Tax Considerations for Estate Planning:
One of the main reasons for making a will is to make sure your assets are dispersed according to your wishes after you die. That being said, you can also plan to decrease taxes on your estate.
1. Understand taxes and fees – Estate administration taxes are based on the size of the estate that is required to be probated. In BC, probate rates do not apply to the first $25,000 after which it is calculated at a rate of $6 per $1,000 for the first $50,000 of assets required to undergo probate and $14 per $1,000 for assets in excess of $50,000 that are required to undergo probate. Tax may also apply to registered plans, such as Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs). Registered plans are generally deemed to be included in income at a rate of 100 per cent. For example, an RRSP with a value of $100,000 at the date of death would result in $100,000 being taxed as income on the deceased’s final return. However, in certain circumstances, the registered plan may pass to a qualified beneficiary on a tax-free basis. The most common example of this is where a spouse is named as the beneficiary. In this case, the value of the plan wouldn’t be taxed until the death of the surviving spouse. At the time of death, you are deemed to have disposed of all of your assets at fair market value. For assets with accrued capital gains, this means that the capital gain becomes taxable at the time of death. These assets could include things like nonregistered investment portfolios, shares in private companies and real property. Any gains on your principal residence are not taxed. At the time of death, 50 per cent of the accrued gain on assets subject to these rules would be included in the taxable income on the deceased’s final return. As with registered assets, a tax-free spousal rollover is available at the time of death. In this case, the accrued gain would not be taxed until the death of the surviving spouse.
2. Determine what taxes would apply to your estate– Prudent tax planning would involve looking at all of the various taxation impacts that would arise in the event that you die today with your existing will, or without one. You can then examine the various alternatives that will achieve your objectives while reducing taxes.
3. Take steps to defer or minimize taxation of your estate – Planning techniques can include a wide variety of strategies. These include, but are certainly not limited to: (a) Transferring the ownership of an asset prior to death (b) Taking advantage of income-splitting opportunities (c) Using the tax-free rollover rules, as applicable (d) Making sure beneficiaries are named on registered plans and life insurance policies (e) Making specific charitable bequests (f) Using a variety of trust structures, including spousal trusts, that are allowed under the Income Tax Act (g) Using secondary wills for assets not requiring probate (h) Estate freezes, using privately owned corporations
4. Talk to a professional – I would always recommend that a lawyer be involved in the actual drafting of your will. A Chartered Accountant can add significant value to the process by working with your lawyer to outline the current tax consequences to the estate in the absence of planning. Your CA can then work on a variety of planning strategies to minimize the taxation impact, while making sure your assets are distributed according to your wishes.
People of all ages find it hard to contemplate their own death and its consequences. As a result, when death occurs, survivors are often left unprepared for the effects of taxes on themselves or on the deceased. Reviewing your personal financial position, planning your estate and discussing your options with your accountant is a positive step toward eliminating unpleasant surprises for your loved ones as they face one of the most distressing events of their lives – your death.
There is no “estate tax” in Canada, but when a person dies there is a deemed disposal of any capital property, so any capital gains would be taxed at this time. This would include assets such as vacation properties and investments. However, if the deceased taxpayer’s property is being distributed to the taxpayer’s spouse or to a “spouse trust”, then under certain circumstances taxable capital gains, allowable capital losses, recaptures of capital cost allowance, and terminal losses may be deferred. The deceased taxpayer’s cost basis for the property would then become the cost basis for the property to the spouse. Thus, any taxable capital gains would be deferred until the property is disposed of by the spouse. The spouse also has an option available to “opt out” of these deferral provisions.
Really, there are two main tax consequences resulting from the death of a taxpayer: the disposition of property and the filing of returns.
Disposition of property
Generally, at the time of death, taxpayers are deemed to dispose of all of their capital property for proceeds equal to fair market value. Any resulting capital gains and recapture are included in the deceased’s terminal return.
If the surviving beneficiary is a spouse or common-law partner, the automatic spousal rollover applies to defer capital gains and recapture. The deceased is deemed to have disposed of the property at cost and the spouse acquires the capital assets at the same ACB and UCC. However, the estate may elect to opt out of the option if there are unused losses.
The return filed in the year of death is referred to as the terminal return. The terminal return includes any income or loss resulting from the deemed disposition of capital assets, as well as periodic payments such as interest, rent or salary accrued until the date of death. The terminal return allows a taxpayer to claim a full year of personal tax credits.
