My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, June 27, 2011

Probate Fee Planning- Income Tax, Estate & Legal issues to consider

Planning to reduce or eliminate probate taxes requires one to navigate a minefield of income tax rules, joint tenancy and right of survivorship issues and legal precedents. Questions of legal versus beneficial ownership of property and evidence of intention often come into play. The scary thing is, that this type of planning is often done by the uninformed.

When I started writing this blog months ago, my objective was to provide probate planning techniques. However, as I wrote and researched, I realized the legal concepts were extremely complex and beyond my area of expertise. Consequently, this blog became more conceptual in nature than initially planned. After reading this blog, I hope it becomes clear to you that you need to consult a tax or estate lawyer when undertaking any significant probate planning.

Probate Fees in Ontario

In Ontario, probate fees (technically called the “estate administration tax”) are levied on a deceased taxpayer’s estate at the rate of $250 on the first $50,000 of assets and $15 per $1,000 thereafter. Consequently, if a person were to die with assets of $1,000,000, the estate would have a probate fee liability of $14,500. An estate of $5,000,000 would have a probate fee liability of $74,500. For the other provinces, see this summary.

Two of the more common strategies to minimize probate fees are making gifts and transferring assets to joint tenancy. While these techniques may reduce or eliminate probate fees, they can create significant income tax and estate issues if not done properly.

Gifts to children and your spouse

If cash gifts are made during a person’s lifetime, they will reduce the value of his or her estate for probate purposes. If the gift is made to a child under 18 years of age, the income earned on the gifted property (i.e.: interest and dividends) will be attributed back to the person making the gift for income tax purposes. Where a cash gift is made to a spouse, the income earned on these assets (i.e.: interest and dividends as well as capital gains and losses) is attributed back to the person making the gift for income tax purposes. Cash gifts made to children who have attained the age of 18 do not invoke the income attribution rules in the Income Tax Act. So, you can make a gift to an 18 year old child which will reduce probate fees and not create any income tax problems.

Where non-cash gifts of capital property (such as gold or stocks) are made to a person other than your spouse, the property is deemed to be sold at its fair market value for income tax purposes. Thus, if a mother were to gift 1,000 shares of BCE having a total cost of $10,000 and fair market value of $30,000 to her 20 year old son, she would realize a capital gain for income tax purposes of $20,000, even though the shares were not sold and no money was received.

In an effort to avoid probate fees, some families seek to “add” the names of children to the title of a surviving parent’s home. This is done by transferring the title to the house from the surviving parent (“original owner”) to the children and surviving parent, as joint tenants (the “new owners”). Upon the transfer, the original owner/parent is treated for income tax purposes as having sold a portion of the transferred house based on the number of new owners. For example, if the new owners were parent and two children, each new owner will be treated as owning a one third interest. This means the original owner/parent in this example will be considered to have disposed of a 2/3 interest in the house. The 2/3 sale would be tax-free due to the principal residence exemption. However, 2/3 of any increase in value from the date of the gift until the house is ultimately sold will not be eligible for the principal residence exemption (assuming that the children have their own principal residences). If you are into horror stories, check out Jim Yih's blog for a nightmare of a story of a parent that put a child on title to her principal residence.

Situations such as the above may be avoided in certain circumstances where a lawyer knowledgeable in tax and/or estate law separates legal from beneficial ownership before the transfer. The Canada Revenue Agency (“CRA”) has stated that where there is a change in legal ownership without a corresponding change in the beneficial ownership (the real value is in beneficial ownership), there is not a disposition of the asset for tax purposes. What could be accomplished in the above scenario is a transfer of legal title only, without changing beneficial ownership. This would have no income tax implications but would assist in dealing with probate issues.

A further problem with transfers to joint tenancy (such as the home above) arises because with a joint tenancy, the entire title will pass to the last person alive which often is not the intent of the parent. For example, if a bank account belonging to Mom is transferred into a new account in the names of Mom, Son and Daughter, as joint tenants with right of survivorship, and Mom and Son die together, Daughter would become the “owner” of the entire account. This was not likely the intent of Mom, who likely wanted the split the account between her two children (or her grandchildren if one of her children passed away) – if not for trying to save probate fees, Mom would have never done this.

Joint Tenancy can be problematic-The Pecore Case

If property is held as joint tenants with a right of survivorship, on its face, the property will pass automatically to the surviving joint owner and is therefore not subject to probate fees. I have seen many cases where parents put their adult children’s names on bank accounts and investment portfolio accounts. The parents consider these accounts to now be exempt from probate, yet the parent continues to report the income earned on these investments in their own name for income tax purposes. (As noted above, it is the CRA’s view that if beneficial ownership has not changed there is no disposition for income tax purposes, which is in accordance with the parents plan above, however, at least from the CRA's perspective, they have some issue with whether probate transfer is effective, which is not in accordance with the parents plan above). However, many parents fail to look past the probate issue and their intention in regard to the funds is unclear, i.e., is it the parent’s intention that the funds held jointly with one child belong to that child or do they belong to all their children and there is an understanding that the child on the account will share with their siblings?

This issue was addressed in Pecore v Pecore , a 2007 Supreme Court case where the court addressed these two potentially conflicting intentions. Legally, these two intentions are known as the presumption of a resulting trust and the presumption of advancement. The presumption of resulting trust means that when a parent dies, the transferred assets form part of their estate and will be passed on to the beneficiaries of the will, typically all their children. The presumption of advancement presumes any transfer to a specific child belongs to that child. The potential for conflict is rife where a parent transfers assets into joint tenancy with one child for ease of administration.

In the Pecore decision, the Supreme Court stated that where assets are transferred without consideration (such as to a child to avoid probate) that the presumption of resulting trust will operate in almost all cases save transfers from a parent to a minor child. This means that where a parent transfers assets into a joint account with one child, there must be evidence of the intention to make a gift to that specific child. As I am not a lawyer, I cannot state what counts as irrefutable evidence, but from what I have read, a written document is a minimum requirement.

The best summation of the various legal concepts discussed above that I have found is an article by a lawyer James Baird who attempts to explain these complexities.

If done correctly and carefully, gifting, creating joint tenancy arrangements and separating legal from beneficial ownership can result in the reduction or elimination of probate fees. However, probate planning can lead to unintended income tax and estate implications as discussed above that far outweigh the probate tax savings. It is thus essential that you engage a lawyer who is comfortable in dealing with these issues, most likely a tax or estate lawyer when undertaking any significant probate planning.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.