Mortality and Tax: Leaving More, Owing Less

Photo Credit: Mike Smith

All references to a spouse include common-law partners. All references to the ‘Act’ mean the Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended. All references to the ‘Regulations’ mean the Income Tax Regulations. The following should not be construed as legal nor tax advice. Consultation with your usual tax/legal professional is advised. Please contact us to discuss the contents of the article herein.

Good morning Toronto! Today, we continue the strong start by discussing some estate planning tips.

In the last article, we discussed the broad implications that arise on the death of a taxpayer: the payment of probate fees, the deemed disposition of capital property, the deemed withdrawals of certain registered plans, and the taxation of income post-taxation at the highest marginal tax rates. For each of the above, some strategies can be used to mitigate or defer these consequences, which will be explored herein.

Probate Fees

Probate Fees are only paid on the value of the estate. When assets bypass the estate, they are not considered to form the estate or be subject to probate fees. The most common way to do this in Ontario is to hold property as Joint Tenants with Right of Survivorship (JTWROS). This form of ownership is frequently used for real estate, bank accounts, and investment accounts. In JTWROS, assets are evenly split – if there are 2 people, they each own 50%, and so on. On death, the deceased's share passes directly to the surviving co-owner. If there are more than 2 owners, then the deceased’s share is evenly split among the survivors. For individuals seeking to minimize probate costs and delays, JTWROS is the preferred arrangement.

However, it should be noted that JTWROS-held assets, while bypassing probate, are not exempt from potential deemed-disposition requirements. Under the Act, each owner’s share is taxed individually. On death, the deceased’s share of capital gains would be subject to tax on the final return. However, if the other tenant on the property is a spouse, then the spouse would be entitled to a §70(6) rollover, which would allow the use of the original ACB of the property, thereby paying no capital tax until their death. §70(6) rollovers apply to all capital property. There are no other provisions to permanently delay capital gains if the other tenant is not a spouse, aside from the use of trusts and private wills, which are both beyond the scope of this article.

Deemed Disposition Taxes

As mentioned, the death of a taxpayer triggers a deemed disposition event for all of their capital property. Aside from the mentioned §70(6) rollover, there are few other provisions in the ITA that substantially reduce taxes. In most cases, estate planning defaults to ensuring that the estate has sufficient liquidity at death to meet these tax obligations. Perhaps the most effective tool to provide liquidity is life insurance. When properly used, the death benefit portion helps cover the final tax obligations without forcing the estate to sell off its assets.

When purchasing insurance, it is important to ensure that a beneficiary is directly named on the policy. When this happens, the proceeds bypass the estate and probate, being paid out on a tax-free basis to the beneficiary. However, if the proceeds are paid to the estate, the payout is subject to estate tax.

Generally, the amount of life insurance should be enough to cover all final debts, including capital gains and estate taxes. If there are additional circumstances (such as children in post-secondary education or a surviving spouse), extra coverage should be seriously considered to pay for these future needs. Furthermore, to balance affordability and protection, many Canadians opt for a combination of term and permanent life insurance. Term insurance offers high coverage at a low cost for fixed periods (10, 20, or 30 years) while permanent life insurance is lifelong.

Deemed Withdrawal of RRSPs/RRIFs

Assuming that the RRSP/RRIF accounts still have funds/assets in them, the Act allows the tax-deferred status of the account to continue, in some form, if the intended beneficiary is considered a qualified beneficiary. Should this happen, money is taxed as it is withdrawn/received from the new RRSP, RRIF, or annuity. There are three main types of qualified beneficiaries.

• Spouse: RRSP/RRIF assets can be directly or indirectly transferred into the spouse’s own RRSP, RRIF, or qualified annuity. On transfer, the financial institution issues a T4RSP/RIF slip that reports the full FMV of the transfer. While this is reportable as ‘income’, the spouse then claims a §60(l) offsetting deduction on their tax return, equating to zero immediate taxes paid. Funds are to be taxed as they are withdrawn from the new account.
• Financially dependent AND infirm child/grandchild: Under the same provisions as spouses, financially dependent & infirm (mentally/physically disabled) children/grandchildren (with a DTC) can transfer the amounts to their own RRSP, RRIF, or annuity under the same procedure as spouses. They may also elect to transfer amount(s) to their RDSP, while respecting and being bound by the $200k lifetime limit.
• Financially dependent minor AND NOT infirm child/grandchild: May only use funds to purchase an annuity that starts immediately and ends (fully paid out) by the time they turn 18.

The funds are considered directly received(if they are designated as a beneficiary on the deceased’s RRSP/RRIF). An indirect receipt of the funds can arise if the deceased failed to name a beneficiary. In this case, to qualify under the rollover provisions, the qualified beneficiary must be an heir (under the will) and, with the estate trustee, file a joint election. In all cases, the transfer to the new account must be completed within 60 days after the end of the year in which the death occurred.

If there is no qualified beneficiary, the entire value of the RRSP/RRIF will be treated as income on the terminal return, subject to probate fees and income tax. Again, if this is the case, life insurance is highly recommended as a way to ensure that the estate has liquidity to pay for these final taxes.

Taxation of Post-Death Income

Normally, trusts are taxed at the top marginal rate (53% combined) if income is retained (not distributed to beneficiaries) in the trust. The Act allows estates to be designated as Graduated Rate Estates (GREs) for up to 36 months after the date of death. In this period, the GRE is allowed to use the same graduated personal income tax rates. To qualify as the GRE, only one estate may be designated as the GRE, and this designation must happen in the first T3 return filed after death. On expiry of GRE status, the estate becomes a regular trust, subject to the top marginal rate.

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Too complicated? No worries! KLee Tax specializes in filing tax returns and tax advisory for individuals, businesses, and corporations. Whether you are working your first job, running a business, or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

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