Non-periodic payments that have not been received at the time of death do not have to be reported on the terminal return. Rather, these “rights and things” can be reported on a separate tax return. This is advantageous because the taxpayer can claim a full year of personal tax credits and will also be charged at a lower marginal rate. Alternatively, the “rights and things” return need not be filed if the income is assigned to a beneficiary.
The terminal return is due the later of the normal filing due date and six months after death. If the taxpayer dies before the return for the prior year has been filed, that return is also due the later of the normal filing due date and six months after death. If the return for the prior year has been filed, there is no issue. The rights and things return must be filed by the later of one year after death and 90 days after the assessment of the terminal return.
Avoiding Tax on RRSPs and RRIFs at Death
The deceased will not be subject to tax on the value of his or her RRSP or RRIF on death to the extent the RRSP or RRIF proceeds are:
• transferred to a financially dependent child or grandchild, or
• transferred to a Registered Disability Savings Plan (RDSP) of a financially dependent child or grandchild.
When the beneficiary of an RRSP or RRIF is a financially dependent child or grandchild of the deceased, the value of the RRSP or RRIF is taxed in the hands of the dependent rather than the deceased. If the child or grandchild is under 18 the tax can be spread over the number of years remaining until the child is 18 with the purchase of an annuity.
Should the financial dependency have been due to a physical or mental disability, the dependent can avoid being immediately taxed on the RRSP or RRIF proceeds by making a transfer to his or her own RRSP or RRIF or using the funds to purchase an annuity. Tax is then only paid by the dependent as withdrawals are made from the RRSP or RRIF or when an annuity payment is received.
A new provision in the Income Tax Act permits a deceased taxpayer to avoid tax on the value of an RRSP or RRIF at death where the proceeds are transferred to a RDSP of a financially dependent child or grandchild.
The amount transferred to the RDSP cannot cause the beneficiary’s maximum RDSP contribution room of $200,000 to be exceeded and no Canada Disability Savings Grant is paid on the transfer. The beneficiary will pay tax as amounts are taken out of the RDSP.
For the child or grandchild to be considered financially dependent, his or her income for the previous year is not to exceed the amount used for the basic personal tax credit amount of $10,527 (2011). If the child or grandchild is disabled that amount is $17,868 (2011).
This is the total of the basic personal tax credit amount and the disability tax credit amount. The Income Tax Act states that these amounts are to be used “unless the contrary is established.”
Tax-Free Savings Account
On death, the TFSA retains its “tax-free” status and no tax is payable by the deceased. If the surviving spouse is named the “successor holder” of the TFSA, the funds can be transferred to the surviving spouse without affecting the spouse’s TFSA contribution room. The TFSA of the deceased continues to exist and the income earned in the TFSA after the date of death is not taxable to the surviving spouse.
When the spouse is not named as a successor holder, but is named a beneficiary, he or she may still receive the deceased’s TFSA funds tax-free and contribute those to their own TFSA without affecting their TFSA contribution room. This is referred to an “exempt contribution”. The maximum the spouse can receive tax-free and the maximum exempt contribution that may be made is limited to the value of the deceased’s TFSA at the time of death. Any income earned in the deceased’s TFSA after death is taxable to the surviving spouse.
Beneficiaries other than a spouse, such as a child, cannot make an exempt contribution. Of course, any funds received can be contributed to their own TFSA provided the beneficiary has unused TFSA contribution room. The amount received by the beneficiary is not subject to tax to the extent it does not exceed the value of the TFSA at the time of the deceased’s death.
Any taxable capital gains that result from the deemed dispositions of personal-use property, such as cars and boats, are subject to tax on death. If there are accrued losses on assets such as these, the capital losses are not permitted to be claimed. A capital loss on one personal use asset cannot be used to offset a capital gain on another personal-use asset.
An exception to the above deals with personal-use property that is “listed personal property”, such as art, jewelry, rare books, stamps and coins. In respect of the deemed disposition rules on death, capital losses are permitted to be claimed on listed personal property assets but only to the extent they offset any capital gains on listed personal property.
The minimum value to use in calculating the gains and losses on personal-use property for both, the deemed market value at time of death and the tax
cost, is $1,000.
Matthew Gustavson Chartered Accountant can help advise clients as to plan for their future. Contact us today for your free no obligation consultation!