| The will is one of the most notorious testaments, embracing all the elements of money, power, passion, insurance, life and death.
It provides a fascinating source of material for stories, both real and fictional, of murder, forgery, romance, inheritance, drama and even comedy, be it Howard Hughes or Agatha Christie. Cloaked by all the mystique and sometimes overlooked is the mundane fact that the will is a key element of estate planning. For most people it is the cornerstone document of their estate plan and for some the only estate and succession planning they will ever need to do. The will, more than any other planning tool, reflects and achieves the essence of estate planning, namely the transfer of property from one generation to the next in accordance with the wishes of the testator, while at the same time minimizing the amount of tax and probate fees payable. "Death and taxes are inevitable" is a phrase that is frequently uttered. Unfortunately, in Canada the two often occur at the same time due to our system of deeming the disposition of all capital property on death, at fair market value, with the exception of capital property to a spouse or spousal trust and the exemption which applies to a principal residence. Will planning increases in importance because it is not only the size of estate, but also the kinds of property owned by the testator at the time of death that determines the tax consequences in the terminal year. Also, the Income Tax Act (ITA) provides exceptions to the rules for realizing income in the terminal year as well as a number of elections that permit personal representatives and trustees to affect the taxation of the deceased, the estate, any testamentary trusts created in the will and the beneficiaries of the trust. Consequently, tax-oriented will planning involves the use of various legitimate techniques, not confined to those incorporated in the will document itself, but extends to estate planning techniques adopted in anticipation of death and taxes (including probate fees) as well as techniques applied by executors and administrators after the death of the testator. The three inter-related components that comprise will planning are commonly referred to as: Probate Planning, Will Drafting and Post-mortem Planning. Perhaps the best way of demonstrating the importance and value of this strategic planning is to select a few examples, from the multifarious techniques that are available, in each of these three areas. Probate PlanningThis component of will planning is designed principally to avoid or reduce the probate fees and to minimize the effect of capital gains taxes on death.Inter VivosDispositions Obviously, the less property that belongs to the testator at the time of death the less the probate fees and taxes that will be payable. The testators can dispose of their property inter vivos by the way of gift or for consideration and either absolutely or by means of trusts with certain reservations or obligations. If there is no indication of imminent death then the question of the tax consequences of the disposition becomes important as the prepayment of income tax might well offset any probate fee saving. However, if there are little or no accrued gains or if the gains are exempted, this technique is often worthwhile. Before embarking on a gifting program, testators must consider other means of support and income. If there is a need for support for the donor, assets can be settled in a remainder trust, reserving the right to the donor to receive lifetime income and a power of encroachment, with the remainder interest passing on death to the intended beneficiaries. A hybrid gift-sale is sometimes used to transfer property and still provide for the donor. It involves the absolute transfer of the property subject to an agreement by the donee to provide support, use, occupation or maintenance by or for the donor for life. The obligation can be collaterally secured by a pledge of the property transferred.top of page Utilization of ExclusionsThe provisions of the ITA and the Estates Act contain a limited number of exclusions which allow property to pass outside the will with the result that the excluded property will not be subject to probate. Specifically these are: encumbrance on real property, life insurance and annuity proceeds to a named beneficiary, jointly owned property which passes by survivorship, e.g. real property and bank accounts.top of page Transfer to a CorporationIn determining value of the estate for probate purposes, there is no deduction of debts except encumbrances on real property. Therefore, a person holding personal property subject to debt should consider transferring the property to a corporation in return for shares since the value of the shares will be net of the liabilities. If the assets are of sufficient value, they could be transferred to a corporation in return for shares and debt, which become the estate assets. Directors of the company are usually prepared to effect the transfer of shares and debt on death, without probate. In situations where probate is required, the corporation would be incorporated in a jurisdiction that had the lowest probate fees.top of page Powers of