Considering the many tax implications of estate planning
Estate planning should not rest solely on the dollars but take into account family dynamics, as well as meeting the overall testamentary intentions of the individual who has passed on. When planning your estate, one should consider estate administration taxes (formerly referred to as probate fees) and also the income tax impacts resulting from the deemed disposition assets triggered just before death.
Estate Administration Taxes (EAT)
Ontario levies a tax of 1.5% on the value of the assets of a deceased. Accordingly, on a $1 million dollar estate, the EAT would be $15,000. Good estate planning can reduce the value and mitigate the tax impact. Examples include:
Inter vivos gifts – Transferring assets to trusts can minimize estate administration taxes, but can have income tax implications.
Registering assets in joint tenancy with right of survivorship – These assets can include real estate and non-registered investment accounts, allowing the assets to pass to the survivor outside of the estate.
Beneficiary designations – Specific designated beneficiaries can be named on certain assets, allowing them to be passed on outside of the estate. These would include RRSP or RRIF accounts or proceeds received from life insurance policies.
Income Tax Planning
As indicated above, on death, an individual is deemed to have disposed of all his/her assets at fair value, triggering a tax consequence. Planning considerations must therefore be given in order to minimize this tax impact.
Freeze of Private Corporation Shares
Let’s take a scenario where an individual owns a corporation. On death, the person will be deemed to have sold his shares are fair value. Accordingly, once there is enough value in the company that can provide for an income stream to that person, a typical strategy in planning for one’s succession and estate plan would be to freeze that person’s interest in the company. This will provide the person with the opportunity to know what the maximum income tax impact would be on the deemed disposition of the shares and plan around financing that liability.
Further, in order to reduce the person’s income tax liability on death, changes to that person’s compensation structure should be considered and may include sub-situating a salary or dividend in exchange for a redemption of shares over a period of time.
Assets transferred directly to the spouse of the deceased or to a spousal trust are an exception to the deemed disposition rule. Assets transfer at costs and tax consequences are differed until the death of the surviving spouse. Consider which assets would transfer to the spouse and which assets would got to the other beneficiaries. Typically, it is beneficial to transfer assets with higher inherent gains to the spouse to lower the tax liability to the estate.
Inter Vivos Gifts
Gifting typically accelerates the timing of the tax liability to a person. However, all factors should be considered, such as whether the person has unusual capital losses or unutilized room within their capital gains exemption limit. Triggering a taxable event early sometimes results in future tax savings with no immediate tax impact. Also, any future growth in the value of those assets would have no impact on the tax liability on death since the assets are no longer of that person.
Post Mortem Planning
Will planning – Multiple Trusts
Creating multiple testamentary trusts through a will was recently a common tax strategy to transfer assets to each beneficiary’s trust. The income generated from the assets in each trust would be taxes, starting at the lower marginal tax rates. The multiple-trust strategy multiplied the use of the lower income tax, resulting in significant tax savings.
Application of this strategy, however, may be somewhat compromised or limited based on a 2012 Ministry proposal to limit the eligibility of the lower tax rates for testamentary trusts to the first 36 months of the estate starting in 2016.
Capital LossesCapital Gains
Section 164(6) of the Income Tax Act allows for any capital losses triggered in the first year of an estate to be applied against any capital gains that were triggered in the first year of an estate to be applied against any capital gains that were triggered and reported on the terminal return of a deceased. Due to the one-year limitation, careful planning is required in order to take advantage of this opportunity and reduce the overall tax liability to the estate.
If you have any questions, please contact Richard Rizzo, Tax Principal at (905) 633-6332.