemptions
- It’s possible to benefit from a capital gains exemption on the primary residence if the client owns a secondary residence, by designating as primary residence the one which is registered with the greatest appreciation. For example, if a client owns a secondary residence, when he dies, the estate can decide to designate the secondary residence as the primary one if it was subject to a higher appreciation, even if the client never lived there permanently.
Capital Gains Exemption
This exemption is:
- $848,252 in 2018 for eligible small business corporation shares. This amount will be indexed on an annual basis.
- $1,000,000 for farms and fishing firms.
If qualifying small business corporation shares (that is eligible for the enhanced capital gains exemption of up to $824,176 for 2016) are held, a number of options are available. For farm or fishing property disposed of after April 20, 2015, the capital gains exemption has been increased to $1 million. If the exemption is available, the individual will generally want to utilize it before he or she passes away. This can be done even if the shares are left to a spouse, because of a special rule that allows an individual to “elect into” a capital gain on a property-by-property basis ( for e.g., one or more shares of a corporation). Also, the surviving spouse is potentially eligible for his/her own capital gains exemption. If it is expected that, after death, there will be future appreciation in the shares that will more than “eat up” the surviving spouse’s capital gains exemption, it may be a good idea to leave at least some shares to children (or grandchildren) if it is intended that they remain within the family. This could be done before death through an “estate freeze” reorganization, to meet the family’s financial needs.
4.Bequests of Farm or Fishing Property
Special rules apply to farm or fishing property passing to a beneficiary who is a child, grandchild, or great-grandchild of a deceased person. The definition of a “child” of a taxpayer includes a person who was, at any time before he or she attained the age of 19 years, wholly dependent on the taxpayer and under the taxpayer’s custody and control. The rules apply if all the following conditions exist:
(a) The farm or fishing property must be in Canada;
(b) The beneficiary must have been resident in Canada immediately before the death of the person;
(c) The property must be land or depreciable property;
(d) Before the taxpayer’s death, the property in question was used principally in a farming or fishing business in which the taxpayer, the taxpayer’s spouse or common-law partner, or any of the taxpayer’s children were actively engaged on a regular and continuous basis; and
(e) The property must vest indefeasibly in the beneficiary within 36 months after the death of the person. (The vesting period can be extended where the legal representative applies in writing to the minister within the 36-month period and the minister considers that a longer period is reasonable in the circumstances.)
Property leased by a taxpayer to his/her family farm or fishing corporation or to a family farm or fishing corporation or partnership of the spouse or common-law partner or child qualifies for the tax-free transfer if the property is used in the business of farming or fishing by any such family farm or fishing corporation or partnership at the time of the transfer. Property transferred or disposed of in 2014 and subsequent years, when that property was used for both farming and fishing will also be allowed the tax-free transfer.
5.The Tax Burden
The recipient of the deceased’s RRSP or RRIF may be jointly and severally liable with the deceased annuitant for a portion of the deceased’s tax liability. However, it is only where there are insufficient funds in the estate to pay the deceased’s tax liability that this provision will apply to hold the recipient liable for the tax.
It should be remembered in drafting the will that, unless the will stipulates otherwise, it will be the residual beneficiary who bears the tax burden when someone other than the spouse (or spousal trust), or a qualifying child or grandchild, is designated as the beneficiary of an RRSP.
This is because, where a plan holder of an RRSP or RRIF dies, and the proceeds are paid to a person other than his/her spouse (or spousal trust) or a qualifying child or grandchild, the fair market value of the plan immediately before his/her death must be included in the plan holder’s income for the year of death. Yet, the full amount of the proceeds in the plan will be paid out to the beneficiary without any withholding for tax.
The tax treatment accorded RRSP and RRIF proceeds on death can result in the designated beneficiary receiving a greater gift than intended. A common example where this might occur is the deceased being survived by two children, one of whom is designated to receive the proceeds of the plan and the other of whom is designated the residuary beneficiary.
On the face of things, the value of the two gifts may be equal, but the value of the residual estate is reduced by the tax payable by the testator on the deemed proceeds from the plan. Careful consideration regarding the appropriate will provisions as to the payment of debts and taxes may be necessary to avoid an unintended result.
A simple solution is to allow the RRSP to form part of the estate. However, if probate avoidance or creditor proofing is the objective but the testator still wishes the estate to be distributed in accordance with the scheme in the will, another solution could be the use of a hotchpot clause in the will. Hotchpot clauses are used, where a parent has advanced more to one child than to the others and wishes this to be taken as an advance on that child’s share of the estate.
Given the incentives, parents should be encouraged to establish a registered education savings plan (RESP) for their children. Where the children are minors, it will be especially important to address the issue of any RESPs of which the testator is the subscriber in the will.
In a technical interpretation, the CRA was asked to comment on a situation involving an individual who, under the terms of his will, left all his movable and immovable properties to his two-year-old son. The terms of the will also provided that, following the settlement of his estate, an RESP, under which he was the subscriber and his son was the beneficiary, would be transferred to a testamentary trust created for his son’s benefit. The CRA was asked if the testamentary trust would qualify as a “subscriber”. The CRA confirmed that since a trust was deemed by the Act to be an individual in respect of the trust property, it could qualify as an RESP subscriber, provided that the trust acquired the, individual’s right in the RESP after his death or contributed to the plan in respect of the beneficiary.
If someone is financially indebted to an individual and the individual wishes to forgive the debt, it is best to do this in the will. If the individual forgives the debt before he or she dies, there will be adverse tax consequences to the debtor if a debt was investment-related or business-related (that is, the interest was potentially deductible to the debtor).