AttorneyWhile not a technique per se, having a continuing general power of attorney can enable the attorney, on notice of impending death of the donor, to take steps to realize and transfer assets out of the name of the donor to another person as trustee. This avoids the necessity for probate. Such a transfer will preserve the assets for purposes of estate distribution.top of page Will DraftingThe terms of a will have a significant effect on both the taxation of the testator in his or her terminal year and the taxation of the estate and its beneficiaries. Where there are alternative methods by which the testator's dispositive wishes can be implemented, the method which produces the least amount of tax should be chosen. Further, where certain options or elections are available, the draftsman must ensure that the will is sufficiently flexible to take advantage of all benefits. The impact of matrimonial property regimes in force in different jurisdictions must also be kept in mind. A classic example of the options available to the personal representative when filing a final income tax return is that relating to "rights & things."top of page Rights & ThingsSignificant possibilities for saving tax in the terminal year are provided by the rules relating to "rights & things" which generally include income items that are amounts receivable at death as opposed to received, that would normally be included in income only when received. A "right or thing" includes any of the following items: Uncashed bond coupons, Unpaid dividends receivable, Unpaid salary or share of profits accrued prior to death, but not received, Unpaid commissions receivable including insurance agents' renewal commissions. The legal representative may elect to exclude any right or thing from the regular terminal tax return and file a separate return which includes all such items. Alternatively, the representative could choose to transfer certain items to one or more beneficiaries or allow the value to be included in the deceased's terminal return. Considerable tax savings are achieved because effectively two sets of marginal rates and personal credits are used.top of page Spousal DeferralsThe ability to defer tax by interspousal transfers of property is well recognized, especially on death. A spousal deferral is available with respect to non-depreciable capital property, depreciable capital property of a prescribed class, land, resource properties, reserves and refunds of premiums under RRSPs and RRIFs.top of page Charitable DonationsIn 1996 the tax credit for charitable donations was raised from 20% to 100% in the year of death, with any unused credits being allowed to be carried back to the prior year. The change meant that the previous bias against testamentary gifts as opposed to inter vivos gifts disappeared with the pendulum actually shifting towards bequests. It is now more attractive also to have the death benefit of an insurance policy paid to the estate and then bequeathed to a charity than was previously the case. A large percentage of older Canadians have unused RRSP and RRIF funds which they will now be willing to leave to charity, since the income inclusion of funds in the year of death will be offset by the gift. All that is needed is a revision of the potential donor's will to direct the donation of the RRSP/RRIF funds to a charity of choice, to meet the statutory requirements. Indeed, the transfer of capital assets which trigger a deemed realization at death by will may not only ameliorate the tax bite in the year of death, it may also produce a bonus for the year preceding the gift. For example, a potential donor owns a family cottage with a cost base of $100,000 and a fair market value of $400,000. If, in the year of death, the cottage is donated to a charity (which presumably would sell it), the gift would be worth $400,000, but the taxable amount included in income would only be $200,000 (three quarters of $300,000). The gift would not only cover off the tax associated with the deemed realization but would offset $175,000 of other income in that year. Moreover, if there was no other income in the year of death, up to $175,000 can be carried back to the prior year to offset income in that year which should result in a windfall tax refund to the estate in respect to the previous year.top of page Post-Mortem PlanningThe estate planning that occurs after death is to a large extent dependent on the inter vivos planning already completed and, of course, on the provisions of the will. This area of planning relates mainly to the allocation of assets to beneficiaries, minimizing tax on income of the estate and, where possible, rectifying planning omissions.top of page Allocation of AssetsIn general, where there is a surviving spouse, it is beneficial to defer the capital gains tax. However, there are situations where this is not always the most suitable strategy. Consider, for example, where the taxpayer owned shares in a private company which qualify for the $500,000 capital gains exemption and which were directed to be left to a spousal trust. In these circumstances, it might be beneficial instead to cause these shares to be held in a non-qualifying or tainted spousal trust