Estate planning: Understanding the tax implications

The taxation of estates in Canada is a complex topic that is often best addressed by speaking to an estate and/or tax expert. Here are some basics to be aware of in order to ask the right questions.

Dispositions of property

Generally, at the time of death, individuals are deemed to dispose of all of their property. This can result in recognition of any gains and losses accrued up to the date of death. In addition, the remaining value of any deferred income plans such as an RRSP or RRIF may also be subject to tax at that time.

Property in a Tax-Free Savings Account (TFSA) including any accumulated income up to the date of death can generally be received tax-free. Where the surviving spouse is a successor holder of a TFSA the surviving spouse will not be subject to tax on income earned. Where the surviving spouse is named a beneficiary, they may transfer the TFSA assets to their own plan without affecting their contribution room or creating an excess contribution.

Opportunities to reduce tax

Where the deceased taxpayer’s property is being distributed to their spouse or common-law partner (referred to here as “spouse” for simplicity), under certain circumstances capital property including real estate, stocks, bonds and mutual funds can be received by the surviving spouse through a tax-free transfer at cost. This has the effect of deferring any tax until the death of the spouse or until such time as the spouse disposes of the property themselves.

In addition, the tax otherwise payable on death from deferred income plans such as a RRSP or RRIF may be deferred. RRSP and RRIF proceeds passed to a spouse on death will become taxable when they withdraw amounts from the plan or upon their death.

Where the beneficiary of the RRSP or RRIF is a financially dependent child or grandchild the value of the plan will be taxed in the hands of the dependent. Where the child is under 18 years of age the tax may be deferred over the number of years remaining until the child attains age 18 through the purchase of an annuity.

In addition, where the child or grandchild is financially dependent due to disability, the proceeds from the RRSP or RRIF may be transferred to a plan for the disabled dependent and taxed on withdrawal which may result in a significantly lower overall tax burden.

Another option to consider will be the transfer of proceeds from the RRSP or RRIF to a Registered Disability Savings Plan (RDSP) of the dependent where the proceeds will be taxable upon withdrawal.

Capital Gains Exemption

Canadian residents are entitled to a limited lifetime exemption from tax on net capital gains realized on the disposition of certain property. The exemption is indexed to inflation. For 2016 the maximum cumulative exemption in respect of qualified property, other than farm or fishing property, is $824,176. The exemption for farm or fishing property is proposed to increase to $1 million for dispositions after 20 April 2015.

Estate Freeze

One of the primary tools used to reduce tax on death for small business owners is an estate freeze, which results in the transfer of the future growth of a business, investments or other assets to other family members.

The most common form involves transferring, typically on a tax-deferred basis, the desired assets to a corporation in exchange for fixed-value preferred shares. The shares are retained by the taxpayer. The family members who are to benefit from the future growth would subscribe for nominal-value common shares.

Probate fees

In addition to income taxes payable on property disposed of at death most provinces impose a fee for probating a Will of a deceased individual. Probating is the process by which a Will is approved by the courts and confirmation of the appointment of executors is made.

Typically, probate fees are determined as a percentage of the value of the assets of the estate of the deceased and can be as high as 1.5% in the province of Ontario.

There are a number of strategies which can be used to reduce the basis upon which probate is determined, the costs and benefits of which need to be considered relative to the cost of probate.