Wills and Estates and Wealth Planning
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Effective estate planning is about preserving family relationships as they existed prior to the passing of a family member, while retaining as much wealth as possible in the process. The following are some basic tax and other concepts about estates, estate planning and wealth planning:
- When a Canadian taxpayer passes away, there is a “deemed disposition” of all of the taxpayer’s capital property, pursuant to subsection 70(5) of the ITA. This essentially means that any capital property with an inherent gain will be taxed as if the taxpayer had sold the property for fair market value (notwithstanding that no sale actually occurred, and no sale proceeds are received). This would apply to property such as, for example, shares of a private corporation, real estate, stocks, etc. which are owned by the deceased upon passing.
- Property that passes to the spouse of the deceased occurs automatically on a tax-deferred basis. An election can be made to have this transfer taxable. On the passing of the surviving spouse, the property will then be taxed (if no election was filed to have it taxed on the passing of the first to die).
- The estate of the deceased is deemed to acquire the property of the deceased at fair market value.
- On a person’s passing, the estate must pay “Estate Administration Tax” (commonly referred to as “probate” tax). This is a provincial tax that is equal to about $15,000 on the first $1 million of assets. Probate tax can be reduced if the deceased has “multiple wills”. This means that a particular person has two wills – one that governs all of the person’s assets that must be probated, and one that governs all of the person’s assets that do not have to be probated.
There are numerous estate and tax planning strategies that can be implemented to reduce the tax liability that arises on death. These strategies can be used to pass a business and other assets to the next generation while skipping the tax.
For example, an “estate freeze” is a very common and effective strategy. Essentially, the owner of a corporation which is either an operating company or a holding company can “freeze” his/her/their shares via section 86 of the ITA on a tax-deferred basis, and issue new common shares (i.e., the “growth” shares) to the next generation, or – even better – to a family trust. Over time, the owner with the “freeze” shares can erode the shares over the course of many years in a tax-efficient manner. Upon the passing of the owner, he/she will have completely eliminated, or at least substantially reduced the capital gain that would otherwise become payable on passing. The business and/or wealth will have passed to the next generation without generating a large capital gain on the death of the owner.
In the event that the above planning was not undertaken, there are also “post-mortem” tax strategies. An estate can reduce some of the tax liability by implementing a “164(6) loss carry back”, or an “84.1 pipeline”. The appropriate post-mortem strategy depends on the particular scenario.
Trusts are among the most powerful tax-planning tools in the right scenario. They provide the ability to, among other things, income split and multiply capital gains exemption, while keeping control of the trust property in the hands of one or more trustees and not in the hands of beneficiaries. Trusts also provide additional creditor-proofing opportunities.
Trusts are often used in the context of an “estate freeze”. The trust often holds the “growth” shares of the company until such time as the trustee wishes to distribute the shares (often to the next generation, in the context of a succession plan). Generally speaking, the trust will be able to roll out the trust property to one or more beneficiaries at cost without triggering a capital gain. However, in some instances, a trust will not be able to roll the property out at cost. For example, a trust cannot roll out property at cost to a non-resident beneficiary of the trust. Also, if subsection 75(2) (a specific attribution rule) ever applied to the trust, the trust will not be able to roll out its property at cost.