and subject the deceased to a taxable capital gain at fair market value. The shares, held in a tainted spousal trust, would not be the subject of a further deemed disposition. Provided that the shares are disposed of within 21 years of the death of the deceased, they could be transferred on a tax-free basis to beneficiaries. Similarly, assets in the estate which have no inherent capital gains such as cash on deposit, treasury bills and life insurance proceeds, if transferred to a spouse or spousal trust can give rise to tax consequences in the future, without achieving any benefit at the time of death. The assets could for example be invested in stock or mutual funds with potential large capital gains for the surviving spouse. If, on the other hand, these assets were directed to a tainted spousal trust, there would be no tax consequences on the spouse's death because the tainted trust would still exist, or could be dissolved on a rollover basis. Where the will confers flexibility to allocate assets among different beneficiaries, significant tax benefits can be achieved by making an appropriate allocation. The ITA helps because, in order to obtain the spousal rollover, the assets must vest in the spouse or spousal trust within 36 months of death. Not only does this allow for flexibility in tax planning, it allows also for essential retroactive tax planning in that the determination can be made with the benefit of hindsight. The executors could implement a post-mortem estate freeze in favour of the surviving spouse's beneficiaries or a trust for them. In this way, if the spouse survives the deceased for a considerable period of time, the deemed disposition on the spouse's death will be at the value of the asset at the time of the freeze, rather than on death, which could be considerably higher.top of page Income SplittingTestamentary trusts are given the graduated rates applicable to individuals. If a trust has earned income of $60,000, the tax on this income would be $19,130 (in Ontario). On the other hand, if the same income were realized by an individual taxpayer in the top tax bracket, the tax would be $31,750. Consequently, there is a tax savings of $12,620 from having income retained and taxed in a testamentary trust. To the extent that a testator creates multiple testamentary trusts by virtue of the will, the benefits can be multiplied. Where a trust holds shares that qualify for the $500,000 capital gains exemption, there is also fertile ground for income splitting. If a capital gain is created in an estate from either a designation or a crystallization, an actual payment to beneficiaries will be required. It may be possible to make the payment in the form of shares of the corporation.top of page Life InsuranceLife insurance has traditionally played a significant role in will and estate planning, primarily by ensuring that the estate has sufficient liquidity to provide income to dependents and to fund tax liabilities. The role of the life agent and estate planner is to identify the tax liabilities that arise on death and to advise on the estate planning strategies to defer and minimize the impact of taxation. If the life insurance policy is issued appropriately as to ownership and beneficiary designations, the proceeds on death can be tax effective in a number of scenarios, such as: When the proceeds are payable to a named beneficiary, rather than to the estate, they are excluded from the value of the estate and probate fees are avoided. In Ontario, for example, for every $1 million of life insurance proceeds so designated $1,500.00 of probate fees is saved. If a corporation is the beneficiary of life insurance proceeds used to redeem shares (grandfathered from the stop-loss rules) from an estate, every $1 million of insurance received by the estate as a capital dividend means a saving of approximately $290,000 in tax on the capital gains to the estate. If the estate is the beneficiary of life insurance proceeds which are used to pay a charitable bequest, the estate is entitled to a 100% tax credit for the donation. On the other hand, if the charity is designated as the beneficiary of the life insurance, there is no tax benefit to the estate.top of page ConclusionWill planning is a continuous process of estate and tax planning which does not refer only to the drafting and execution of the will testament. Nor does it just take place in advance of death and end at death, but continues through the life of the estate to the ultimate disposition of the deceased's assets. Too often this consummate nature of will planning is overlooked which means that many of the valuable tools and techniques available to minimize tax are not even considered, let alone used. As is often the case, life insurance plays a key role in this planning process. Statistics reveal that only 50% of all adults in Canada have a will and that many of these are incomplete, out of date or inefficient from a tax planning perspective. Nobody likes to think about death or taxes but there are encouraging signs of a growing awareness that both are facts of life which are best confronted by skilful will planning. top of page |
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