Estate Planning: Preserving the Estate
Estate Planning is to preservation of estate value what love is to marriage – you can’t have one without the other.Absent an estate plan, estate assets are almost certain to be eroded by a number of costs and expenses to which an estate is subject. Erosion of estate value is caused primarily by Taxation and secondarily by a multitude of fees charged to and paid out of the estate.
Taxation will inevitably deplete estate value. The challenge and the goal of the estate plan is to minimize the extent to which taxation does so. Consider the following types of taxes which an estate may be made to sustain.
Estate Administration Tax
- While neither the government of Canada nor the provincial government imposes a death tax, Estate Administration Tax (“EAT”), also known as probate fees are charged and taxable on the value of the estate.
- EAT is currently taxed on the total value of the estate wherever estate assets are situated.
- EAT is furthermore calculated as follows:
- $5 for each thousand dollars, or part thereof, on the first $50,000 of estate value; and
- $15 for each thousand dollars, or part thereof, of the value of the estate over and above the first $50,000.
Capital Gains Tax
- The Income Tax Act stipulates that a taxpayer is “deemed to have disposed of all capital property immediately prior to death at its fair market value.” The effect of the legislated deemed disposition regime is as follows:
- Unrealized capital gains are realizable, i.e., taxable;
- Recapture of all capital cost allowances; and
- Realization as income of registered investments.
Consider the following kinds of capital property subject to gains tax:
- Capital property, such as mutual funds or shares in a corporation, are subject to capital gains tax on 50% of the gain portion of the property. For example, shares acquired at a base cost of $10,000 and today worth $90,000 would yield a gain of $80,000 and, accordingly, 50% of the gain or $40,0000 would be taxable at the tax payer’s marginal tax bracket.
- Depreciable capital property such as rental/income generating real estate is subject to recapture of any capital cost allowance claimed, that is the depreciation claimed over the lifespan of the property. Depreciation is, simply put, the reduction in value of an asset or property over time due to deterioration and age. Depreciation, which is accounted for as an annual expense, would, in the case of depreciable capital property such as a rental building, be applied to the building but not the land, given that land maintains its value and does not deteriorate over time. Bearing in mind the above noted tax law that a tax payer is deemed to have disposed of all capital property immediately prior to death at its fair market value, the disposition of depreciable capital property could result in not only a taxable capital gain but also the inclusion of recaptured depreciation in the deceased taxpayer’s income.
- Finally, for capital property in the form of registered investments, such as Registered Retirement Savings Plans, Registered Retirement Income Funds, Life Retirement Income Funds, and Locked-in Retirement Accounts, the Income Tax Act mandates the de-registration of these investments – the result being that the savings, together with the accrued grow are realized as income and taxed in the year of death to the deceased taxpayer.
Fees, albeit to a lesser extent, also contribute to erosion of estate property. As with most things in life, however, certain fees are unavoidable and many times very beneficial. Consider for a moment what it would be like to attempt an estate administration without the professional assistance of a lawyer and accountant. Fees paid to professional service providers make the administration possible and ensure that the process is carried out legally and competently.
The above is true of simple, i.e., straightforward estate administrations. Consider now the more complex estate with various long term testamentary trusts established. There is little doubt that such an estate would benefit furthermore from the involvement of professional or corporate/institutional trustees. Fees would, without question, be considerably higher in such a case, but it would be incredibly difficult to administer a complex estate as a sole individual executor.
Still, some fees can be avoided, depending on the circumstances. For example, in a straightforward estate, executor fees – which often range anywhere between 2-5% of the estate and usually comprise the greatest expense as far as fees paid out of the estate – can be completely eliminated by simply naming, as executor in a will, a spouse or other family member who is a major beneficiary under the will. This way, the executor is first and foremost compensated by way of the beneficial interest bequeathed in the will, and secondly the opportunity is available to the testator to reserve an additional percentage of the estate’s residue to the beneficiary named as executor instead of providing for executor fees which allows the executor to receive a slightly larger beneficial and non-taxable interest as opposed to having to account for and pay taxes on executor fees.
Minimizing Tax Payable on Death
Turning back now to the major cause of estate erosion, namely, tax, we consider the fundamental role of the estate plan.
Tax efficient estate planning tends to be most easily achieved when property which is owned individually is transferred to joint ownership. Joint ownership offers a right of survivorship to the surviving owner (or owners) by simply removing from the list of owners the names of the deceased. Joint ownership is a popular option between spouses and often even amongst spouses and their adult children. Assets registered jointly are not only able to pass to beneficiaries on a tax free basis but pass outside of the estate so as to avoid probate (see the discussion above regarding estate administration tax).
Joint ownership with rights of survivorship is not always an available or even advisable option, however, and alternative tax efficient estate planning measures are accordingly important to consider.
Assets and Investments which allow for beneficiary designations offer excellent alternatives to owning property jointly. Such products are able to be paid out to the designated beneficiary outside of the estate and therefore on a probate free basis. Furthermore, there are favourable tax laws in place for spouses which allow these types of assets or investments (and capital property generally) to pass between spouses on a tax deferred basis. The Income Tax Act allows for what is known as the spousal rollover, which is the exception to the deemed disposition of property at time of death for fair market value.
To take advantage of a spousal rollover, the following criteria must be met:
1. a transfer of capital property to either a surviving spouse or spousal trust;
2. the property transferred must be as a result of death;
3. the property transferred must vest in the beneficiary (the spouse or spousal trust) within 36 months of death; and
4. both the deceased and the surviving spouse must have been residents of Canada immediately prior to death and, in the case of a transfer of property to a qualifying spousal trust, the trust must be a Canadian resident when the property vests in the trustee.
A spousal rollover will consequently result in a deferral of any capital gains as well as recapture depreciation until such time as the surviving spouse deceases or the capital property is sold or otherwise disposed of by the spouse or spousal trust.
The foregoing demonstrates the importance of estate planning and our lawyers are available for consultation in order to assist you with the planning of your estate.
Disclaimer: This article provides general information only and is not intended, nor is it to be relied upon as a substitute to obtaining legal advice.