When leaving the shares of a corporation to beneficiaries, carefully consider the impact of the “association rules” if the beneficiary and/or family members are also shareholders in an incorporated business. Unless care is taken, the result may be that, after death the corporation may have to share its entitlement to the “small business deduction” (the low rate of tax for business corporations) and certain other tax benefits with that if the beneficiary’s corporation.
Association rules may also apply to executors and trustees if they are also shareholders of their own corporation and they become executors of an estate that own a corporation.
9.Corporations and Partnership
If share of a corporation, or an interest in a partnership, whose value has appreciated, are to be left to someone other than a spouse, it should be remembered that, in many cases, it will be advisable to undertake some rather complex tax planning within the first year of the estate; otherwise, there could be “double tax” exposure when the underlying corporation/partnership assets are disposed of.
Unfortunately, many executors are not aware of these planning steps until it is too late—as stated, the deadline may be one year after the individual passes away. If such a situation exists, the executors are advised to seek professional tax advise. This should generally be done whenever shares on partnership interests are left to someone other then a spouse, and have appreciated in value. (A similar situation may arise where the surviving spouse who is the beneficiary under a spousal trust passes away.) In addition, the will should give executors and trustee authority to make the various tax election and designation that are required.
If the testator plans to make large charitable donations from his/her estate, it may be advisable to receive professional advise before-hand, as there are a number of tax-planning opportunities and pitfalls here.
Legislation has now been passed deeming certain donations to have been made by the estate in the year in which property was transfer to a qualified done. The legislation also provides for more flexible allocation for donations made by will and for designation of donations, where such donations are made via “graduated rate estates”.
Ensure that you are aware of the advantages of a notarized will. The absence of a properly executed will at the time of death greatly diminishes the purpose of estate planning, because a will is the key element in the settlement of any estate.
Did you know that if you die without leaving a will, the law decides to whom and in what proportions your assets will be divided?
Different Types of Wills
- Holographic Will
- It must be entirely written and signed by hand by the testator.
- No validation by a witness is required for its authentication.
- The testator may or may not be the only person aware of its contents.
- The testator must nonetheless inform a friend or loved one of where the will is kept so that it can be found at the time of death.
- The writing of it can give rise to different interpretations.
- This will is often incomplete.
- It requires verification by a notary or a court after the testator’s death, which can result in significant expense and delay.
- Will before Witnesses
- This type of will can be written by hand by the testator, but may also be written using a computer.
- It’s possible to have it written by another person, as long as they are over age 18.
- To be legal, the will must be signed by the testator and two adult witnesses.
- If the document is written on a computer, the testator and the two witnesses must initial each of the pages for the will to be official.
- The testator must reveal the place where the document is kept so that it can be found at the time of death.
- This will involves a waiting period between the death and the liquidation of the estate.
- The writing of this will can give rise to different interpretations.
- This will also necessitate verification by a notary or a court after the testator’s death.
- Notarized Will
This type of will is written by a notary who, in addition to knowing the importance of correct wording, advises clients so that they don’t forget anything in their will. It’s true that a notarized will is more expensive; however, the costs could prove to be very little compared to the court costs resulting from contesting the will.
- The notary, the testator, and the witnesses must sign the document to validate it.
- A notarized will leaves no ambiguity as to the interpretation of a client’s last wishes.
- The original document is kept in a safe place to guarantee its durability.
- This will takes effect upon death.
- It ensures optimal estate and tax planning.
Under the Income Tax Act, couples in common-law partnerships are subject to the same legal rules as married couples. However, the Civil Code of Québec does not recognize common-law partners in legal devolution and estate law. The transfer of property to these spouses must therefore be expressly stated in the will, or they will receive nothing. In the absence of a will, the estate is vested according to the provisions of the Civil Code as presented below:
Taxation at Death
- Spouse Children and others
- Primary residence None None
- Secondary residence (cottage) None* Capital gain or loss
- Life insurance benefits None None
- Non-registered investments None* Capital gain or loss
- (depends on the type of investment)
- Registered investments None* Added to income of the deceased taxpayer
- Office or rental property None* Recovery of amortization
and capital gain or loss
*Rollover to spouse
No discussion of tax-planning of a will would be complete without a brief mention of probate tax (or, as it is referred to in Ontario, “estate administration tax”). In essence, probate planning is aimed at reducing the value of the estate that passes to the personal representative. Probate tax is proportional to the value of the estate, so the tower the value of the estate, the lower the probate tax that will be payable.
Reducing the value of the estate can be achieved through the use of multiple wills and a variety of will substitutes. However, it is worth noting that many of the more popular probate planning techniques (such as transferring assets to an alter ego trust or into joint tenancy with the intended beneficiary) present significant potential pitfalls, not least of which is that they can hinder effective tax planning. For example,
—if the bulk of a testator’s assets pass outside his/her estate to the intended beneficiaries, this will mean foregoing the use of one or more testamentary trusts to engage in postmortem income splitting:
—transferring assets into joint tenancy will result in a deemed disposition, possibly accelerating the recognition of capital gains; and
—transferring assets to an alter ego or joint partner trust raises a host of tax issues, such as the fact that such trusts are taxed at the flat rate applicable to inter-vivos trusts rather than the marginal rates applicable to individuals and testamentary trusts, and that any capital gains or losses realized on the deemed disposition of assets held in these trusts will be segregated from gains or losses taxable to the deceased in the year of death.